Ireland should back move to make global tax system fairer

Many Irish people were shocked and disappointed to read about the latest Irish tax exploits from Vodafone.

The danger with a story like this is precisely that such shock and disappointment will kick in too hard to allow lessons to be drawn, especially when there is sensitivity towards any Irish involvement in yet another tax scandal. However, that is no reason not to examine honestly some of the questions the story raises, and to think about where the solutions might lie.

The facts are well covered. We know that for years Vodafone ran millions of euro in royalties through an Irish subsidiary with no employees whatsoever. Only later did the group attempt to retrofit some substance to the Irish company by relocating London workers to Dublin, giving them the stark choice of continuing doing their jobs from there, or facing redundancy. We know that when challenged by the UK tax authorities on the alchemy of making money without a workforce, the company reached a settlement with them effectively agreeing that those profits were properly subject to UK rather than to Irish tax. As a consequence, they claimed back the Irish tax they had already paid here, which basically means that the Irish taxpayer stumped back up €67m in taxc, and this was used to partially offset the company’s UK settlement. We know that all of this was perfectly legal. And that last fact is perhaps the most challenging of all.

So we have several problems. First, an Irish company generating millions in income with no employees apparently set off no alarms as long as they were paying Irish tax. Why does this matter? From a self-interested Irish perspective, a challenge from the UK effectively undermined the previously-agreed Irish tax status of that company, graphically illustrating how unsustainable it is to collect tax revenue based on aggressive tax planning. From a global perspective, this particular little arrangement is only part of a very much larger problem of offshoring. Multinational firms use shell companies in a range of countries, European and otherwise, to draw taxable income into low-tax or low-tax jurisdictions. The amount of such profit held offshore by US firms alone amounts to €1.8 trillion. The problem is even more acute for the Global South, where countries struggling to free themselves from dependency on international aid now also struggle to collect taxes from their hard-won foreign direct investment, as firms blithely channel profits and royalties out of their reach.

We clearly need tax rules in Ireland and elsewhere to detect and challenge such empty, profitable companies, something far easier said than done. What Vodafone did was perfectly legal. Our rules on transfer pricing are well up to current international best practice. Still, they only allow a challenge to artificial arrangements if the adjustment would result in more taxable income in Ireland. They don’t cover arrangements whereby too much income is being channelled into the country; this is what seems to have happened here, as indicated by the rather clumsy effort to backfill the paper flow of royalties to Ireland with real live employees. That our transfer pricing rules are the international norm only serves to highlight the need for better international norms.

Another difficulty is that companies have a far better view of their own transactions than the countries which seek to tax them. Each taxing authority sees the little bits of a transaction that cross its own borders, or impact on companies within its jurisdiction. Companies, by contrast, can and often do put in place a long and opaque chain of payments that freely spans the globe. Countries do share tax information, but not automatically, not globally, and companies may not provide information to the tax authorities in every country about aspects of a deal or structure that take place elsewhere.

Imagine an air traffic control system in which each country could see the planes as they flew in and out of their own airspace, but the pilots didn’t have to file a flight plan, and the systems in each country were only loosely connected in an ad-hoc way. This gives you some idea of the chaos of tracking international money flows, and effectively taxing multinational firms.

This is why the OECD, now fully backed by the G20, have drawn up ambitious and detailed plans to tackle aggressive tax planning by multinational firms. Transfer pricing rules will be overhauled over the next two years. Connecting infrastructure will be put in place to allow tax Information to be exchanged automatically and spontaneously, enabling all taxing authorities to see more clearly what is behind the money that flows through their borders. They plan to expose situations where profits are generated in one location while the employees or capital investment are in another. Most significantly, work is underway on a single multi-lateral tax treaty to replace the 3,000-plus bilateral treaties in place around the world. That is simply a game-changer. If this works out as planned, it will reduce or eliminate many of the glitches in the system exploited by multinational firms. As Charles Haughey didn’t say, it’s a global solution to a global problem.

What might that mean for Ireland? The extremes, at least, of the tax-avoidance game will become less profitable, so countries depending on aggressively tax-based investment will lose out in the short term. However, what could be called “real” investment, whereby real goods or services are made and sold by real employees will be unaffected. In the long term, it should deliver a more sustainable stream of tax from multinational firms, good for Ireland and for poorer countries in the Global South. There will be a loss of tax revenue to countries playing host to empty, profitable firms which make very little contribution to the real local economy, and a corresponding increase in tax revenue to the countries hosting the kind of activity which spills over to the real economy. Where do we want to be, in this brave, new, tax-unified world?