For the past several decades, CEOs of multinational corporations have been privy to a dirty secret–that they can significantly decrease their tax liability by creating a network of holding companies and subsidiaries based in various tax jurisdictions. A prime player in this scheme was Ireland, whose lax rules for “tax residency” allowed for the off-writing of a large proportion of a company’s profits. Now, amid popular outcry, the government is attempting to derail the gravy train.
The so-called “Double Irish Arrangement” went like this: a large company, usually doing most of its sales in either the US or EU, would create an offshore entity in a “traditional” tax haven such as the Cayman Islands. This de facto subsidiary would then purchase the rights to the non-US profits of certain intellectual property. Since Irish law determines tax residency based on the location of a company’s management, this subsidiary would not be subject to Irish tax.
From here, this offshore company would license its intellectual property rights to another sister company, this one based fully in Ireland. This second company would accrue the actual benefits of the non-US use of intellectual property, but all of those potential profits would be offset (or “written off”) by the steep fee that it paid the offshore subsidiary in licensing fees. Thus, the net income on which Ireland would tax this second company would be minuscule in relation to the yearly value of the intellectual property rights. Any remaining profits would be taxed at Ireland’s already low 12.5% corporate income tax. The initial write off, along with the low double-digits tax rate, allowed US-based companies to avoid paying the more uniform 35% US tax rate on a large portion of its earnings.
This strategy will no longer be available to multinationals however, as Ireland recently changed its tax laws, requiring all companies that wish to incorporate in Ireland to also be bona fide tax residents there as well. This eliminates the first offshore company, which was previously used to sell licensing rights to an Irish company, but which was not itself considered a tax resident, and therefore was not subject to Irish corporate tax.
This move comes a few years after pressure from both the Obama administration and EU regulators to clamp down on corporate tax havens, which also include the tiny enclave of Luxembourg. UK agencies and the European Commission itself were already investigating unilateral ways to prevent companies from using the double arrangement; now, such action appears unnecessary.
Reasons given for the closing of the loophole range from practical (tax revenues may increase by billions) to equitable (many simply view the arrangements as unfair) to more personal: some argue that the arrangement has tarnished Ireland’s reputation and hope that eliminating it will help Ireland gain attention not for its sweetheart tax deals but for its dynamic and talented workforce.
What will be the net result of this action? No one is precisely sure, and intellectual property giants who will be most immediately affected (such as Google and Apple) have not made official comment. Likely, the cat and mouse game played by regulators and corporate boards will continue, but one thing is certain: the rules of the game have been changed.