The robust performance of the Irish labour market over the past number of years offers the most tangible evidence of the recovery in the Irish economy. With unemployment falling and vacancies rising, an obvious question that arises is the extent to which the current pace of growth can be maintained. Today, colleagues in the Central Bank published a paper examining this very issue, bringing together a range of labour market indicators to assess the current state of play including prospects for wages over the short-term. We also revisit Okun’s law and the Phillips curve drawing on the latest Irish data. We hope that this research proves useful as 2017 draws to a close. The paper is titled ‘The Labour Market and Wage Growth after a Crisis’ and can also be accessed by clicking this link.
Guest post below from Muiris MacCarthaigh from Queen’s University Belfast:
Budget 2018 and a tale of two Departments
The budget to be published this Tuesday will be the first since 2010 to be prepared and delivered by a single Minister, Paschal Donohoe T.D., who holds both Finance and Public Expenditure and Reform portfolios.
As will be widely remembered by readers of this blog, following the 2011 general election the Department of Finance was essentially split in two, with that Department retaining control over taxation and reform of the financial services sector. (Indeed for a while consideration was given to renaming it the Department of Finance and Taxation). The ‘spending’ side of the Department was removed and combined with public service reform and industrial relations into the Department of Public Expenditure and Reform (DPER). As well as providing for a significant reallocation of central government functions, and an organizational focus for administrative reform, DPER served the useful political purpose of allowing the Labour Party hold another central government portfolio. This also gave it co-equal status with Fine Gael at the Economic Management Council or ‘War Cabinet’.
What is not widely appreciated is the enormity of the task faced by officials in the Department of Finance over the pre and post-election period to prepare for and then execute the process of creating the new Deparment, all in a matter of weeks. When beginning the research for my recently published book on DPER over the 2011-16 period, the sheer scale of this undertaking quickly stood out. Led by a small group of officials, it involved trawling the Irish statute book for all primary and secondary legislation concerning the responsibilities of the Minister for Finance in law from 1922 onwards (as well as some pre-1922 treasury-related functions), before that Department could be disaggregated into two.
The range of responsibilities for which the Minister for Finance had a legal responsibility included such diverse issues as provisions for compensation applications arising from property damage during the 1921-23 Independence and Civil War period, to consenting on borrowings for capital investment for commercial state enterprises. All told, it resulted in a process involving the transfer of over 4000 specific legal functions originally assigned to the Minister of Finance.
In respect of Budgets, a number of interviewees for my study identified how the institutional split between revenue-raising and expenditure functions had created a useful ‘buffering’ effect on demands for increased expenditure by line Departments. Prior to DPER’s existence, the relevant section in the Department of Finance assessed new expenditure proposals from a line Department, and the merits of raising taxation or other forms of revenue to support the measure were also considered in that same Department. With the decoupling, appeals to DPER for extra resources fell largely on deaf ears as the Department and its Minister had no say in taxation matters.
The quality of engagements between DPER and other Departments were also deemed to have taken a step change by virtue of the economic evaluations provided for them by the IGEES. Additionally, the strong relationship between Ministers Howlin and Noonan were consistently referred to as being vital to the Irish crisis response, including budgetary coherence, and by proxy to the stability of the government as a whole.
At the launch of my book, Minister Donohoe identified that the Taoiseach had been keen to maintain the two Departments when announcing his Cabinet following his election in June. Whether this was to preserve the integrity of DPER’s reform agenda, to place coordination of fiscal and budgetary policy in one Minister, or to avoid accusations of a return to pre-crisis arrangements for government departments is hard to say. As is how long DPER will continue to operate as a separate Deparment .The economic crisis may be a decade old, but its effects on budgetary policy and the organisation of Irish government continue to be felt.
Dr Muiris MacCarthaigh is Senior Lecturer in Politics and Public Administration at Queen’s University Belfast. His new book, Public Sector Reform in Ireland: Countering Crisis, has just been published by Palgrave.
Outside the UK, where words apparently mean whatever you want them to, it is universally understood that in order to avoid a border on the island of Ireland, Northern Ireland (and preferably the UK as a whole) needs to stay in an equivalent of the existing EU customs union, and the European Single Market. Inside the UK, on the other hand, it seems to be commonly accepted that the UK needs to leave the Single Market because it has to restrict freedom of movement.(An argument that I have never accepted, but that is another matter.)
And so we have a problem.
