The recent OECD Base Erosion and Profit Shifting (BEPS) reports released earlier this month provide a new international context through which to consider the competitiveness and transparency of Ireland’s tax system. The OECD BEPS project aims to redefine the basis upon which companies tax profits of global business, and also seeks to introduce measures to ensure increased transparency and fairness in relation to tax strategies. Both the budget announced by the minister last Tuesday and the published update on Ireland’s international tax strategy build on the improvements and progress already made in the previous two budgets. They outline the government’s continued commitment to supporting a competitive, best-in-class and stable suite of corporate tax incentives for companies looking to invest in Ireland, within the parameters and in the spirit of the BEPS reports.
The budget measures relevant for foreign direct investment (FDI) announced last Tuesday, most notably the Knowledge Development Box and the introduction of some OECD BEPS measures, build on the success of Ireland’s corporate tax regime in attracting companies, and recognise the importance of ensuring that Ireland remains a top competitive location for multinational companies to locate valuable and high-value assets.
While it is important that Ireland adheres to the new international guidelines outlined in the BEPS reports and is considered to offer a transparent and fair tax system to companies looking to invest here, it is equally important that Ireland strives to maintain its competitive edge amid increased pressure internationally.
A key BEPS project objective was to align international tax rules with the commercial realities of modern global businesses and, in particular, align the taxation of profit with a company’s substance and activities. Under the BEPS proposals it will no longer be possible to locate significant profits in locations with limited substance and activity. As a consequence, many companies will need to restructure their operations to better align high-value intellectual property assets with substance. It is clear that the outcomes of the BEPS project and the guidelines laid out in the recent reports will result in companies operating globally paying more tax, and Ireland must seek to ensure that we offer an attractive environment when multinational companies are forced to rethink their operational structures.
Ireland’s ability to attract foreign direct investment has played a significant role in the recovery of the Irish economic landscape. Indeed, as total US investment into Europe fell 19 per cent in 2014, investment into Ireland for the same period grew 42 per cent.
A key part of Ireland’s ability to attract and retain investment is the robust, competitive and stable tax environment which Ireland provides, including the low corporate tax rate, research and development tax credit, intangible assets relief and an attractive holding company regime. Previous budgets featured some key improvements to these regimes which were widely welcomed.
Budget 2016 introduced some additional incentives for companies and individuals looking to invest in or relocate to Ireland respectively. The Knowledge Development Box (KDB) regime, as outlined by the minister, provides a preferential tax rate of 6.25 per cent to income earned by businesses who are carrying on R&D activities in Ireland and who derive income from those activities. The framework of the KDB will follow the rules laid down by the OECD.
This framework is called the Modified Nexus Approach and it uses the quantum of R&D being carried out by the company in Ireland as a driver in identifying a proportion of income which may be entitled to benefit from the regime. Under this approach, the benefits available under the KDB to global groups carrying on research and development activities all over the world, including Ireland, may be significantly limited. Modern business models and technology advancements have allowed companies to establish centralised and specialist R&D functions worldwide in order to develop products, notwithstanding the location of their sales teams.
Therefore the location of R&D activity and sales activity is rarely aligned and on that basis the KDB may offer limited benefit to companies who have significant presence in Ireland but globally dispersed R&D activity.
However, even in situations where the KDB may be limited in its application, Ireland’s overall tax regime continues to provide a competitive tax offering relative to other jurisdictions and we are the first country to offer an OECD compliant KDB type regime.
The introduction of the KDB provides certainty and clarity in relation to the tax regime for innovative activities for companies looking at their investment or restructuring strategies. “KDB type” regimes currently on offer in other countries, aiming to offer preferential tax rates to income derived from intellectual property, will be required to adhere to the same parameters laid down by the OECD. While larger economies have the scope to attract the required individuals to carry on R&D activities in country, they may not have scope to offer a significantly lower tax rate under their regime, due to their existing headline corporate tax rates.
In this scenario, Ireland’s 12.5 per cent headline tax rate, combined with the other tax incentives available, may offer a sufficiently attractive tax rate for companies who think that they may struggle to satisfy the conditions outlined under the modified nexus approach.
As widely expected, the minister confirmed the Finance Bill will contain legislation to bring into law country-by-country reporting in accordance with the OECD standards.
These rules will require companies operating globally to disclose information on their business operations and transfer pricing policies. These reports will highlight where companies are booking significant profits but with little or no substance. It was confirmed that Ireland will seek to introduce the updated OECD transfer pricing guidelines into Irish law when approved by the OECD in 2016 and that the government will continue to engage constructively in relation to international developments on other BEPS actions, including the agreement of a multilateral instrument, controlled foreign corporation rules, interest deductibility and hybrid mismatches.
As outlined above, the OECD BEPS reports will mean that companies operating globally will need to review and restructure how their business operates and, in particular, where they hold valuable intellectual property.
In the near term, companies may be considering whether they should look at restructuring their operations to avoid any reputational exposure arising from the publication of information required under the country-by-country reporting rules. A key opportunity for Ireland in this scenario is to encourage companies to relocate offshore intellectual property to Ireland, in most cases building on existing substantive operations in Ireland.
There is significant competition internationally to attract mobile, valuable assets and, while Ireland has continued to punch above its weight in this area, it must ensure that it continues to offer a best-in-class regime for investment. Ireland has been, and continues to be, a pioneer in terms of offering a competitive corporation tax regime to attract companies to Ireland. A key shift in the international context brought about by the BEPS reports will mean that effective corporate tax structures will require significant levels of substance, activity and most importantly, people. While the overall income tax burden in Ireland was reduced in the budget measures, no further improvements were announced to attract and retain key employees.
Given recent international tax developments, such as the OECD’s BEPS initiative, and the move towards aligning profits and taxation with the key decision-makers, Ireland is relatively well positioned from a corporation tax perspective, however we are much less attractive when it comes to hiring the key individuals. Our Special Assignee Relief Programme (SARP) was improved slightly last year, but further improvement should be made.
Many countries have sought to emulate Ireland’s success in attracting foreign direct investment and over the last number of years Britain has continued to improve its suite of corporate tax incentives to promote investment.
The headline corporation tax rate in Britain will be reduced to 18 per cent and a number of incentives aimed at attracting innovative international operations have been introduced. In particular, Britain may offer a more attractive proposition for key executives being asked to relocate to align profits with key decision-makers. In the shifting international tax landscape, where companies are now faced with making fundamental decisions on how to structure their operations going forward, Ireland must remain vigilant, offer a world-class and transparent tax system while maintaining its competitive edge.