Tuesday, August 30, 2016

Some take outs from the Apple ruling

Lots to muse over in the €13 billion tax ruling from the European Commission in the Apple case today.  And that’s just the tax.  Add the Revenue Commissioner’s 8 per cent per annum simple interest bill on top of that you’re probably looking at something north of €18 billion.  I didn’t think they’d do it but they have. 

Here are some extracts from the Commission Press Release in the order they appeared:

These profits allocated to the "head offices" were not subject to tax in any country under specific provisions of the Irish tax law, which are no longer in force.

This seems to be a bit of a contradiction to what follows later and also a bit of a stretch of what Irish tax law can achieve.  I doubt Irish tax law can be used to argue that profits in other countries are not subject to tax there.  And if these specific provisions of Irish tax law deemed that the profits of the head offices were not subject to tax in Ireland how is that state aid?

This selective tax treatment of Apple in Ireland is illegal under EU state aid rules, because it gives Apple a significant advantage over other businesses that are subject to the same national taxation rules.

Not sure I get this.  If what Apple did was under “specific provisions of the Irish tax law” why couldn’t other companies do it.  I guess some probably did!

This tax ruling was terminated when Apple Sales International and Apple Operations Europe changed their structures in 2015.

Well I guess that confirms where the 26% GDP growth rate in 2015 came from!

Apple set up their sales operations in Europe in such a way that customers were contractually buying products from Apple Sales International in Ireland rather than from the shops that physically sold the products to customers. In this way Apple recorded all sales, and the profits stemming from these sales, directly in Ireland.

Hmmm. I’m not sure that’s true.  Some customers, such as online customers, may have bought from ASI but anyone going to a shop bought the product from that shop – especially when they bought from non-Apple stores such as Currys, Carphone Warehouse, Dixons etc.  These retailers may have bought from ASI but that’s a bit different to saying the customers did.

And even for Apple stores it’s not clear that the customers were buying from ASI.  Apple Retail UK Ltd which runs Apple stores in the UK had £900 million of sales in 2014 (accounts here).  The shops might have bought the devices from ASI but the customers bought them from Apple Retail UK Ltd.

Only the Irish branch of Apple Sales International had the capacity to generate any income from trading, i.e. from the distribution of Apple products. Therefore, the sales profits of Apple Sales International should have been recorded with the Irish branch and taxed there.

And this is the contradiction.  We have “specific provisions in the Irish tax law” in the first extract saying the profits are not subject to Irish tax and the factual position set out by the Commission that only the Irish branch has substance.  The Commission are going for substance over law.

The "head office" did not have any employees or own premises. The only activities that can be associated with the "head offices" are limited decisions taken by its directors (many of which were at the same time working full-time as executives for Apple Inc.) on the distribution of dividends, administrative arrangements and cash management.

I’m not sure “limited decisions” is how best to describe the activities of the board of directors.  They signed the cost-sharing agreement with Apple Inc. which the Commission highlight as being key to the profit earned by ASI.  They negotiated and signed the contract manufacturing agreements with the manufacturers in China.  And they set the price at which ASI could sell the products.  All the key elements of ASI’s costs and revenues were controlled by the board of directors and not the responsibility of the Irish branch.

These activities generated profits in terms of interest that, based on the Commission's assessment, are the only profits which can be attributed to the "head offices".

So the EC are attributing 60 per cent of Apple’s global profits to what goes on in Hollyhill in Cork because the “limited decisions” of the board of ASI only generate interest income.  Everything else is down to the staff in Cork. That’s serious productivity!

This is only a first run through the ruling and this is only from the press release.  In a couple of months we’ll get the full 130-page decision (minus some redactions) so we’ll see then if the Commission have their ducks in a row. 

And if you want to look through the finer details of Apple Sales International they are in this previous post which showed that the approach proposed by the Commission gives a tax bill of $14 billion for 2004 to 2013.  Add 2014 and you get to in and around the €13 billion figure the Commission have come out with.  And the interest probably comes to another €5 billion or so (if we apply the Revenue Commissioner’s 8 per cent simple interest rate).  €18 billion. Who’d have thunk? Not me!

