Wednesday, May 29, 2013

Apple's iTax

The US Senate hearings on the tax avoidance activities of Apple last week places uncomfortable attention on Ireland’s relationship with this key multinational company.

This followed a Public Accounts Committee into the affairs of Google who again are effectively using Ireland as a means of legally paying virtually no tax in the UK.

And they are by means alone in this regard. For example an article in the Wall Street Journal back in 2005, highlighted the manner in which Microsoft used two subsidiary companies operating within a law firm in Dublin to again substantially reduce their overall tax liability.

Then when questioning the extremely high cost of prescribed drugs In Ireland, one can also point to a growing concentration of the pharmaceutical sector. 9 of the top 10 multinationals are now in operation here with - I strongly suspect - tax avoidance on their global operations a major consideration.

One of the key consequences of all of that due to a growing unhealthy level of dependence on foreign direct investment (mainly of US origin) that it has now become the elephant in the room that is stifling honest economic debate on many important economic issues here in Ireland.

For due to the  exorbitant price of drugs under our national health schemes (with so satisfactory official explanation) I reached my own conclusions i.e. that this in fact represents a hidden subsidy with the Government fearful of the short term employment consequences in the sector if it were to adopt a tougher bargaining position.

Ireland is now one of the most open - if not the most open - economy in the world.
Some of the statistics are truly extraordinary (though rarely the focus of economic debate). 
At present the total value of stated exports (goods and services) is now over 100% of recorded GDP (with up to 90% accounted for by multinational companies).

Thus the wealth in the economy is largely generated by overseas companies (principally of US origin). However they account directly for a relatively small amount of overall employment.

So the vast majority of jobs in our economy relate to the trade of low value services which we buy and sell to each other at very high prices.

One of the fallacies surrounding the EU internal market (trading without restrictions) is that it would thereby ensure the benefits of competition in all sectors.

However this clearly does not apply to many services. If I need to buy groceries, get a car repaired, visit a dentist or a solicitor, use the health service etc., the prices will be largely governed by purely local circumstances that are largely immune from outside competition.

During the earlier part of the Celtic tiger (1994 – 2000), Ireland - in comparison to its EU neighbours - was a competitive economy . However the wealth created by growing multinational activity considerably fuelled demand for local goods and services.

It particular this led to a highly artificial form of domestic wealth creation through an unprecedented boom with respect to both commercial and residential property. This then in turn created a growing demand for domestic services that were largely protected (geographically and otherwise) from overseas competition.

So when the financial crash came in 2008, ending the property bubble, prices in Ireland had now risen well above the EU norm for most goods and services.

With debt levels rising and demand plummeting, this led to a significant loss of employment in these sectors.
This in turn has created an even greater level of dependence in recent years on ever more investment being attracted to our shores in the hope of counteracting adverse domestic trends.

So we now effectively have a two-tier economic system in Ireland.

On the one hand multinational activity in Ireland is booming (helped recently the location of leading financial service companies such as City Bank and Merrill Lynch and Internet giants such as Google and Facebook).

However the domestic economy is largely on its knees with many smaller firms on the verge of extinction.

Though this has led to a series of distortions with potentially enormous consequences, the official unspoken consensus is that no negative questions should be raised regarding the role of multinational investment in Ireland.

Not surprisingly therefore the official reaction to the hearings in the UK and the US last week have been highly defensive with continual protestations that Ireland meets none of the criteria for a tax haven, that no special deal ever applied to any investor here and that we are totally transparent in all our tax arrangements. The same sentiment has then been largely shared by the media and tax commentators.

Unfortunately this response is most unconvincing. The same kind of official propaganda was used during the latter years of the Celtic tiger to quell to criticism of anyone who dared question the enormous excesses of the property boom.

The official mantra then was that the fundamentals in the economy were all sound and that growth in Ireland was the envy of our European neighbours. Then when the credit policies of the banks were questioned we were continually assured that they were stress tested with capital reserves greater than required so that no problem could emerge.

Then when it was no longer possible to ignore the possibility of a property crash the new official position was now that Ireland would have a “soft landing”  and that after a short period of adjustment would quickly return to a sustainable growth rate (in excess of 4% pa).

The main research Institute the ESRI - despite its fears and misgivings - in effect largely shared this cosy official consensus as did the media and the main political parties.

In the 2007 elections the programmes of both Fianna Fail and Fine Gael were predicated on maintaining growth rates in excess of 4%.
(In fact the projected growth rate of the opposition party Fine Gael was slightly higher than Fianna Fail!)
So any retrospective attempt by FG to maintain that it warned of the impending crisis is without foundation.

Let’s look briefly at some of these distortions created through the significant presence of multinational companies in Ireland.

