The Age of Empires

Oct 14, 2019

Sunday Business Post, 13 October 2019

The ink had hardly dried on Paschal Donohoe’s Budget papers warning about the sustainability of Irish corporation tax when the OECD launched its latest plan to change the way multinationals organise their tax affairs.

Donohoe's concerns are real and not just because of Ireland's unusually high reliance on corporation tax receipts. 

The contribution of the Irish corporate sector to the Irish economy is more than just corporation tax.  It is also jobs.  The Social Insurance Fund is bolstered by the PRSI paid by employers, levied next year at a rate of 11.05% on most private sector wages.  An international consensus that would squeeze the Irish corporation tax regime too hard could prompt companies to hesitate on expansion plans, or worse, relocate altogether.  This is the last thing we need given the pending disruption to our trading relationship with the UK post Brexit.

No matter, the truth is that the international corporation tax regime has to change, and indeed has been changing over the last decade or so.  Companies are still taxed largely on rules which were first devised in the age of empires.  These rules conspired to ensure that profits from the colonies were taxed first and foremost where the companies were headquartered, rather than where they operated. 

In an increasingly digital world, where neither offices nor staff on the ground are required to sell or indeed deliver product, such arrangements are unsatisfactory.  The OECD’s new notion, published on Wednesday last to remedy this is simple.  Allow those countries where goods are sold a share of profits to tax, irrespective of whether or not the multinational has a physical presence in the territory. 

It's a simple concept which is proving difficult to deliver.  This week’s announcement is the OECD's third bite (at least) of this particular cherry.  Initial attempts towards taxing the digital economy in the OECD’s first Base Erosion and Profit Shifting project (BEPS) some five years ago were inconclusive.  A second attempt earlier this year also didn't land particularly well, so what are the prospects for this third set of proposals?

The OECD isn't the only show in town for tax policy, but it is the main one.  Attempts by the EU to introduce a digital levy have already been parked in anticipation of the OECD sorting out the problem.  Unilateral attempts by countries like France and UK have been half-hearted, or have met with considerable political reluctance.  This political reluctance is particularly acute in countries like Ireland which have a large corporate sector, but a relatively small domestic market.  If in the future companies are to be taxed everywhere they sell, rather than where they make, do or physically locate, that will inevitably drill a hole in Irish Exchequer receipts.

There is, however, some encouragement for Ireland in the proposals which emerged this week.  First of all, they acknowledge that some kind of protection is required for countries who might lose out because of relatively small domestic markets.  Secondly, the focus of the new OECD proposals seems to be on the very largest multinational entities which primarily supply services to consumers.  A third aspect of the plan offers reassurance in that it recognises that much of the value of a digitalised product lies in the research, know-how and other forms of intellectual property which underpin it. 

It’s too early to predict how much corporation tax Ireland might lose as a consequence of the proposals this week.  What is clear is that this set of proposals seems more benign than previous OECD approaches.  In the past, international cooperation on the corporation tax system has worked in Ireland's favour.  As international consensus grows, uncertainty over the future of the corporation tax regime diminishes.  A genuinely low 12.5% rate when applied in the context of a widely agreed approach over where and how much of a multinational’s profit should be taxed becomes even more useful. 

The Department of Finance line is that some form of international consensus is indeed achievable on the taxation of multinational profits, where countries have had no previous entitlement to levy tax on profits earned from sales made in their jurisdictions.  The proposals are still at consultation stage.  That’s critical because a second OECD consultation on corporation tax is due in a few weeks time.  It is understood it could posit the introduction of minimum effective rates of corporation tax , irrespective of the domestic headline rates of the territories where multinationals operate.

That kind of notion could be far more damaging to Ireland's corporation tax base, but it is not a foregone conclusion.  I gather that there are concerns within the OECD itself that the minimum tax idea goes further than current political thinking might allow.  Politics will always defeat policy, no matter how good the policy might be.   While politicians understand the political pressure to do something to tax multinational corporate empires, they will not want to surrender tax revenues to other countries when doing so.

Nevertheless, we can expect some sundering of the old system to allow a limited redistribution of taxing rights across the world.  The system that worked for the old empires of dominant nations will be changed to tackle the new empires of dominant high-tech multinationals.

Dr Brian Keegan is Director of Public Policy at Chartered Accountants Ireland