Tuesday, August 16, 2016

The latest Corporation Tax pot of gold

Ireland’s Corporation Tax generates a huge amount of domestic debate.  There are a couple of common themes that run through it.  One of them is that “we would collect X billion in extra tax if only we did Y.”  The latest of these relates to companies who have no liability for Corporation Tax under the headline “68% of companies paid no Corporation Tax in 2014”.

There is, of course, a pretty simple reason why most companies don’t pay Corporation Tax: they don’t make a profit.  This is because they have never started trading, stopped trading or are trading but didn’t generate a taxable profit.  There a several reasons why companies are established with trading for profits being only one of them.

However, the story doesn’t end there and goes on to say that companies with no Corporation Tax liability actually had earnings of €17 billion in the period from 2009 to 2014.

The Irish Corporation Tax regime is actually relatively straightforward.  Once a company’s taxable income is determined it is multiplied by 0.125 (or 0.25 in some cases) to get the gross tax due.  There are then a limited number of credits and reliefs available which give the ultimate calculation of tax payable.  Here is an aggregate calculation using 2011 data.

So if there are €17 billion of earnings out there that results in a tax payable of zero it shouldn’t be too difficult to work out what is going on.  And it isn’t.  First here are the annual figures:

Companies wth no CT liability

The average amount of net taxable income per company with no Corporation Tax liability is just under €32,000.  But the distribution is probably highly skewed because it requires the use of the limited credits and reliefs we have to get the gross tax due from the €16.8 billion of net taxable income to a tax payable of zero.  And indeed those making the queries were told as much:

The Department of Finance says there is a range of tax reliefs available to companies which explains much of this, such as double taxation relief, which prevents companies being taxed on profits they have already paid tax on elsewhere or tax reliefs that apply to research and investment.

But that didn’t stop some heroic conclusion jumping been made:

Sinn Féin says vital public services have suffered as a result. Employers, however, say Irish businesses already face high taxation.

TD Louise O’Reilly said: “Our estimation is that from 2009 there could potentially be 2.1 billion euro in tax revenue that has been forgone by the State through whatever means. I think when you’re looking at figures that size though, you’re not talking about simple loopholes. You’re talking about government policy.”

Yes, €16.8 billion multiplied by 0.125 is €2.1 billion but wouldn’t it be helpful to actually understand why the tax payable on this net taxable income is zero and propose to remove the provision that results in it rather than just shooting off blindly.

Here are the reliefs and credits used by the companies with nil or negative Corporation Tax liabilities over the six years in question.

Companies wth no CT liability reliefs and credits

And there is the €2.1 billion reduction of the €2.1 billion gross tax due to give tax payable of zero.  Almost 95 per cent refers to Double Taxation Relief.

Ireland operates a worldwide Corporation Tax system whereby Irish-resident companies owe Irish Corporation Tax on their earnings no matter where earned and can owe Irish Corporation Tax on dividends from subsidiaries and other passive income receipts.

However, if an Irish-resident company earns profits through a branch or subsidiary in another jurisdiction it will pay corporate income tax on those profits in that jurisdiction.  In Ireland these profits will be included in the company’s taxable income and the gross tax due will be calculated including foreign profits.  To avoid double taxation the company can apply for relief of the gross tax due in Ireland based on the corporate income tax paid in the foreign jurisdiction. 

It is fairly obvious that in this instance we are dealing with a small set of companies who have no domestic profits (which would trigger a tax liability excluding them from the above table) and have foreign earnings where the foreign tax paid exceeds the amount of gross tax due at Ireland’s Corporation Tax rates thereby giving a tax payable figure of zero.  These companies are not avoiding tax; they have already paid it.  If the amount of eligible foreign tax paid was less than the amount of Irish tax the company would have to pay the balance to make up in the difference.

So, in theory, we could have collected €2 billion of extra Corporation Tax over the last six years if we had abolished Double Taxation Relief from 2009.  And the figure would be even higher as this €2 billion only includes companies who have nil or negative Corporation Tax liabilities.  Over the past six years the total amount of Double Taxation Relief granted to all companies has been almost €4 billion (and was almost €1 billion in 2014 alone).

