Acid by Design

Sep 24, 2018

Sunday Business Post, 23 September 2018
“It's not Ireland's fault that US tax law looks like it was written by somebody on acid.”  This remark, by Kevin Hassett, chairman of the White House council of economic advisers drew laughter from the crowd attending the US Embassy’s “Racing towards a Trillion” conference in the Phoenix Park last week.  It was a disarming way to signal to the crowd that the times are indeed changing, but I suspect Dr Hassett doesn't really believe the truth of his “acid” analogy.   

The 2017 US Tax Cuts and Jobs Act kills off the idea that US corporations could cheerfully make money offshore to their hearts content without paying US taxes as long the cash wasn’t brought back to the States.  That was a notion which dates from the Kennedy era.  It was an expansionist policy designed to encourage US companies to grow abroad, with the added prospect of Uncle Sam ultimately reaping 35% from the foreign rewards of his corporate offspring.  But it was an idea of its time, and the times have changed.

All this is relevant to Ireland, and not just because of the very high levels of US investment in this country.  The new US tax regime has a far greater significance than our domestic concerns because it hammers another (very large) nail into the coffin of the international consensus as to how cross-border businesses should be taxed. 

Up until relatively recently, almost all countries levied taxes on foreigners by reference to a network of internationally agreed tax treaties.  By and large these required a business to have a significant physical and management presence in a particular territory before any taxes could be applied on their activities.  This concept was further supported by a complicated set of rules to ensure that companies couldn't arrange for their cross border profits only to arise in countries with low tax rates.  Now there is a perceived problem that the old tax rules disregard cross-border trade flows.  Their effect is to leave countries with very large markets at a disadvantage, because if management and value creation isn't located in those countries, they can’t tax the corporate profits driven by substantial sales within their territories.

Signs of this crumbling consensus can be found in the UK and Australian attempts in the last five years to tax what they call diverted profits - money which is generated offshore by virtue of sales in their countries.  The EU itself has had a go at breaking the cross border tax consensus with its Common Consolidated Corporate Tax Base project.  This would artificially reallocate profits to different countries by reference to sales, as well as employment and capital investment levels.  The current debate on digital taxation erodes the consensus even more.  The suggestion is that value is in some way created (and therefore should be taxed) in the territory of the consumer when the consumption takes place via a website.

Against such a backdrop, the US Tax Cuts and Jobs Act looks almost reassuringly protectionist.  While the headline has always been about the US corporation tax rate reduction from 35% to 21%, the real mischief lies in its policing provisions.  The returns on US corporate know-how abroad are guaranteed to be taxed, under a regime known as GILTI.  But exploit that knowledge Stateside, and companies will do better under a regime known as FDII.  Prozac has replaced acid in US tax system design.

This new vision of the US Internal Revenue Service dancing at the crossroads of international trade is not without its opponents,  not least because it seems to throw some elements of the old rulebook (like anti-transfer pricing rules) out the window.  Even the World Trade Organisation has rowed in with a challenge to the FDII regime, on the grounds that it creates an unfair trade subsidy.

A dilemma for businesses with US interests is that the US Tax Cuts and Jobs Act is not yet a fully formed creature.  The 2017 act provides a framework for the new tax regime, but the details of how the framework will apply are governed by regulations.  A substantial part of these have yet to emerge.  For instance, while the new rules allow the US to police and charge tax on the returns on foreign intellectual property, there are still no regulations governing how credit might be given for foreign taxes already paid on such returns, if at all. 

That puts companies in a bit of a bind when it comes to future investment decisions.  Adding to the confusion is that quite a few of the US provisions are time limited, with 2025 being a critical date at which some of the tax relief provisions will become less generous, and when some of the anti-avoidance provisions will bite harder.

Nevertheless the international debate is now less about how much multinational corporations should be charged as about where those tax charges should be paid.  That’s a big factor in attracting foreign investment and the jobs it brings.  The US Tax Cuts and Jobs Act clearly says any company with a footprint in the US should be paying its taxes in the States and is indifferent to more modern arguments about market sizes or the location of value creation.

The small size of the Irish economy in an international tax debate could be our greatest weakness, but it could also transpire that it is our greatest advantage.  Will the great nations on either side of the Atlantic condone an international tax system where the profits of their companies are ultimately taxed in the BRIC bloc of nations (Brazil, Russia, India and China) by reason of those huge markets?  It certainly looks like the US won’t ever condone that.  With a corporation tax yield in the single billions, Ireland may end up being too small to worry about in a battle between economic giants. 

Brian Keegan is Director of Public Policy and Tax at Chartered Accountants Ireland