Ireland – caught in the low corporate tax trap?

Daragh McCarthy and Aoife Ní Lochlainn: In the wake of the Public Accounts Committee in the UK interrogating a trio of multinational executives on the meagre sums of corporate tax paid by many trans-national companies, last Saturday’s episode of the Business on RTE featured a segment on the topic that closed with Feargal O’Rourke of PwC saying that he expected to see these companies pay “a fairer rate of tax” in the coming years. It appears that the pressure for reform is building.

The issue has garnered a significant amount of media attention over the past couple of months—from the storming of Google’s offices in Paris to the naming and shaming of Facebook, Starbucks and Apple in the UK press. Senior government officials in many EU countries are openly voicing their discontent with the increasingly aggressive tax dodging strategies employed by these corporations, and the European Commission is scheduled to discuss the international tax practices of multinational businesses on December 5th. It remains to be seen if this is simply bluster, or if there is a genuine will to devise a coordinated pan-national strategy to reduce tax avoidance.

A recent report by TASC, Tax Injustice: Following the Tax Trail highlighted how the Irish tax system is a key component of a subsidiary-based structure that drastically reduces the overall tax bill of transnational businesses. A friendly tax environment has been a central part of the effort to lure multinational corporations to Ireland. FDI of this nature has been at the core of successive governments’ industrial policy for over half a century, and this policy is generally regarded to have been successful.

Accommodating these companies has come at a substantial cost, however. Contributors to this site have noted the obsessive focus on FDI is likely to have hindered the development of indigenous firms. The contribution made by multinationals to the Irish exchequer has diminished considerably in recent years; currently it is down 2.5 per cent year-on-year. The recent spike in media attention heightens the risk of damage to the state’s reputation. This summer, the US Senate’s Permanent Subcommittee on Investigations sought to establish Ireland’s role in “tax practices that range from egregious to dubious validity.”

However, while much of the media focus of the past few weeks has been on the use of tax loopholes to decrease tax bills in European countries, it remains the case that these countries are still better equipped to address the consequences of such corporate behaviour than countries in the Global South. Tax avoidance by companies and individuals hampers the capacity of these states to develop their economies and pay for much needed public service.

According to Christian Aid, between 2005 and 2007, six Irish Aid programme countries lost nearly €82 million in tax revenue to EU or US – almost 17 per cent of total Irish Aid budget for the countries concerned. A recent report by the Tax Justice Network (TJN) claimed that since the 1970s, 139 low-to-middle income countries have lost a total of $7.3 to $9.3 trillion to tax dodging by the super rich. This vast sum is more than enough to cover the debts of these countries, whose aggregate gross external debts stood at $4.08 trillion in 2010.

The TASC report contains a number of recommendations for tackling tax injustice, including the introduction of country-by-country reporting. However, while increased transparency would help countries better understand the methods of tax avoidance, it will not in and of itself solve the problem and is unlikely to appease many of Ireland’s critics.

The debate elsewhere: stimulus and tax havens

Jeffrey Sachs has an interesting take on the stimulus debate in the Scientific American here - any comments? - while the Tax Justice Network's blog examines and critiques steps taken in last week's UK budget to combat tax evasion and avoidance.

Shadow regulation and shadow banking: the role of the Dublin International Financial Services Centre

This piece has been cross-posted from the Tax Justice Network blog. Although written in July 2008, it remains highly topical.

Jim Stewart: Shadow regulation and shadow banking: the role of the Dublin International Financial Services Centre There has been much analysis of this topic and various policy reforms have been proposed: these include looking at the role of ratings agencies, mark-to-market rules, greater transparency, and especially reform of financial regulation. Very little has been written, however, on the role in this crisis played by tax havens and offshore financial centres with “light touch” regulation. Below is an examination of their role in the crisis, looking specifically at the Dublin International Financial Services Centre (IFSC,) where many of the funds that have collapsed or have been in difficulties are located.

