Friday, June 3, 2011

Memo to US Multinationals: Ireland Resisting Rise in Corporate Tax Rate -- But for How Long?

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Ireland's low corporate tax rate is under sharp scrutiny as speculation abounds that the EU is informally pressing for a rate hike to cut the country’s budget deficit and massive debt, brought on by the 2008 global recession, subsequent bank bailouts, and years of excessive borrowing. EU Economic Affairs Commissioner Olli Rehn set off a storm of controversy recently when he stated at a press conference that "Ireland … will become a normal tax country in the European context." Ireland, unlike Greece, has not turned to the EU for financial assistance, leading to speculation that Rehn’s comments indicate that a rate rise would be a key demand should EU aid become necessary. Although Rehn added that the issue is for the Irish to resolve, his remarks set off a stern reaction in Ireland, where the corporate tax regime is a revered element of economic development policy. 

The 12.5% statutory tax rate applies to the trading income of both domestic and foreign companies and is by far the lowest in Western Europe and the third lowest in the eurozone. Originally penned at 10%, the 12.5% rate became standard in 2003, following an agreement with the EU, and ushered in a downward trend in corporate tax rates across the EU. As such, the Irish corporate tax rate has long been a bone of contention for many EU Member States – notably France and Germany, who continue to view it as predatory. (Ireland applies a 25% tax on company non-trading income, such as capital gains.) 

While this matter implicates fundamental EU institutional issues, including the on-going debate over greater tax harmonization, it also will resonate with US corporations who have – or are considering – a presence on the Emerald Isle, which has become a top-tier destination for foreign multinationals seeking a gateway to European markets and for exports to the US. 

Many people are aware of Ireland's economic transformation into the "Celtic tiger" over the past decade, but few likely can recognize what a magnet the country has become for US investment. Commerce Department data for 2009 shows that US direct investment in Ireland reached nearly $166 billion, keeping the United States the leading investor in the Irish economy. The significance of this relationship becomes clearer when one considers that combined US investment in the BRICs (Brazil, Russia, India and China) climbed to only $146 billion for this period. According to the Irish Industrial Development Agency, by 2009 this influx of US investment was represented by a diverse group of 471 US-owned companies out of a total of 987 foreign-owned firms, accounting for upwards of 96,000 of the nearly 136,000 jobs that are supported by foreign investment. 

Given the importance of Ireland's corporate tax regime for inward investment and its export-reliant economy, which is dominated by foreign multinationals, it is no wonder that the government and pro-business groups are blasting any discussion of an upward tick in the corporate tax rate. Although Ireland might be able to retain its low-tax country status with a modest rise in corporate taxes, the worry in Dublin is that such a move may not generate additional tax revenue as it could compel foreign investors to relocate operations. 

But the Irish government does not have much room to maneuver. Ireland's gross external debt – among the largest in the world – is $2.43 trillion (or approximately $540,000 per capita), according to the latest data of the Irish Central Statistics Office. Less liquid assets available to apply toward those liabilities, the Irish National Treasury Management Agency places the national debt at over $124 billion and various projections show it heading to 80% or more of GDP by year-end, up from only 25% in 2007. To make matters worse, Irish debt is trading at rates exceeding 6%, which compelled the government to call off bond auctions planned for October and November. Tack on an economy that has rapidly contracted (change in GDP fell from 5.6% in 2007 to -3.5% in 2008 and -7.6% in 2009, according to Eurostat), an unemployment rate currently pushing 14%, and a populace already enduring austerity measures. Given the state of the Irish economy, tax revenue is in significant decline, including receipts for all of the major tax categories – personal, corporate, VAT, and national insurance contributions.  

In contrast to other debt-laden eurozone countries, Ireland responded quickly to counter its deteriorating fiscal position. Thus far the Irish debt-reduction strategy has focused primarily on slashing expenditures, namely by targeting the salaries and pensions of civil servants and social welfare programs. While the government’s initial austerity measures may have salvaged some Irish credibility in the eyes of investors, this provided only temporary relief as expenditures continue to significantly outpace revenue. Indeed, following a record budget deficit of over 14% of GDP in 2009, Ireland’s 2010 deficit is expected to be a whopping 32%, which again will make it the highest in the EU. Consequently, the government has stated that additional spending cuts are on the way. However, the question arises as to whether, under these conditions, the government realistically can continue to rely primarily on a strategy based on squeezing further budgetary savings.  

Media reports are now indicating that tax increases will also form part of the Irish government's strategy, which is due to be unveiled in a four-year economic plan in November and the 2011 budget to be released in early December. The personal income tax base is virtually certain to be expanded, as are VAT and excise duties, and assorted property tax incentives will likely be targeted. Yet, there remains an adamant resistance to altering the 12.5% corporate tax rate, leaving many observers wondering how it will be possible for Dublin to meet its EU obligation of reducing the budget deficit to 3% of GDP by 2014. 

Whatever approach the Irish government takes to dealing with the debt crisis, its forthcoming budget and fiscal plans must receive the blessing of the European Commission to restore confidence in international markets. Even if, for the time being, the 12.5% corporate tax rate remains untouched, foreign direct investors would still be wise to anticipate a larger tax burden in some form. Over the long term, however, Ireland’s stance on this issue will likely depend less on its own actions, but rather more on the overall state of the global economy. 

For a discussion of doing business in Ireland, see T.M. 965-4th: Business Operations in the Republic of Ireland. 

Tome Tanevski, U.S. International Tax Editor

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