It would be hard to overstate the importance of reputation in international tax. Cross-border tax planning involves extremely arcane and technical rules that only brainy experts can understand. But the opinion of regular people matters, too. If, as in the United Kingdom. the general public perceives that corporations are abusing tax rules, then democratically elected governments may have to stop pandering to footloose multinational businesses and start cracking down on them. And as much as corporate CEOs fear reporting lower after-tax profits to Wall Street. they fear even more that their company’s name will appear in a Wall Street Journal article implying that they’re not paying their fair share.
Howth - Ireland (Photo credit: infomatique)
No jurisdiction, except perhaps Bermuda, has more at stake per capita in the international tax game than Ireland. Again, reputation is central. Corporate boards and CEOs don’t want their prestigious brands smeared by association. They cannot have their regional headquarters located in a jurisdiction that–whether fairly or unfairly–has obtained a reputation for less-than-aboveboard business dealings. The label “tax haven” implies sunny beaches and shady business. If Ireland wants to continue to attract investment by the world’s most respected companies, it desperately needs to avoid the tax haven label. It must also avoid incurring the wrath of the citizenry of the European Union, who want Ireland to stop using low-tax rates to steal jobs and investment from their countries.
Ireland has a 12.5% corporate tax rate. That’s a big deal on its own. If a U.S. corporation builds a factory in Ireland that generates $10 million in profit, it pays $1.25 million in Irish tax instead of the $3.5 million that it would pay if it built the factory in Indiana, where the federal rate is 35%. But that’s only the beginning of tax benefits available for locating in Ireland. Lax U.S. transfer pricing rules allow the Irish factory to book inordinate profits that rightly should have been taxed in the United States. Suppose that in the example, the Irish factory books something like $30 million of profit in Ireland.
It pays $3.75 million in Irish tax, but at the same time, because it shifts $20 million of profit from the United States to Ireland, it reduces its U.S. tax by $7 million. So the choice between locating a factory in Indiana or Ireland is the choice between pay $3.5 million of U.S. tax or net tax of negative $3.25 million (that is, $3.75 million of Irish tax minus $7 million of lower U.S. tax.) In effect, the U.S. Treasury is subsidizing investment in Ireland .
But wait — there’s more. Multinationals are no longer satisfied with Ireland’s 12.5% corporate rate. They can turbocharge their tax benefits by shifting profits out of Ireland to zero-tax jurisdictions like Bermuda. This maneuver received a lot of attention at a Senate hearing earlier this year. And so Ireland, fearing for its reputation with multinationals and with the European Union, has moved to restrict this benefit .
Irish politicians. business leaders. and newspapers are ardent defenders of the country’s corporate tax regime. And any hint that you think Ireland is a tax haven will set off a storm of protest. They point out that Ireland does not meet the OECD’s definition of tax haven. Well, that’s a low standard if there ever was one. And they like to say that Ireland is not a tax haven because it is not the legal domicile of letterbox companies but a location for real investment with real business purpose. That’s true. But to me, that makes their tax generosity even more offensive because instead of just reducing U.S. tax, they are reducing U.S. jobs.
Ireland is in the throes of a deep recession. Scaring away foreign investment is the last thing it needs. We all understand perfectly well why the Irish will never accept their country being called a tax haven. But if we cannot use that label we must have a term for a country whose extremely generous tax rules allow it to attract enormous amounts of foreign capital. Hmmm, if not a tax haven, let’s just say Ireland is a bagel.