Will the US trump Ireland’s tax ace?

An American attempt to close a loophole could have a major impact on the recovering Irish economy, writes John Walsh in Dublin.

“The company concluded it was not in the best long-term interests of our shareholders to attempt to redomicile outside the US.”

That single sentence, uttered by Walgreens’ chief executive Greg Wasson as part of his announcement on Wednesday that the pharmacy giant would be buying the remaining 55pc of Alliance Boots it does not already own, ended speculation surrounding the future tax domicile of the growing company.

But Walgreens’ decision not to relocate from its Springfield, Illinois, domicile – much to the pleasure of national and local politicians – places it in a minority.

About 22 American firms have announced an inversion deal since 2011, choosing to move a their tax domicile to some European country such as the UK, the Netherlands or Switzerland, where the rate of corporation tax is lower.

Such deals have opened up a new battleground between the US and Europe. But it is the Republic of Ireland, struggling to rebuild its economy after the ravages of the financial crisis, which finds itself at the centre of this ongoing war.

Despite Ireland’s best efforts – given the significant implications the move will have for an economy still struggling to recover from a steep downturn – the US is looking to bring such inversions to an end, with President Barack Obama standing shoulder to shoulder with the US Treasury on the need to keep tax proceeds from domestic companies within its own coffers.

In a speech delivered to an audience at the Los Angeles Technical College in late July, Mr Obama outlined the direction of travel, ratcheting up the heat on US companies that make “tax inversion” deals by describing them as “unpatriotic” and “gaming the system”.

He added that such businesses “stick you for the tab to make up for what they’re stashing offshore. If you’re basically still an American company but you simply change your mailing address to avoid paying taxes then you are not doing right by the country and its people.”

But for policymakers in Ireland, the president’s speech contained a most unwelcome reference.

“If you simply acquire a company in Ireland or some other country to take advantage of the low tax rate, you start saying we are now magically an Irish company despite the fact that you may only have 100 employees there and 10,000 in the US; you are just gaming the system. You are an American company, you continue to benefit in all kinds of ways from being an American company,” he said.

And last week there were reports that the US Treasury is examining ways of stopping such deals.

For Ireland, it is perhaps ironic that the proposed deal that really raised the issue of investors in the American political consciousness was Pfizer’s failed £69bn bid for AstraZeneca, the Anglo-Swedish drugs giant.

This was quickly followed by the $40bn takeover of Dublin-based Shire by America’s AbbVie, which was depicted in the US media as an American corporate moving headquarters to take advantage of low-tax Ireland. Although Shire has historically paid tax in Ireland, the enlarged entity will be domiciled in the UK, saving it $1.3bn (£772m) in taxes between now and 2020, according to analysts at Barclays.

Although there are no official records, tax experts estimate that there have been roughly 50 tax inversion deals over the past decade with the vast bulk of these going to Ireland, the UK, Switzerland and the Netherlands, which appear to be symptomatic of much wider US corporate disaffection with the country’s corporate tax system.

The last time there was a comprehensive reform of the US corporate tax code was in 1986, with every president since pledging to overhaul what many agree has become an unwieldy and increasingly complex tax structure.

When Mr Obama was elected in November 2008, he noted, in withering terms, that there were 29,000 US companies registered in the Cayman Islands.

Initially, it was expected that the 44th President of the United States would look to reform his country’s tax system in the early part of his presidency.

But with only two-and-a-half years to go until the end of his second, and final, term, it is unlikely to change in the foreseeable future given continued divides between Republicans and Democrats in the US Congress.

The headline US corporate tax rate is 35pc, and as part of its system, the federal government has the right to tax worldwide profits – although it does operate a system of deferral, which means that these profits are only taxed when they are sent back to the US.

Feargal O’Rourke, PwC’s head of tax in Dublin, says that the growing number of tax inversion deals “appears to be a sign that US companies are voting with their feet. There is no sign of reform to the US corporate tax system and there is no sign that it will happen soon”.

Moreover, there is nothing that the Irish, UK, Dutch or Swiss governments can do to prevent American companies from pursuing tax inversion strategies, he continues. “The issue of US-headquartered companies leaving America can only be solved by the US government.”

