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Monday 25 September 2023 Dublin: 16°C
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# Taxing matters
Explainer: Why is Ireland about to raise its corporation tax rate from 12.5% to 15%?
It could be 2023 or 2024 by the time the new rules are actually implemented.

IT’S D-DAY FOR Ireland’s 12.5% corporation tax with the Government looking likely to drop its objections to global tax reform proposals at a special meeting of Cabinet this afternoon.

Finance minister Paschal Donohoe and his colleagues have managed to maintain their poker faces since July when 130 out of 140 Organisation for Economic Cooperation and Development (OECD) member countries signed up to the proposal.

Since then, the doomsday clock has been edging further towards midnight for Ireland’s world-famous (or notorious, depending on who you ask) 12.5% rate, the key component of the successive governments’ industrial policy since the 1990s.

But how did we get here and what might the changes mean for the Irish economy? 

What’s happening today?

After months of negotiating, the Government is expected to sign Ireland up to a new 15% global minimum rate of corporation tax.

The deal was agreed in principle in July but ministers, concerned that the proposal would effectively spell the end of Ireland’s attractive 12.5% rate, held out.

Ireland was one of nine out of 140 countries to not sign up to the proposed overhaul at the time.

But over the summer months and into the autumn, having sought greater clarity on the terms of the international agreement, the Irish position softened somewhat.

Why is this happening now?

Formal talks around corporate tax reform, led by the OECD — an international organisation focused on fostering global economic cooperation — have been going on since 2018.

For the last 30 years or so, the world’s biggest corporations have cut labour costs by offshoring production to emerging markets like China and India where wages are cheaper.

Simultaneously, through tax competition and sweetheart arrangements with national governments, they have been empowered to shop around for the lowest rates available.

A related issue is profit shifting.

This is when a company like Apple, for example, books its sales revenues in a home base, low tax country like Ireland, far away from where most of its users are and where its sales are generated.

Engaging in this (perfectly legal) practice means that just three companies — Microsoft, Google and Facebook — could be depriving the world’s pooresta countries of a whopping $2.8 billion each year, according to ActionAid International.

The OECD discussions are aimed at addressing both these issues and the global ‘race to the bottom’ on corporation tax rates characterised by countries undercutting one another to attract investment.

However, the talks largely came off the rails during US President Donald Trump’s term of office.

Early this year, in just its first few months in office, US President Joe Biden’s administration gave new impetus to the discussions.

In essence, Biden wants to raise America’s own corporate tax rates without having to worry about whether America will be undercut by other jurisdictions looking to lure multinationals with lower rates.

​​Essentially, there are two pillars to the OECD talks around global tax reform, focused on something called BEPS, which stands for ‘base erosion and profit shifting.’

The first pillar relates to finding a way to tax large multinational tech companies in a more effective manner. The second relates to the global minimum rate of corporation tax.

Ireland signed up, in principle, the first pillar earlier this year. But getting to ‘yes’ on the second issue has proved more difficult.

So what’s changed since then?

Ireland has been under considerable pressure to sign up since the broad contours of the agreement were signed off on earlier this year.

Apart from the obvious threat to Ireland’s attractive low-tax environment, one of the major sticking points was a reference in the draft agreement to a minimum global tax of “at least” 15%.

The Irish Government’s concern was that this could lead to a situation where the 15% rate because 18% or 20% in just a few years, causing considerable uncertainty for policymakers and companies alike.

But in recent weeks, the reference to “at least” has been removed from the draft text of the agreement.

Minister for Finance Paschal Donohoe is bringing that draft proposal to Cabinet today ahead of an OECD meeting tomorrow.

So is today the end of the line?

Not by a long shot.

Ireland isn’t the only country with reservations about aspects of the deal and there is plenty to be hashed out when representatives of 140 OECD member countries meet in Paris tomorrow to discuss the proposals.

When the details are finalised, the deal will have to be ratified by each country’s legislature, which could be a very tall order for the likes of Biden.

It could be 2023 or 2024 by the time the new rules are actually implemented.

