Tax deals raise questions over Ireland’s growth spurt

Four years after entering a punishing €67bn bailout, the Irish economy is booming again. Gross domestic product expanded at an annual rate of 5.5 per cent between January and June. The European Commission expects Ireland to be the fastest-growing country in the eurozone in 2014.

Yet a chorus of economists say Irish official data have become so distorted this year by an upsurge in offshore activity from a small number of pharmaceutical companies that it paints a misleading picture of the health of the economy.

The distortions are likely to be seen again when third-quarter data for Irish economic activity are released on Thursday. This means that doubts about whether Ireland’s economic turnround is as robust as its boosters claim will persist.

According to the Irish Fiscal Advisory Council, an independent watchdog for the budget, an offshore activity known as contract manufacturing, relatively common in the pharma industry, was especially evident in the second quarter. In those three months, the Irish economy grew at a reported annual rate of 7.7 per cent. John McHale, the council’s chairman, says the second-quarter data “has to be taken with more than the usual pinch of salt”.

Ireland’s pharma industry has long been a large player in the economy. Its exports of €40bn account for about 45 per cent of total goods sold abroad from Ireland. However, it employs just 37,000 people. Some companies, such as Pfizer, have large manufacturing operations in Ireland. Others, such as Shire, use their Irish bases for tax and financial operations.

The sector’s contribution to Irish GDP growth in 2014, however, is much larger than usual. The IFAC estimates that about 40 per cent of the growth in the first half of this year is attributable to contract manufacturing — more than twice the usual level. The activity involves sending manufacturing offshore, but counting the manufactured goods as Irish exports.

The problem with contract manufacturing is that it may artificially boost GDP. “This is manufacturing that is taking place in another country but the sales are being accounted for in Irish GDP. That is not generating jobs or value in the Irish economy,” Prof McHale says.

Economists say it is possible that the contract manufacturing surge can be attributed to a lack of production capacity in Ireland for certain products. But some say it is more likely to be related to “transfer pricing” — the shuffling of cash among related companies — or to other tax-driven strategies involving pharma companies headquartered in Ireland but with little or no manufacturing activity here.

They note that the surge in GDP coincides with the flood of “inversions” that inspired much of the merger and acquisition activity in the pharma sector in the past two years. An inversion is a tax-driven M&A deal where a company acquires an Irish pharma asset and re-domiciles as an Irish company to take advantage of the country’s 12.5 per cent corporate tax rate.

Contract manufacturing usually balances out over several quarters because its export component is offset by royalty payments back to the Irish-based company, which are counted as Irish imports. However, as the finance ministry pointed out in the government’s official Budget 2015 statement, “this relationship appears to have broken down in the first half of 2014”.

According to the Irish Exporters Association, five pharma companies are among the top 20 Irish exporters — Johnson & Johnson (through its Janssen division), Pfizer, Boston Scientific, Gilead Sciences, and Warner Chilcott (now part of Actavis). Among companies that re-domiciled as Irish after “inversions” are Perrigo, which bought Elan, and Actavis, after its Warner Chilcott acquisition.

Pfizer says it is not connected to the contract manufacturing activity; Perrigo says it does not carry out contract manufacturing in Ireland. The other companies did not respond to requests from the FT for comment.

If the surge in contract manufacturing is tax-driven, it suggests that Ireland’s role as a centre for corporate tax management may be undermining the credibility of official statistics. An economist who attends regular briefings on economic data by the Central Statistics Office but prefers to remain anonymous says: “We spend half our time arguing over what is and isn’t brass-plate activity.”

Many economists ignore Irish GDP and concentrate on indicators such as domestic demand as a guide to economic activity. These show that the economy is growing, but at a more modest pace than the breakneck GDP figures suggest.

Eamonn Walsh, professor of accounting at University College Dublin, says GDP has become so unreliable that “it’s like using a sextant rather than a GPS to know what is going on”.

Conall MacCoille, chief economist at Davy Stockbrokers, agrees. “National accounts are getting worse at capturing actual economic activity, especially in Ireland,” he says.