Firstly important issues arise regarding the accuracy of a great many of our economic statistics.

The official measurement of growth is in terms of GDP. As we have seen exports contribute disproportionately to Irish GDP. However one could validly question the true extent of these exports.

Take the activities of Google as one example! Google at present considerably benefits from its double Irish arrangement. Clearly it trades in Ireland (currently employing over 2,000) with the offshore company here owning its intellectual property rights. However under Irish law Google also has set up a 2nd company which is allowed to be tax resident elsewhere, - in this case in Bermuda - where no tax on profits applies.

The 2nd company then charges the other Irish company license and royalty fees (based on the holding of its intellectual property rights). Not surprisingly these are designed to effectively wipe out any liability for tax under our system (where officially a 12.5% rate applies).

In fact it has been revealed that Google has paid a miniscule amount in tax to the Irish exchequer in the past few years of its operation (.13%).

They pay even less in the UK (where a substantial amount of the advertising revenue is effectively generated).

The UK authorities would like Google to pay tax on the revenue (effectively generated in the UK). However Google cleverly uses a technical loophole whereby they maintain that all sales are closed in Ireland thereby avoiding such a liability.

One might validly ask why the Irish authorities are therefore not protesting – since Google attributes UK sales to their Irish operation – about the tiny amount of tax paid here on such large amounts of income.

Well, let’s say it is a convenient arrangement that benefits both sides. On the one hand Ireland has located here one of the most prestigious companies in the world providing high skilled jobs in an expanding enterprise. On the other hand Google is enabled to legally pay a very small amount of tax (on its non-US earnings).

Paradoxically the very arguments of the Government demonstrate the effectiveness of Ireland as a tax haven. So while it validly protests that it does not fulfil any of the legal criteria for a tax haven, this offers further cover for companies such as Google and Apple (who use it precisely for this purpose).

This is not to maintain that Ireland is by any means alone in this regard. In Europe  the Netherlands, Luxembourg and Switzerland for example are involved in similar type activities.

The case of Apple is even more curious in that its 2nd (tax avoiding) company does not seem to have a designated tax residence.

So, all in all, perhaps Apple’s greatest design is with respect to this ingenious iTax which renders vast sums of money invisible for taxation purposes anywhere in the world.

Considerable distortions also arise through transfer pricing policies that are deliberately designed to artificially lower reported costs with respect to an Irish subsidiary. This criticism has recently been made of Marks and Spencers who operate in both the UK and Ireland. However with corporate taxation higher in the UK, some of this burden can be transferred through the company selling goods and services to the Irish subsidiary at artificially low prices. This then enables the Irish branch to show higher profits which are then taxed at the lower Irish tax rate.

However with multinational activity at such a high level in Ireland, this raises serious question marks regarding the accuracy of many of our leading economic statistics.

Once again the official measurement of economic performance is based on GDP which is designed to measure the total value of what is produced in a country.

However because of the significant use of Ireland by large multinationals to reduce their international tax liabilities this figure is likely to greatly overestimated. For example as we have seen with Google they attribute large amounts of sales advertising to Ireland that effectively is sold elsewhere in Europe!

So a substantial amount of what is reported in Ireland as GDP, represents artificial profits (created to legally avoid tax payments). Significant amounts of these profits are then - according to our Balance of Payments - treated as negative income flows.

At present over €30 bl. of profits is reported as flowing out of the economy annually representing nearly 20% of GDP. So our GNP (which takes count of this movement) is considerably less than GDP and arguably a much more accurate indicator of our economic performance!

But even this figure must be severely questioned. Though “profit repatriations” is commonly used with respect to these US multinationals, it is very unlikely that the money is going back to the US. Presumably in many cases it is being held in their tax resident location e.g. in the case of Google, Bermuda. However in other cases as revealed in the case of Apple, the profits do not seem to be going anywhere. So in effect Ireland here seems to be the location for the artificial generation of vast amounts of profits that are not officially recorded in our statistics.

Apart from profits flows (recorded and unrecorded) we then have huge amounts recorded under licence fees and royalties (again at nearly 20% of current GDP). Now these would be treated as services imports in the Balance of Payments. However one could validly question – like the profits - how accurate these figures can be!

Thus enormous question marks hang over the accuracy of our GDP, GNP, import and export figures.  And all of this matters in several important respects.

For example our contribution to the EU Budget is largely based on GDP.

Now if one accepts that in the case of Ireland – for the reasons stated -  this figure represents a substantial overstatement of our true economic performance - then significant sums of money are being lost to the domestic exchequer each year (at a financially difficult time).

