In the context of Ireland’s banking and fiscal crisis and the impending bailout by the EU and IMF, the finance ministers of Austria and France have suggested that the bailout should be made conditional on Ireland raising its 12.5% corporation tax rate. This would help squeeze Ireland’s budget deficit and resolve what has long been a bone of contention between Ireland and its European partners.
The Irish government has been quick to rule out any such move and most commentators (in Ireland) tend to support this on the basis that such a move would make Ireland “less competitive” and would lead to foreign multinationals leaving the country. Although these comments make a lot of sense, they do miss a more important point – in the short term, raising Ireland’s corporation tax rate is unlikely to have strong positive effect on the corporate tax take from foreign operations.
We must realise that Ireland’s 12.5% corporation tax rate is only one aspect of Ireland’s constellation of incentives to attract foreign direct investments. Other important pillars include, amongst others, recent legislation for holding companies, taxation of patent royalties, double taxation agreements and the (US) legislation for cost sharing arrangements.
All these elements together have made Ireland an attractive location for foreign “headquarters”, notably for “managing” intellectual property (IP). In addition to their traditional involvement in manufacturing and services operations, many multinationals such as Pfizer and Google have established separate headquarter subsidiaries in Ireland for the management of IP and other intra-firm financial services. The US parents have licensed large shares of their IP to holding companies in Ireland. Although, in some cases, the royalty income is again re-allocated to genuine tax havens such as Bermuda, the Irish subsidiaries do pay 12.5% over some of the profits. Because we are talking about billions of royalty income, this is a substantial source of revenue for a small country like Ireland. One example of such carefully designed corporate structures was recently outlined in the context of Google.
It is not difficult to imagine what would happen were Ireland to raise its corporation tax rate to the level of its European counterparts. Because most of the manufacturing, and even services, operations are relatively inert in the short term, the corporation tax take from such operations would rise. However, the situation is different in relation to holding companies involved in IP management and other intra-firm financial services. In reaction to a hike in corporation tax rate, IP can relatively simply be relocated to other jurisdictions using buy-in payments. This would result in a serious loss of corporation tax revenues from foreign companies in the short term. Thus, in the short term, raising Ireland’s corporation tax rate is unlikely to have strong positive effect on the corporate tax take from foreign operations and is unlikely to help squeeze Ireland’s budget deficit. This point has been missed in most of the current commentary on corporation tax. Raising the corporation tax rate would, of course, also affect the indigenous sector. I am in no position to estimate the effect of this on the corporate tax take, but, given the embattled state of this element of the Irish economy and the limited profit margins, I expect that this will not have a strong positive effect on the tax take either, while many indigenous companies will simply call it a day – a double whammy.
So, this does not appear the right moment to raise the corporation tax rate. This is not to say that Ireland should not raise its corporation tax rate at some stage – quite the contrary, in fact. The low level of corporation tax rate has done wonders for Ireland’s economic development. But we had reached a threshold level that would have allowed us to divert to a more sustainable economic development trajectory, both from an economic and social point of view. If we want to develop a sustainable economy we will need to adopt a strategy that will eventually involve a proper level of taxation. Very few equitable societies are built on a low taxation model. In the short term, it would clearly be counter productive to touch the corporation tax rate. But I don’t buy this idea that, even in the long term, Ireland can only be competitive on the basis of a low level of corporation tax, or other taxes for that matter. What is so special about Ireland?
Chris van Egeraat