In the meantime, the Irish Government is hoping it can operate two rates of corporate tax — 15% for the biggest companies and 12.5% for those with a turnover of less than €750 million.

Speaking in the Dáil today, Tánaiste Leo Varadkar said he had received “assurances” that this will be possible. However, it seems likely that the proposal will require European Union approval, which could also take some time to hammer.

When was the 12.5% rate introduced?

Ireland’s world-famous 12.5% rate was introduced between 1999 and 2003, a cornerstone of the country’s model for attracting foreign direct investment.

Before that, a patchwork of different, highly competitive tax arrangements designed to attract foreign companies existed including a specific 10% rate of tax for manufacturing businesses.

This 10% rate was later extended to the financial services sector in 1987 under Taoiseach Charlie Haughey. But the arrangement fell foul of European Union rules in 1998 and was eventually replaced by the 12.5% rate.

How important is the 12.5% rate to the Irish economy?

Partially because of it, Ireland has punched well above its weight in its ability to attract and retain foreign companies like Google, Facebook and Apple, all of which have based their European headquarters here.

Figures from 2017, suggest that Ireland’s share of total global foreign direct investment was about 2.5% in that year.

That’s hugely disproportionate, given that the Irish economy accounted for just about 0.4% of world gross domestic product in that year.

Ireland isn’t even the worst offender in Europe, however.

Hungary offers a 9% rate, for example. Luxembourg’s 17% standard rate combined with various sweetheart tax deals for individual companies mean that the tiny, land-locked country, with its 0.1% share of global GDP, enjoyed a whopping 12.8% share of world foreign direct investment in 2017.

Expressed as a percentage of its world GDP share, it means there’s an over 7000% gap between Luxembourg’s country’s share of global investment and the size of its output. In Ireland, it’s about 264%.

How important is the 12.5% rate to the Irish public finances?

Because the rate is relatively low compared to international standards, you might think that corporation tax isn’t a particularly important source of revenue for the State.

But it is — increasingly so over the past six years.

In fact, something like one in every five euros of tax collected by the Revenue here is from corporation tax. It’s now Ireland’s third-largest source of tax revenue, behind income tax and VAT, worth €11.8 billion to the State in 2020.

Economists often describe it as a ‘volatile’ tax bracket and with good reason.

For one, the Government’s annual take from it is massively dependant on a relatively small handful of companies. While every company registered in Ireland pays corporation tax at the 12.5% rate, 40-50% of the revenue generated through corporation tax is paid by just 10 companies, according to the Irish Fiscal Advisory Council.

Most of these companies are multinationals that have set up their European headquarters here. So the risk, if you like, isn’t particularly spread out across the entire ecosystem of companies operating here.

Another reason corporation tax is considered a volatile source is, because of the reliance on such a small handful of international operators, it’s vulnerable to international political and diplomatic developments.

Corporation tax receipts have boomed in the past six years, largely because of Trump administration tax policies, which — to oversimplify it massively — incentivised American companies to offshore.

So the Government’s take can go up and down depending on prevailing political winds in other jurisdictions that have nothing to do with Irish politics.

So what will be the impact of the new 15% rate?

It’s very difficult to say at present.

The Department of Finance estimates that up to €2 billion in corporate tax revenues could be lost in the shake-up of Ireland’s tried and tested tax environment.

But as Thomas Hubert wrote for The Currency earlier this week, the precise impact is difficult to forecast. In fact, he explained, “unless multinationals suddenly decide to leave, raising the tax rate from 12.5 to 15% would actually increase the amounts collected here”.

For a few reasons, it seems unlikely that a host of major companies headquartered here are going to up sticks and leave.

Firstly, if nothing else, Donohoe and co’s facade over the summer months has signalled to large corporations that Ireland will only be a reluctant adopter of the new rules.

In other words, the government isn’t suddenly going to change its extremely corporation-friendly, pro-business stance any time soon.

Secondly, as Taoiseach Micheál Martin and others have been at pains to point out, Ireland is an attractive destination for foreign direct investment for a host of other reasons, including our skilled workforce, our place in Europe, etc ad nauseum.

At the very least, it looks like those assumptions could be challenged over the coming years.

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