After Ireland closed its notorious corporate-tax loophole, it might have been thought tax avoidance would have gone with it. Not so.
To find out what large scale corporate-tax avoidance looks like when it flows through a macroeconomic statistical system, Ireland is an excellent reference point. The closing of the ‘double Irish’ avoidance scheme has led foreign-controlled multinational corporations (MNCs) to enumerate more of their business and profit-shifting activities in the Irish national system of accounts.
In particular, in the aftermath of the ‘double Irish’, intellectual property (IP) appears to be of paramount importance to MNCs in sustaining their Irish-based profit-shifting activities. Ireland has significant tax incentives for foreign-controlled MNCs—with requisite proficiency in financial engineering—carrying on Irish trading activity in the development and exploitation of IP.
The ‘double Irish’ was a corporate-tax tool for base erosion and profit shifting (BEPS) deployed by foreign-controlled MNCs. It exploited the difference between tax regimes in Ireland and the United States: in the former liability depends on control, in the latter on residence of incorporation. Companies could therefore register an offshoot located in Ireland but with control lodged in a tax haven, such as Bermuda. If profits were attributed to the Irish corporation, they could remain off-balance sheet and taxed by neither state.
When the ‘double Irish’ was in full force, large swaths of business rents remained outside the Irish economic accounts. The scheme finally closed in 2020. An interesting winding-down feature was that foreign-controlled MNCs declared increasing business activity within the Irish system of national accounts—much having been previously ‘stateless’ and not reported. This did not however mean corporate-tax avoidance had come to an end.
Wide-ranging interest in the 2015 Irish national accounts—labelled ‘leprechaun economics’ by the Nobel laureate Paul Krugman—followed the publication of balance-of-payments data in July 2016 by the Irish Central Statistics Office (CSO). These depicted a phenomenal growth in real gross domestic product (GDP) in 2015—the year the ‘double Irish’ loophole began to close—of over 25 per cent. The former Central Bank of Ireland governor Patrick Honohan said the impact on the national accounts of MNCs in Ireland made ‘a mockery’ of conventional uses of GDP.
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‘Leprechaun economics’ straddles both income and expenditure line items in the national accounts. As the loophole closed, reported MNC income in Ireland increased dramatically—but so too did expenditures deemed tax-deductible, enabled through enormously facilitative IP tax laws. This kept corporate profits in check, though incomes were soaring. In 2013-19 Ireland’s 361 per cent rise in foreign-owned MNC ‘value added’ was offset by a 507 per cent increase in IP services costs and a 975 per cent hike in IP depreciation.
The Irish legislature, under the auspices of the Office of the Parliamentary Counsel, had fashioned a series of laws accommodating foreign-controlled MNCs in increasing their IP cost base in Ireland, driving the outsized flows in Ireland’s phantom IP trade. Two specific parts of Ireland’s tax regime were instrumental.
From an IP perspective, there are two ways to generate cost and so reduce corporate taxation. A company may import IP services or buy IP assets from sister organisations in no-tax jurisdictions. MNCs in Ireland do both. Imports of IP services and depreciation of IP assets increase costs and reduce profits in the host jurisdiction, thereby maximising corporate profits elsewhere.
Irish tax legislation affords very generous treatment in both cases. With services, withholding taxes on patent royalties are a crucial point. Ireland historically levied withholding taxes on royalty payments to offshore financial centres. The 2010 Irish Finance Act abolished this constraint.
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The precipitous increase in IP costs after the ‘double Irish’ is fully borne out in the Irish national economic accounts. In 2013, CSO data reveal imports of royalties and other business services from offshore financial centres of €5.5 billion. By 2019, IP service imports from offshore financial centres skyrocketed, to a staggering €110 billion.
The second facilitative Irish tax component relates to a tax deduction for the relocation of IP rights to Ireland. These IP rights, which include patents, copyrights, trademarks, licences, copyrights, computer software, brands, know-how and goodwill, are termed specified intangible assets under the Irish tax code. They are treated similarly to plant and machinery, allowing corporate profits to be reduced.
CSO figures reveal IP depreciation multiplied from €5 billion in 2013 to €47 billion in 2019. The sharp rise in foreign-owned Irish intangible stock, due to the relocation of IP phantom capital, affords large depreciation privileges to foreign-owned MNCs.
Ireland’s trade in IP is grossly incommensurate with the size of its economy. The rapid rise of IP imports, IP assets and depreciation between 2013 and 2019 does not align economic substance with legal profit formation.
After the ‘double Irish’, IP trade appears to have become the new modus operandi for foreign-controlled MNCs to excavate the Irish corporate-tax base. Profit shifting is facilitated through specific provisions in Irish law relating to withholding taxes and capital allowances.
In this new era, while the loophole is closed, IP transactions are emerging as the new corporate tool in the tax-avoidance toolbox. Weaknesses in Ireland’s century-old tax design expose a globalised corporate world lacking sufficient regulatory constraint.
International tax architecture needs urgent reform. The imposition of withholding taxes on unsavoury IP structures should be front and centre in this debate.