In fact, however, the only bit of the European Single Market that the UK really has to stay in to avoid a border is the single market for goods — this would of course require it to apply European goods standards, accept all relevant ECJ rulings, and so forth.
Quite properly, the EU is ruling out cherry picking: the UK cannot stay in the bits of the Single Market it likes, and not in others. But what if it were ourselves, rather than the British, who picked the cherries?
In particular: it would be completely unacceptable for the UK to remain in the single markets for capital and services, while excluding itself from the single market for labour. This is, we all understand, never going to happen. And I suspect that they wouldn’t be allowed to remain in the single market for goods alone, either, and that proposing this is therefore a non-starter.
But I’m going to propose it anyway, in the full knowledge that I will be (probably quite properly) shot down, since it seems to have a few things going for it.
First, we would avoid borders, not just within Ireland but more generally, and this would help businesses across the continent. Supply chains would be unaffected, and so forth.
Second, the British would not have cherry picked — something that we could never allow a mere third country to do. We Europeans would have done the picking, on the grounds that it suited us to do so; and that seems to me like an important distinction.
Third, however, the Brexiteers would be able to say to their voters that they had restricted freedom of movement.
Fourth, however, this deal would only be made available on the basis that the UK also stayed in a customs union with the EU, since that would be required to avoid borders, which is the whole purpose of the exercise. So EU politicians would be able to point out, to their own populations, that the UK (a) was unable to do its own trade deals with other countries (b) had to accept ECJ jurisdiction as it affects the single market for goods (c) had been unable to cherry pick as it saw fit.
This would not be a great deal for the UK. Yes, they would keep their car industry, remain in Airbus supply chains, and all the rest of it. And that ought to be something that they would welcome. But: they would lose access to the single markets for services and capital, as long as they remained outside the single market for labour. They would lose jobs and tax revenue from the City. As a service economy, this is not the deal that they would have chosen. But it is a lot better than the rather shallow goods-only FTA arrangement they seem to be heading for right now (if they get even that). And they would always have the option of going for a deeper arrangement involving all four freedoms, if they decided that that is what they wanted at a later date.
You sometimes hear the British say that they can’t make progress on the border before getting to the second stage of talks. While superficially plausible, the claim strikes me as disingenuous: there are surely several things that they could say right now that would make a lot of difference. For example, they could pledge that
- The United Kingdom will remain in an equivalent of the customs union and the single market, if that is required in order to avoid a hard border
- Northern Ireland will remain in an equivalent of the customs union and the single market, if that is required in order to avoid a hard border
- They will change their red lines regarding the nature of their exit from the EU and their future relationship with it, if that is required in order to avoid a hard border
As I think about it though, perhaps the key thing they should say is that (a) they accept that a customs union is defined as a group of countries surrounded by a common external tariff barrier and border; (b) that in addition, the European Single Market has always been and needs to be protected by an external border of some sort in order to maintain its product standards and so forth; (c) that they accept that Ireland will remain a full member of the EU, and hence of its customs union and single market; and (d) that there will therefore continue to be a border between Ireland and all third countries or regions not belonging to the European Single Market and a customs union with the EU.
None of these points is a matter of opinion, or subject to negotiation. (1) to (3) are a matter of fact or definition, and (4) is a logical consequence of (1)-(3). And it is very difficult to accept that you are negotiating with someone in good faith if they refuse to accept that black is not white and that 2 + 2 = 4. Right now the UK seems to most outsiders to be talking out of both corners of its mouth, claiming it doesn’t want an Irish border, while preparing to do things that will require one. How can you negotiate seriously with such a country?
If the UK were to accept (1) through (4), publicly, then its claim to want to avoid a hard border in Ireland — including any physical infrastructure, something that Mrs May very helpfully added in Florence — would sound rather different. (Right now, it sounds like hypocritical posturing.) Publicly accepting (1) through (4), and saying that they were willing to do whatever it takes to avoid a hard border, involving any sort of physical infrastructure, would mark a big step forward in my opinion. And it doesn’t seem like a lot to ask for.
The Central Bank of Ireland will be hosting a Conference entitled “ETFs – Stability and Growth” on 29 November 2017 in the Convention Centre Dublin.
Are ETFs still the safe, simple, transparent product they are understood to be? Is the ETF structure appropriate for any type of product? Should there be limits? What impact do ETFs have on their underlying market and what liquidity concerns are relevant and valid in an ETF context?
