23/03/18

EU tax proposals are a political move dressed up as a technical argument

 (EU Observer) -- “Context” is potentially the most important word in Minister Donohue’s statement on Wednesday in response to the EU’s digital tax proposals. And yet, with tax matters, context is the key element that is often lacking. As such it is worthwhile to contextualize yesterday’s EU proposals, but also the recent EU country report on Ireland, to try to place Ireland’s tax regime within the international milieu.

The EU has set out two proposals to alter the ways in which “digital” companies are taxed within the Union. The long term plan appears to favour a new approach to determining the way in which a company creates a taxable presence. This, however, could take time and so the interim measure is set out in a second proposal which seeks to tax the turnover of certain large digital companies. While arguments can and will be made about the longer term proposal, the interim measure is the one of immediate worry and should be met with a hefty degree of skepticism.

The arguments against this approach are multifaceted but the simple facts are that turnover taxes take no account of profitability or margin, hence a highly profitable company would get taxed at the same level as a loss making company. This appears counter intuitive. From an Irish perspective the worry comes from the fact that it is likely that this new tax would be deductible against taxable income in the home country. Hence if a “digital” company, based in Ireland, is forced to pay this additional turnover tax in another member state it is Ireland’s tax base that would pay for the privilege. The EU says that this rebalancing will redistribute tax revenues in a “way which better reflects how companies create value online”. This in itself is a huge statement and rallies against the current understanding of value creation. Ireland, therefore, has a lot to lose.

The crucial context and backdrop here though is the work being undertaken by the OECD who are attempting to get countries to move unilaterally rather than bilaterally - which they suggest could create larger problems in the longer term. Ireland has always supported the work of the OECD and the BEPS project and has consistently stated that this is the forum for agreement on this divisive and complex issue.

At a more macro level the timing of this proposal from the EU is puzzling to say the least. Despite their insistence to the contrary, it would appear that these measures are mainly targeted at US tech companies (with a certain amount of non-US collateral damage) and as such will likely only escalated trade tensions at a time when a calming touch is needed to attempt to stabilise global trade.

The political context of tax is also a key issue at play here. Some EU members are potentially looking enviously at the success of others (i.e. Ireland) and radical measures such as these are a thinly veiled tax grab. This can be further seen by the soundings emanating from the EU earlier this month surrounding the EU’s country report on Ireland. This report partly focused on taxation, however, subsequent commentary would suggest that tax was its only subject and that it went to significant lengths to undermine Ireland’s tax system.

The EU report goes far beyond taxation. These annual EU reports seek to give an overview of the economic, fiscal and social picture in each member state and provide a very good snap shot of an EU member state. However, the public focus has centered on the taxation section and, as such, it may be worthwhile providing context to the areas of concern raised rather than blindly accepting the current narrative that Ireland is some form of a free for all tax haven.

The EU’s report suggests that Ireland’s tax code is at risk of being used for aggressive tax planning by multinationals. The main indicators that the EU report cites are our large stocks of both inward and outward FDI which, according to the report, can only be partly explained by economic activity here, and the level of royalties and dividends that Ireland receives. The EU report claims that all of this indicates that Ireland is being used for aggressive tax planning.

Royalty payments have, on average, accounted for 23% of our GDP between 2010 and 2015 whereas the average across the EU is generally a small fraction of that amount. As a simple comparison, Ireland does look like an outlier, but does this automatically point to tax avoidance or is a somewhat simpler reason available?

Ireland is, and has traditionally been, a net export state when it comes to both goods and services. Being a net exporter does not necessarily result in a significant level of royalty revenue - that is dependent on the export industries. Ireland is the largest exporter of digital services in the world. Ireland is the second largest software exporter in the world, 16 of the top 20 largest global software companies have operations in Ireland, the top 10 born on the internet companies are based here……. In summary, we are big in ICT. This is excellent news for Ireland as Digital companies are growing significantly faster than the rest of the economy globally. How do these companies charge for a significant portion of their revenue? License fees or royalties.

To attempt to put this somewhat in context, it is interesting to consider other industries. As an example let’s look at the automotive industry. There wasn’t one commercial road car manufactured in Ireland last year and yet there are currently over 2m cars driving our roads every day. Does this suggest that Irish revenues (and associated taxing rights) are being artificially diverted to, say, Germany? Clearly not, but then should the same not be true for ICT and our other service exports? Ireland has consistently made itself attractive as an export hub for ICT (and many other licensed services). As a small open economy, we have been agile enough to take advantage of the digital boom we are currently experiencing - it is difficult to see why we should be targeted for this success.

It’s also pertinent to deal with the EU Commission’s comments which focus on the tax section of the report. Tax planning practices “undermine fairness and the level playing field in our internal market, and they increase the burden on EU taxpayers”, said Pierre Moscovici, EU Tax Commissioner. “While we recognise the steps some of these member states have taken to adapt their tax model recently, clearly more needs to be done.” However, with an objective of promoting a level playing field for tax, Mr Muscovici must bear in mind that his core tax goal, the CCCTB, favours larger economies and small open economies, like Ireland, are at a disadvantage. Hence, let’s not forget that EU tax policy is a political debate dressed up as a technical argument. The EU has an agenda it must pursue but, as in many other areas for many other member states, silent acceptance is not always the best route to fairness.

Detractors will suggest that the above arguments may only amount to a fig leaf and yet it’s interesting that the context, that Minister Donohue highlighted, is often the key point lacking from those same detractor’s well-worn narrative on Ireland’s standing in international tax.