Also growth performance in Ireland can be highly misleading. Once again the official emphasis is on GDP growth. However official GDP figures can be rising while GNP figures (which are more representative of true performance) are falling at the same time. 

The official position at the moment is that the Irish economy now in recovery with moderate GDP growth taking place. However this belies the fact that many parts of the domestic economy are still in deep recession.

And in any case - again because of the uniquely important role of multinational activity in Ireland - it is especially difficult to trust the accuracy of key recorded statistics.

Associated with this is a growing dichotomy as between two economies i.e. the one based on the multinationals and the other relating to locally traded goods and services.

It is no accident that the very conditions that have led to record success in the last couple of years, with respect to attracting multinationals, equally are causing growing problems for the domestic sector.

In many ways the Irish economy is now more attractive than ever to US multinationals.

The US authorities understandably are annoyed at the manner their companies legally avoid paying tax in their own country.

So as a first step they are now clamping down on the use of pure tax havens (i.e. where companies register solely for tax purposes with no productive activity taking place).

Some of the companies affected have thereby moved to less overt tax havens - such as Ireland - where genuine production is required and can to an extent be used to mask the nature of tax avoidance adopted. 

As a result of the domestic recession, labour and rental costs have dropped making it more attractive for foreign investors.

Also because of high unemployment the Government is more anxious than ever to meet their special requirements with an ever expanding range of new proposals such as write-offs on R&D, income tax waivers on earnings of top executives located here and even suggestions to further lower the current corporation tax rate of 12.5%.  

As these multinational mainly use Ireland as a base for selling into the wider European market and elsewhere, the recession in the domestic economy is not of direct concern. Also they are not affected - unlike domestic producers - by the continuing liquidity crisis in our banking system.

However one feature of special concern with respect to our continued reliance on multinational investment that it is leading to considerable distortions with respect to acceptable notions of social justice.

Since the property crash in 2008 a huge burden has been placed on young middle income earners.

Many of these have suffered substantial negative equity on their properties struggling to repay mortgages taken out at the height of the boom.
Indeed many are now unemployed with little immediate prospect of finding work in Ireland!

Then to finance the huge debts that have accumulated at public sector, corporate and private levels, the Government has resorted to austerity measures leading to substantial increases in taxation and a decline in customary public services.

The domestic retail sector has then suffered the fallout from the rapid decline in disposable income while also facing further considerable obstacles.

So while everything is done to make Ireland even more attractive for outside investors, in effect a reverse set of circumstances applies to domestic business.

Due to the banking crisis Irish business is starved of credit. Meanwhile because of a crazy system of upward only reviews, rental costs for retailers remain far too high  forcing many out of business. Other important costs such as communications, energy, insurance and waste disposal are among the highest in Europe.

It is not surprising therefore that the wider public is now taking more notice of the tax avoidance activities of multinationals.

Put simply they ask: Why should these massively wealthy companies be assisted to allowed  pay virtually no tax when low to middle income earners are being squeezed for tax at every turn? Where is the equity, where is the social justice in all of this?

In fact I believe that this represents a growing crisis for the way in which the capitalist system works.

Multinational companies are immensely powerful due to the considerable resources they control. Because they can bring obvious short term advantages to the economies in which they locate, effectively they can play off one Government against another so as to get the best deal.

Considerably hypocrisy attaches to the stance for example of the US government (which held its Senate Hearings into Apple). They could change their  laws so as to make Apple liable for tax on its foreign earnings. However they will not do this, as they are fearful of the consequences with Apple perhaps then threatening to move its entire operations elsewhere.

So in the absence of a globally agreed approach to the issue of taxing their profits, multinationals will continue to exploit the tax loopholes that inevitably emerge with respect to separate systems designed to maximise national advantage.

Unfortunately, the very notion of global cooperation does not fit in with capitalist notions of competitive individualism (at either firm or state level).

Thus accepting this, the US is likely in the end to attempt to improve its national competitive advantage by providing additional incentives for Apple to repatriate their substantial overseas profits e.g. through a much lower rate of tax applying.

I have long been of the opinion that our standard economic concepts have increasingly become outdated in the modern world and that we can no longer attempt to disassociate economic activity from moral notions of social and personal justice.

Equally we can no longer seek to operate from merely an individual national perspective on a wide range of issues.

For example the environmental crisis can only be properly tackled on the basis of true global cooperation (based not on the interests of any individual nation in isolation but rather their combined long term collective benefit) .

This also applies to the international financial system which will be quickly subject to further major upheavals if the inherent greed and selfishness on which the system operates is not faced through a disinterested form of global cooperation.    

At a deeper level this will require substantial revisions in the accepted capitalist notion of profit which we will return to in a future blog entry!