Participation is free of charge and you can register your interest in attending by emailing ETF@centralbank.ie
Final details will be available on our website.
We look forward to seeing you and to engaging in a frank and open discussion on ETFs!
From an Irish perspective the most significant announcement made yesterday by Commissioner Vestager was in relation to Amazon not Apple. The Commission announced that Luxembourg had granted €250 million of illegal sate aid to Amazon. The structure used by Amazon in Luxembourg is close to a replica of that used by US companies in Ireland. It is a double-luxembourgish. Here is the Commission’s description of the Amazon structure:
Amazon’s structure in Europe
The Commission decision concerns Luxembourg’s tax treatment of two companies in the Amazon group – Amazon EU and Amazon Europe Holding Technologies. Both are Luxembourg-incorporated companies that are fully-owned by the Amazon group and ultimately controlled by the US parent, Amazon.com, Inc.
- Amazon EU (the “operating company”) operates Amazon’s retail business throughout Europe. In 2014, it had over 500 employees, who selected the goods for sale on Amazon’s websites in Europe, bought them from manufacturers, and managed the online sale and the delivery of products to the customer.Amazon set up their sales operations in Europe in such a way that customers buying products on any of Amazon’s websites in Europe were contractually buying products from the operating company in Luxembourg. This way, Amazon recorded all European sales, and the profits stemming from these sales, in Luxembourg.
- Amazon Europe Holding Technologies (the “holding company”) is a limited partnership with no employees, no offices and no business activities. The holding company acts as an intermediary between the operating company and Amazon in the US. It holds certain intellectual property rights for Europe under a so-called “cost-sharing agreement” with Amazon in the US. The holding company itself makes no active use of this intellectual property. It merely grants an exclusive license to this intellectual property to the operating company, which uses it to run Amazon’s European retail business.
Under the cost-sharing agreement the holding company makes annual payments to Amazon in the US to contribute to the costs of developing the intellectual property. The appropriate level of these payments has recently been determined by a US tax court.
Under Luxembourg’s general tax laws, the operating company is subject to corporate taxation in Luxembourg, whilst the holding company is not because of its legal form, a limited partnership.Profits recorded by the holding company are only taxed at the level of the partners and not at the level of the holding company itself. The holding company’s partners were located in the US and have so far deferred their tax liability.
We know why US companies set up this structure: it is to defer the US tax that is due on the profits. The US has a general anti-deferral regime for passive income [the so-called Subpart F] but there are some exemptions. One notable one is the “same country exemption” where passive income flows within the same country do not trigger a payment of the US tax due. By registering two subsidiaries in the same country US companies can avail of this exemption for passive income flowing between them.
The companies then ensure that the company receiving the income is not subject to tax in the country of registration. In Ireland, this has been achieved by being non-resident; in Luxembourg it is achieved by being a hybrid entity such as a partnership with non-resident partners. The outcome is the same: an operating company subject to tax where it is based and a holding company not subject to tax or resident in a jurisdiction with no tax.
The Commission’s case rests on the royalty payment made by the operating company to the holding company for the rights to use intellectual property (that is developed by the parent in the US). Although the details in the press release are scant it looks like we can see how the €250 million tax bill arises.
Amazon’s operating company made €4 billion of royalty payments to the holding company. In turn the holding company made around €2.7 billion of cost-sharing payments to Amazon Inc. as its contribution to the R&D undertaken by the parent. That left an excess of around €1.3 billion in the holding company.
The Commission’s case seems to be that the holding company was not entitled to all of this €1.3 billion (as it has no substance) and therefore most of this income should have remained with the operating company and included in its taxable income. If the €1.3 billion was subject to Luxembourg’s corporate income tax of around 20 per cent it would give a tax liability of around €250 million. Municipal business taxes could increase that amount.
The 2003 ruling that set the royalty was done on a cost-plus basis (see recital 37 of the opening decision). Cost-plus arrangements are not unusual and there a number of the Commission has sight of from Ireland. See recitals 385 to 395 of the Apple ruling. Concerns were raised about the inconsistencies between these.
In Amazon’s case in Luxembourg the margin used was around 5 per cent of the costs of the operating company with additional limits set to ensure that the profit was always between 0.45 and 0.55 per cent of revenue. Anyway, over the years in question (2006 to 2014) this resulted in the €4 billion of royalty payments to the holding company that held the license to Amazon’s IP for use in Europe.