But getting at this latest pot of gold depends on these companies with foreign profits continuing to be Irish resident which would subject them to an additional 12.5 per cent (or 25 per cent) tax on top of the corporate income tax paid where they earned their profits.  Would companies stick around for such double taxation? And if Irish-resident shareholders move away with them we would lose the income tax collected from distributed dividends.

Double taxation relief is not just “government policy” it is international best practice in taxation around the world.  And it is probably going to get more attention in Ireland as inversions and re-domiciled PLCs increase the number (and size) of companies who are eligible for it.

Monday, August 15, 2016

A Processor Surge

Here’s yet another unusual chart extracted from Ireland’s External Trade data.


The chart gives monthly exports for category 77 in the Standard Industry Trade Classification: Electrical machinery, apparatus and appliances not elsewhere specified and parts.  In the first half of 2015 exports in this category were €1.4 billion; for the first six months of 2016 exports have surged to €3.2 billion.  The dramatic nature of the increase at the start of 2016 is apparent from the chart.

So what are we exporting over a billion and a half’s worth more of in this category.  We can get added insight from the CSO’s Trade Statistics publication (though the most recent release only gives data to the end of May).  Anyway within that our attention is drawn to subcategory 776.42: Processors and controllers.  Here is the relevant extract from the May 2016 release.

SITC 776_42

Exports in this sub-category were €421 million in the first five months of 2015 but have reached €1,958 million in the first five months of this year.  Thus processors account for the surge shown in the first chart above.  Over the full year we could be looking at an increase of around €3 billion in this category.  That the primary destinations of these exports are  Israel and the United States should not come as a surprise. 

What may be a little surprising though are the volume changes.  The Trade Statistics also give data on quantities which in the case of many commodities are measured in tonnes – signified by (t).

The quantity given for 2015 is 62 tonnes while that for this year is 52 tonnes.  The notional price of processors given by this data has gone from €7 million a tonne in 2015 to nearly €38 million a tonne this year.  Processors are obviously not a product sold by weight but this change is indicative of something going on. But what?

Monday, July 25, 2016

The size of the provision for depreciation

The key reason for the 26 per cent rise in Irish GDP was the large increase in the productive capacity of the economy as represented by the €300 billion increase in the gross capital stock.  The addition of these assets to Ireland’s capital stock hugely increased the amount of value added that the economy could produce.

We know that most of the changes are due to the actions of MNCs so most of the increase in GVA accrued to them.  Infact 80 per cent of the increased GVA came from firms in the “Industry” sector (as shown here).

If GVA formed the tax base then the provision for depreciation wouldn’t really be an issue but firms can avail of “capital allowances” for the acquisition of certain assets, i.e. they can offset (part of) the cost of the asset against their taxable income for a given period (generally eight years).  This is somewhat similar to the “consumption of fixed capital” concept in national accounts where the value of capital assets is reduced as they are used and become obselete. 

Both are generally described as “depreciation” but there are important differences between them.  We only have the 2015 consumption of fixed capital figure from the national accounts for now but there is no reason to believe that capital allowances in 2015 will not have followed a similar pattern, i.e. a massive jump up.

So although there may have been a large increase in gross value added this may not correspond into an equally large increase in the tax base if capital allowances impact on the calculation of taxable income.  It is a pretty safe assumption that the capital allowances used by companies increased broadly in line with the consumption of fixed capital shown in the national accounts.

So is this an issue?  Possible.  GDP is commonly used for international comparisons.  If the amount of depreciation is the same across countries then it gives ratios that have a value in making comparisons.  Here is depreciation as a per cent of GDP for the countries of the EU (excluding Luxembourg for which data does not seem to be available).

Depreciation to GDP

The 2015 figure is for Ireland and this puts Ireland at top of the pile and the 2014 figure shows the huge impact the 2015 figures had on our position.  In relative terms Ireland now has the largest provision for depreciation though the gap to the next country, Latvia, is relatively small.  As depreciation is removed from the corporate tax base through capital allowances this means GDP may overstate Ireland’s tax base relative to other EU countries.