However, the reputational fall-out from the latest round of tax inversions deals has been much worse for Ireland than the other three countries, partly because it was directly named in Mr Obama’s speech.

“Ireland does not promote such investments and nor do we want such investments. They actually cost us money and we derive no benefit from them,” explains Richard Bruton, Ireland’s minister for jobs, enterprise and innovation.

“Ireland has a very robust strategy for attracting foreign companies who invest substantively, put real investment into the ground and provide employment,” he continues. “That is very different from what has been discussed in recent weeks around tax inversions.”

Mr Bruton said it was not possible for the Irish government to introduce legislation that would have any impact on tax inversion deals. “I don’t think there would be any loss to Ireland should there be a change by the US and I think most people would welcome a change,” Mr Bruton added.

The Irish government is, perhaps unsurprisingly, particularly sensitive to attacks on its corporate tax regime. The country has been extremely successful in attracting – mainly US – foreign direct investment (FDI) over the past 20 years. A 12.5pc corporate tax rate has been the cornerstone of this strategy.

There are roughly 600 US firms based in Ireland. Collectively, they account for €100bn (£80bn) of total Irish exports; directly employ 120,000 Irish people and spend roughly €16bn each year on payroll and local services.

Ireland’s low corporate tax rate has been a lightning rod for criticism for as long as it has been successful in attracting investment. During the country’s EU/IMF €67.5bn bail-out negotiations in November 2010, Germany’s chancellor, Angela Merkel and French president, Nicolas Sarkozy, insisted that Ireland raise its corporate tax rate as a quid pro quo for funds on the basis that it fosters unfair tax competition throughout the EU. A tense game of brinkmanship ensued with the Irish government eventually prevailing.

But much more damaging was the spate of international headlines depicting Ireland as a tax haven after US Senate hearings held in June 2013 into the tax affairs of tech giant, Apple. It emerged that the California-headquartered company had lowered its effective corporate tax rate to roughly 2pc by using a complex mechanism known as the “double Irish”.

This involves routing royalty payments through an Apple subsidiary incorporated in Ireland, but not tax resident in the country, to another Apple subsidiary based in the Cayman Islands, where there is a 0pc tax rate on royalties.

Two of the most senior US Senators, Carl Levin and John McCain, branded the country as a tax haven.

The Apple Senate hearings followed the House of Commons Public Accounts Committee’s own look into the tax affairs of Google and other technology companies. It found that the social media business has paid a corporate tax rate of 0.4pc on £2.5bn of UK eanings by booking sales through its Dublin office.

Ireland’s government strongly rejected any allegations of wrongdoing by the US Senate or the Commons committee. Its position is that Ireland has a transparent tax system and that it meets none of the Organisation for Economic Co-operation and Development’s criteria of a tax haven.

In a research paper commissioned by the Irish Department of Finance last April, it found that on average over the past 10 years, the effective Irish corporate tax rate has been just under 11pc, compared with a headline rate of 12.5pc.

Moreover, the government said that it has never negotiated individual tax deals with any company.

Despite this, the European Commission announced in May that it intends to investigate whether Ireland negotiated bilateral deals with Apple. The Irish government has assembled a number of legal experts to fight this challenge, with the case expected to take up to five years.

Any threat to its tax regime could have huge implications for the economy at a time when it is pulling out of the worst downturn since the foundation of the Irish State.

“It adds to the cacophony of noise about Ireland,” explains O’Rourke.

The fear among Irish businesses is that the government will be bounced into making changes in order to stave off growing international pressure. It has already pledged to co-operate fully with the OECD in the base erosion and profit shifting project that aims to clamp down on corporates avoiding taxes in the multiple jurisdictions in which they operate.

Ibec, the Irish business and employers confederation, has urged the government not to introduce any unilateral changes to the corporate tax system that would undermine the country’s competitiveness.

The most likely outcome is that Enda Kenny’s administration will introduce further legislation in October’s budget to close down completely the legal loophole that enables the use of the “double Irish”. That would remove the incentive for companies to set up brass plate operations in Ireland.

Up until now Ireland has been an extremely useful cog in the sort of aggressive international tax planning that has helped multinational companies to avoid paying billions in corporate taxes.

Whether the removal of this lever will affect its attractiveness as a location for foreign direct investment in the future is the multi-billion-euro question.