The Enemy Within

“There are decades where nothing happens; and there are weeks where decades happen” – Vladimir Ilyich Lenin.

The week of 02nd to 09th December 2017 was nothing short of momentous for the Irish economy, compacted decades worth of progress into seven short days. At the end of an extraordinary period, key developments in three of the most significant external threats to our fragile recovery has given cause for optimism. As the spectres of US Tax Reform and Brexit materialise into perhaps more manageable realities, is most potent threat to us now coming from within the EU, in the form of a new Digital Tax?

Brexit

Following a tumultuous five days, the morning of 08th December brought a quite extraordinary and extremely welcome announcement by Donald Tusk that even in the event of a total breakdown of negotiations, there will be no hard border returning to the island of Ireland. While nothing can ever be guaranteed (even though the word “guarantee” appears in the text), the implications are far reaching.

Phase 1 of the negotiations are complete, well before most thought they would be. Now on to the much more nebulous Phase 2, but with a far greater sense of optimism than many of us dared to hope for. Given the deluded ineptitude of a UK Government that has demonstrated all the stability of nitro-glycerine, is this optimism naïve? Well, in a word, no.

The optimism exists because of their unstable ineptitude, not despite it. Brexit will happen, of that there is no doubt, but the sheer incompetence of their Government is rapidly convincing the UK public that while Brexit means Brexit, May now means “No”. No confidence, no vision, no ability and no resilience. She can no longer lead the UK off a cliff, because quite simply no one will follow her.

This has been implicitly recognised with the declaration that there would be no “regulatory divergence” between north and south but also, crucially, between east and west. The back door has been opened to remaining in the Customs Union or at the very least, a mirror version of it. When Scotland, Wales and London all signalled their intent to leap on the NI alignment bandwagon, the silence from the Tory right was deafening. Bizarrely, the right wing UK tabloids heralding this as a victory for May, a delusion which should be positively encouraged.

But there is a long way to go. There is only one Brexit truism – the more confident the assertion, the more deluded the commentator. By the time you read this, May could well have got her just desserts (perhaps as Johnson’s Eton Mess?). And if he gets in, all bets are offal.

US Tax Reform

Decades of partisan bickering have delayed it, but US Tax Reform is now a reality. The Senate has just joined Congress in passing its own extremely comprehensive bill. Now both must be amalgamated into one final law, ostensibly a mammoth task, but the speed at which this will happen may startle. So why now?

Tax Reform has focused the Republican party for three reasons. Saddled with an unpopular president and with mid-term elections less than a year away, they are desperate for a win. Secondly, it is a Republican, rather than Trumpian objective. And most importantly, most Americans want it, despite having no clue what it really is.

To be fair, they can’t know what it is, because the US Senate simply wouldn’t tell them. 479 dense pages, replete with hand written annotations, were kept secret until the last minute and debated for a grand total of two hours before passing.

The main provision of the final bill will reduce the domestic tax rate from 35% to close to 20%. Further measures will likely to focus on a partial amnesty for accumulated offshore funds rather than dis-incentivisation of foreign investment. It is estimated that there is €2-4 billion sitting in the foreign accounts of US companies. Taxing that at 14.5% generates sufficient fiscal space for a hefty tax cut for billionaires. That’s the objective, make no mistake.

Irish nervousness around these measures seems to stem primarily from President Trump’s constant namechecking of Ireland whenever tax havens are mentioned. But cutting their domestic rate to twice that of Ireland (once State Tax is factored in) will not dissuade US companies looking to penetrate the EU. In fact, it may (optimistically) increase the availability of funds to do so, or will (realistically) be returned make rich shareholders richer, which will not diminish funds earmarked for FDI.

One potential negative would be incentivising the return of internationally located IP, which Ireland has benefited from recently. But US firms will are adept at mitigating potentially negative reform and there is no guarantee this measure will survive. In addition, introduction of “territoriality” into the currently “worldwide” US charge on income may even accentuate the relocation of IP to low tax jurisdictions like ours.

While President Trump may talk tough on targeting Ireland, the reality is that you cannot target a tax system. Just the participants. He would in fact be targeting US firms located here. In other words, key Republican donors. Even the Donald is wary of biting the hand that feeds.

EU Digital Tax

Shortly before his retirement as Minister for Finance, Michael Noonan proclaimed that Ireland could not be the servant of two masters, recognising the disparity between current OECD principals and newly resurgent CCCTB proposals, whose reported demise appears premature.

There is little doubting the continental disdain for peripheral states’ low tax rates and “aggressive” tax practices. Unable to unilaterally force an increase due to the Lisbon Treaty’s guarantee of tax sovereignty and impatient with the lack of progress with the OECD’s base erosion and profit shifting paradigm, the Gang of Ten led by France and Germany have shifted their focus to a new model. But rather than merely move the goalposts, they are intent on fundamentally reinventing the sport. Namely the introduction of a Digital Tax on revenue, rather than profits.

The proposals make for grim reading from an Irish perspective. They potentially include the introduction of:

  • An EU tax on revenues from digital activity
  • A withholding tax on online payments to non-resident providers of goods and services
  • A remotely imposed tax based on the revenue from digital transactions where the non-resident entity that has a significant economic presence (including advertising revenue)
  • A digital transaction tax that applies early in the value-creation process (potentially even based on customer location)

Each of these would diminish the proportion of profits ultimately taxable here. While Ireland is not alone in fighting this, ironically this is where Brexit could weaken us most. Not only have we just lost a key ally in this fight, given their unwavering support for our border stance, the EU big beasts may feel that it’s payback time. And the price for that support could be erosion of the few key competitive advantages we have left.

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