We already knew that GDP overstated the Irish tax base as it includes the profits of MNCs based here.  We can have great fun with hybrids etc. but lets just put the provision for depreciation in terms of Gross National Income (seeing as this aggregate is used in the  calculation of a country’s contribution to the EU).

Depreciation to GNI

And here we can see the outlier that Ireland i2 for 2015 compared to the mid-table ranking for 2014. Within Ireland’s GNI there now is a disproportionate provision for depreciation.  And as this is value added which is not included in Ireland’s tax base we get close to little of benefit from it.

We now have a situation where using GNP or GNI as a denominator excludes the profits of MNCs that we can get a 12.5 per cent chunk out of before they leave but includes a massive provision for depreciation for these companies that we get nothing from.  If these effects offset each other then maybe GNI is a useful denominator for EU contributions and the like but with the headline data we have at the moment it is impossible to tell.

How did the capital stock increase by €300 billion when investment was just over €50 billion?

There are many mysteries in the 2015 National Income and Expenditure Accounts published by the CSO two weeks ago.  The change that had the biggest impact on the accounts and was the source of the 26 per cent GDP growth was the €300 billion rise in the gross capital stock.  The bizarre nature of this is shown in this chart from a recent NTMA investor presentation.

NTMA Capital Stock

We know very little about this €300 billion increase.   The CSO will be publishing final figures for the capital stock later in the year but it is not clear that the sectoral and type figures usually provided will be made available for 2015.

Most commentary has linked the increase to inversions by US MNCs and redomiciling by PLCs from other countries.  It is not clear that this is the cause of the increase.  A company moving its headquarters does not automatically mean that it’s stock of fixed assets are included in Ireland’s capital stock. 

If a US pharmaceutical company does an inversion with an Irish company the manufacturing plants the company has in the US and other countries will remain part of the capital stocks of those countries.  The company may move intangible assets to Ireland but that would be a move separate to the inversion.  Also the only inversion in 2015 was the Medtronic-Covidien match-up which comes no where near the scale shown above.

A key problem is that we don’t know the type of assets that made up the €300 billion increase in the capital stock.  We can take it that much of it is intangible assets (leased aircraft are also said to have played a role but that may have been overstated).  The reason for this uncertainty is that gross fixed capital formation was just over €50 billion.

So how do we get a €300 billion increase in the gross capital stock with a little more than €50 billion of investment?  This seems hard to explain.  With the scrapping and obsolescence of some existing capital we should expect the increase in the gross capital stock to be less than the level of gross investment.  And, in theory, the movement of assets between countries should be de-investment in one country and investment in another country.  The ‘G’ in GFCF refers to depreciation.  Capital formation itself is made up of the net of acquisitions and disposals of fixed assets.

So why was the increase in the capital stock nearly six times greater than the level of investment?

One reason could be that different assets are included in each but that seems unlikely as they are supposed to be related measures.  It could be that US MNCs have transferred the economic rights to exploit their intellectual property to Irish-resident entities and that these economic rights are counted in Ireland’s capital stock but as the patent is retained by the US parent there is no investment expenditure in Ireland.  Not sure.

Another possibility are valuation differences between how the assets are counted for investment and for the capital stock.  It could be that these assets are counted in the investment data on some sort of “cost-plus” basis, i.e. the amount of R&D expenditure it took to actually produce them.  While in the capital stock the assets are counted on the basis of how much they are worth.

There was a large increase in R&D expenditure in 2015 in the €54 billion GFCF total and it went from €9.6 billion in 2014 to €21.3 billion in 2015.  But is €12 billion of additional R&D expenditure enough to explain an increase of a few hundred billion in Ireland’s capital stock.  I suppose it depends on what intellectual property rights were moved to Ireland the value of which does not necessarily depend on the R&D expenditure that went to generating them.

Whatever the reason it seems we need a more nuanced story than linking the increase in the capital stock to inversions and redomicilied PLCs.  In fact, given the massive increase in external debt linked to direct investment shown in previous posts such corporate restructurings don’t seem like a useful explanation at all.