A shadow banking system

The Bank for International Settlements (BIS) in its 78th annual report identified one of the main roots of the crisis. “How,” it asked, “could a huge shadow banking system emerge without provoking clear statements of official concern?”This shadow banking system has boomed over the last decade or so, as a variety of new players have evolved or emerged in the international financial system. Some are hedge funds or investment banks, or more arcane Conduits or Structured Investment Vehicles (SIVs) which are artificial structures created by banks or other institutions, off their balance sheets. These players in the shadow banking system behave rather like traditional banks – they borrow short-term money and then lend it again at longer-term maturities – but outside traditional regulatory structures. Instead of taking deposits, like “normal” banks do, they raise funds in other ways, such as by issuing commercial paper.The financial problems in global markets have been described as “the worst financial crisis since the Great Depression.” The crisis is ongoing, and it is uncertain how deep or protracted it will be.Most of the activity associated with the so- called ‘conduits’ (off-balance sheet vehicles) is regulatory arbitrage: it exists to avoid restrictions placed on banks. Bank supervisors turned a blind eye to it.

Bill Gross, founder of the US financial firm Pimco, said this shadow banking system “has lain hidden for years, untouched by regulation, yet free to magically and mystically create and then package subprime loans into a host of three-letter conduits that only Wall Street wizards could explain.”

Bank regulation exists for very good reasons. Banks must set aside cushions of capital to protect the banks against downturns and other unforeseen events, to prevent problems turning into systemic panics. Such panics are rare, but the collapse of Britain’s Northern Rock last year was a clear example of one. In the shadow banking system, institutions were able to sidestep this kind of regulation and borrow money against much smaller capital cushions than traditional regulators would accept. As a result, systemic risk increased dramatically. “Perhaps,” the BIS report said, “it is simply that no one saw any pressing need to ask hard questions about the sources of profits when things were going so well.”

The role of tax havens

One important reason for the lack of official attention to the growth of the shadow banking system was the extensive use of tax havens. Historically, hedge funds were often domiciled in the Cayman Islands, Bermuda or the British Virgin Islands. However, competition between financial centres on regulation (and tax) is considerable, and more recently European jurisdictions, notably the Channel Islands, Ireland and Luxembourg, have been “streamlining” regulation, among other things, to attract funds.In Ireland, for example, if the relevant documents are provided to the regulator by 3 p.m. the fund will be authorised the next day. A prospectus for a quoted instrument is a complex legal and financial document (a debt instrument issued by Sachsen Bank ran to 245 pages) so it is unlikely it could be adequately assessed between 3 p.m. and the normal close of business (5 p.m.) Even worse, Luxembourg has a new law stating that as long as the fund manager “notifies” the regulator within a month of launch, the fund can enjoy pre-authorisation approval. The Financial Times has noted that the Luxembourg regulator does not “scrutinise promoters”.

It was not especially the low-tax regime that attracted funds to Dublin, but other features: Ireland ticks certain boxes for funds and the regulators in their home countries, including the fact that certain EU directives apply, and being within the Euro currency zone is also highly attractive. Perhaps most alluring of all, however, is its “light touch regulation.” Bear Stearns is so far [NB: writing in July 2008 - JS] the biggest institution to have collapsed from this credit crunch. Problems emerged in June 2007 when two Bear Stearns hedge funds incorporated in the Cayman Islands announced considerable losses. Bear Stearns had two investment funds and six debt securities listed on the Irish Stock Exchange, and it also operates three subsidiaries in the Dublin IFSC through a holding company, Bear Stearns Ireland Ltd., for which every $1 of equity financed $119 of gross assets – an exceedingly high (and in most circumstances dangerous) ratio.

Where is the regulator?

How, and by whom, was Bear Stearns Ireland Ltd. regulated? The accounts state that the Irish group and subsidiaries are regulated by Irish Financial Services Regulatory Authority. According to EU directives, it is clear that the host country – Ireland in this case – has responsibility for regulation (see box 1)

Yet despite the location of managed funds and substantial operations in Ireland, the Irish regulator did not feature in any media analysis or discussions relating to the insolvency and subsequent take-over of Bear Stearns. In an interview, the Irish regulator considered his remit is to ‘Irish banks’ – that is, banks that have their headquarters located in Ireland.Nineteen funds reported as facing difficulties in the sub-prime crisis, have been identified as located at the Dublin IFSC. Almost always, the IFSC link is not discussed. There is an exception, however: the case of four German banks (see Box 2).

Between them, they required state aid from the German taxpayer totalling €16.8 billion as a result of the losses from the shadow banking system. Some people argue that financial innovation associated with risk management has been a major source of economic growth, particularly in the US. But “financial innovation,” in the current crisis appears to have motivated by opaque shifting of risk, and avoidance of regulation.

Dr. Jim Stewart is Senior Lecturer in Finance at the TCD School of Business