More Protectionism

Feb 25, 2019

When the history of the early 21st century is being written, I wonder if commentators will identify the rise of protectionism as a phenomenon.  We have seen a dwindling of confidence in liberal trade values in the last decade. 

This has made it difficult to get the likes of TTIP, the proposed new US/EU trade agreement across the line.  CETA, the trade deal between the EU and Canada, almost fell at the final hurdle when it came to be ratified.  By contrast in the preceding decades, liberal trade values resulted in international conventions and trade deals being drawn up which facilitated rather than restricted cross-border trade, both in goods and services.  The financial crash in 2008 undermined confidence, not just in the financial sector but also in the global industrial model.  There is no longer a general acceptance that industry will give the right results for most people, most of the time. 

The growing dominance of protectionism as a form of control over the business sector is manifest in new employment law, data security law and privacy rules.  None of these developments are necessarily wrong in themselves, but everything from Brexit to the threatened and actual US trade sanctions, to the General Data Protection Regulations are all the facets of the same intent to keep the corporate sector properly in its place.  However, protectionism has been built into tax systems from the start.  There are the obvious examples like customs and excise, but national interests are also built into mainstream business taxes.

One of the longer standing controls over multinational business is now up again for review.  This week the Department of Finance announced a public consultation on the anti-transfer pricing tax rules.

Anti-transfer pricing rules are designed to ensure that multinational groups of companies producing and selling in multiple territories cannot tweak their own profit margins, thereby ensuring that their overall group profits accrue mainly in countries with a low tax rate.  It makes commercial sense to have the bulk of profits in a group accruing in a territory where they will be taxed more lightly.

Transfer pricing is not a new phenomenon.  Rules to tackle it have been in existence for a century.  Here in Ireland, we didn't introduce anti-transfer pricing legislation until about a decade ago.  There was a simple reason for this.  Countries with low corporation tax rates tend not to need anti-transfer pricing legislation, as profits are rarely shifted out of low tax-rate jurisdictions so that they can be taxed in high tax-rate jurisdictions.  Nevertheless, partly to ensure a level playing field, anti-transfer pricing rules have been in effect here since 2011.  In common with most cross-border tax rules in recent times, they have been subject to scrutiny from the OECD and the EU, and changes have been proposed to ensure they remain fit for purpose.

At first glance, this shouldn't present a particular problem for Ireland.  But even though our 2011 rules were introduced in accordance with international standards, and indeed linked directly into those international standards, standards and thinking have changed.  Some of the changes now proposed came from the Coffey review of Corporation Tax conducted some years ago.

Going through the consultation document, I think that there are two main issues where Irish business should have concerns.  First of all, anti-transfer pricing has typically been regarded as a cross-border problem, where groups of companies operate in countries with varying tax rates.  Now on the agenda is what should happen if a country charges one rate of tax on one particular type of activity, and a different rate of tax on another.  That's the case in Ireland, because so called “passive” corporate income (investments, interest, rents and the like) is taxed at 25% whereas trading and manufacturing income is taxed at 12.5%.  Moneys paid between Irish group companies taxed at these different rates could now come under scrutiny, without there being any cross-border element to them.

The second issue is scale.  Generally speaking, anti-transfer pricing rules don’t apply to small and medium sized enterprises.  Those are companies with less than 250 employees and with relatively small turnover and balance sheets.  There is a proposal that this de minimis threshold is now to be removed.  That would be a significant new compliance burden which would be costly on smaller entities.

The timing of this particular consultation is not ideal.  Irish businesses have much more to contend with in the face of a potential no-deal Brexit than having to wonder about whether they might be caught under new anti-profit shifting rules.  Ironically the thinking that underpins anti-transfer pricing legislation is precisely the same kind of thinking that underpins some UK government statements this week, threatening tariff barriers on agricultural imports post Brexit to protect its own agriculture sector.  In the same way, anti-transfer pricing is all about keeping commercial activity and the tax that accrues on it within national borders. 

The transfer pricing issue arises most of all where there is free cross border trade.  Anti-transfer pricing law is an expression of protectionism.  Transfer pricing is one of the very few tax problems which protectionism actually helps solve.

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