The Commission have ruled that this basis for computing the taxable income of the operating company was wrong – or at least not in line with the Commission’s view of how the arm’s length principle, and the concept of the market economy operator in the Treaty, should operate to. But it is not clear what this view is.
Numerous times in the press conference Vestager made reference to the cost-sharing payment made by the holding company back to the parent in the US. She indicated that the amount of additional tax to be paid by the operating company in Luxembourg depends on the cost-sharing payments made by the holding company. In her statement she said:
Furthermore, Amazon’s European profits depend on the level of payments due to Amazon in the US for the IP. This will be reflected when calculating the unpaid tax due in Luxembourg.
By that logic if the holding company had made €4 billion of cost-sharing payments rather than €2.7 billion then the additional tax would have been nil. This seems an odd way of looking at the tax due by a company which does not make these payments to the US but absent the full ruling it is what is implied by what Vestager said yesterday.
From the description above we note that the Commission have said “[t]he appropriate level of these payments has recently been determined by a US tax court.” Yesterday, the IRS announced that they would appeal the ruling of the US tax court and Vestager indicated that the final amount of tax due based on her ruling would depend on the outcome of that. In the question and answer session she said:
The court decisions in the US affect the final calculation of the profit to be taxed in Luxembourg but it is not for us to have a say in how they evaluate what should be paid for the use or development of the IP. This is not for us and we have not being looking into this. And this also means that the appeal of the US tax authorities doesn’t change the methodology that we have set up or how we have been looking into the case.
The thing is that almost nobody thinks the cost-sharing payments are “appropriate”. They might be those as required under US law but that in itself doesn’t make them right. Large profits accruing to holding companies with little or no substance was one of the primary issues that the OECD BEPS project was set up to address. The OECD have clearly stated that the profit should accrue to the activities that generate the profit. In the case of Amazon this would seem to be the R&D activities in the US not the inventory and invoice management undertaken in Luxembourg.
Unlike the Apple case Vestager did not make any comments about the structure used by Amazon or whether additional tax could be due in other (market) countries. She said:
On the question whether or not other tax authorities or national tax authorities should be looking into this I don’t think that it is a given. It wasn’t in the Apple case either but that were, sort of, more hooks in the decision to consider that. We don’t find that to be as obvious in this case. This is very much about European sales recorded in Luxembourg and therefore, sort of, the question about the royalty payment and what should then be taxed in Luxembourg from the profits earned.
This time her concern was limited to the profit attributed to the activities in Luxembourg. Per the OECD approach the correct attribution of Amazon’s profit requires an adjustment of the payment made from the holding company to the parent company rather than adjusting the payments from the operating company to the holding company as Vestager has suggested. But this is not straightforward.
Obviously, most of the focus is drawn to the payments that relate to successful R&D activities, i.e. those that result in large profits, but many arrangements will not lead to large profits. A profit-split based on the proportion of the profit generated by the activities undertaken seems like an attractive alternative and a holding company with no substance would only be entitled to a small share of the profits but costs must be covered even if profits aren’t generated.
Many of the most successful cost-sharing arrangements have their operating bases outside the US in Ireland. As a result Ireland is the origin of huge amounts of royalty payments. Since 2010 these have summed to over €300 billion with €72 billion of outbound royalty payments made last year. We are already seeing the end of this through the onshoring of IP with companies aligning their profits with the substance they have in Ireland. The application of the OECD’s 2016 transfer pricing guidelines would likely disallow such payments.
But the state-aid cases are historic in nature and it may be the view of the Commission that such payments should never have been allowed. We don’t know how much of the royalty payments that have originated from Ireland relate to holding company subsidiaries of US MNCs but it is likely to be a large amount. Nor do we know how much is paid on by the holding companies to the parents as the contributions under the cost-sharing arrangements.
One of the unusual things about Amazon is that it spends a huge amount of its gross margin on R&D. Amazon spends around one-third of its gross margin on R&D which is double the rate of Google, Apple and Facebook. For these companies we can expect the cost-sharing payments to be a lower proportion of the profit accruing to the holding companies.
At this stage it is not clear where all this is going. Maybe all we have had so far is a few foreshocks. What we really need is for some of these cases to come before the courts so that the Commission’s approach to transfer pricing can be adjudicated on. If decisions like the Amazon one are upheld then we really could end up anywhere. If the decisions are overturned then maybe this will peter out. New rules are being written but for the time being we can’t be sure what the old ones were.