Wednesday, March 23, 2016

Ireland’s Net External Debt was zero at the end of 2015

Last week the CSO published the end-year figures for the important International Investment Position and External Debt series.  At a headline level Ireland’s net external debt (excluding the IFSC) fell to zero at the end of 2015. 

External Debt

Net external debt is the balance between gross external debt and external assets in debt instruments.  So while our gross external debt might still be north of €500 billion there is €500 billion owing in debt intruments to Irish residents. 

It is important to look at who has done the borrowing and who is doing the lending and there’s always a lot going on under the surface with Irish macro data. 

First a sectoral breakdown of our gross external debt.

Gross External Debt by Sector

We see that the external debt on the monetary authority (the Central Bank) has fallen significantly with the exterbal debt of our monetary financial instituitions (mainly the banks) also falling.  The external debt of the government sector has remained fairly constant since this new data series began in 2012 while the external debt associated with direct investment has increased by almost €100 billion in the last 12 months.  This increase is masking the reduction in our “underlying” gross external debt.

If we turning to our external assets in debt instruments we see a similar increase for the direct investment sector but this time it will make our net external debt to be falling more rapidily that it otherwise might be.

External Assets in Debt by Sector

It is not clear what happened with the other sectors category which showed a near €40 billion increase in long-term debt instrument assets in Q4.  This is attributed to an increase in “other debt instrument assets” rather than loans or bonds and notes.  This category had almost always been below €5 billion since the start of 2012 but jumped to over €40 billion in Q4 2015.

According to the CSO “other sectors includes financial corporations other than the Monetary Authority and Monetary Financial Institutions, non-financial service and manufacturing companies and other industrial enterprises as well as (implicitly) households.”  NFCs look like a likely candidate and the CSO provide total foreign assets and liabilities for the NFC sector.

Total Foreign Asset and Liabilities NFCs

What is immediately noticeable is the huge increase in the figures in just four years with foreign liabilities going from €350 billion in 2012 to nearly €900 billion by the end of 2015.  Soon the NFC sector will have figures as large as the IFSC sector!  But it can be seen that the gap between the two is relatively constant so the overall net figure is fairly stable. 

But changes between sub-categories can give jumps like the increase shown for external assets in debt instruments in the previous chart.  It seems that there was a big increase in the debt instruments assets of Irish residents NFCs (or maybe just one) in Q4 2015 but that this in turn is owed on again to a non-resident through a non-debt financial instrument.

Anyway if we go back to our debt positions and look at the net external debt by sector we see the following.

Net External Debt by Sector

The non-IFSC financial sector has eliminated its external debt position [the €100 billion net debt that the Central Bank shows here for 2012 would originall have been borrowed by the banks].  The external debt of the government sector remains an obvious issue.

But we’d like to know what our underlying external debt positions are.  Given what we seen above it might be best to strip out debts associsated with direct investment and also with other sectors (though that only really affects Q4 2015 with the sector being close to a net position of zero before that). Doing that means we are left with:

Net External Debt ex FDI

Here we see that maybe the headline that our net external debt is zero may not be reflective of the underlying position but it has fallen by around €100 billion in the past four years and the €100 billion that remains is due to the government sector.

Of course, debts aren’t the only financial assets that make up a balance sheet.  If we look at the overall net international investment positions of the various sectors of the economy we see the following:

Net International Investment Position by Sector

This doesn’t change the position of the government sector much which has a net position of minus €100 billion as it has few non-debt foreign assets to offset its net external debt position.  We do see that financial intermediaries have a net position of more than plus €100 billion.  This are the non-domestic investment of pension and insurnance funds. 

This means that we may be able to get back to zero after all.  Here is the net international investment position for the economy (excluding the IFSC thuogh that has a small net position anyway).  The chart also shows the net position excluding the NFC sector, the figures for which are dominated by MNCs and redomiciled PLCs – both of which are largely foreign-owned.

Net International Investment Position

So our underlying net debt position still might have a bit to go to get to zero but our underlying net international investment position has got there.  We could pay off all our foreign debts with our foreign assets (though I can’t see Irish pension funds putting all their assets into Irish government bonds).  All in all the external position isn’t too bad but there still remains an overhang of domestic debt.

Tuesday, March 22, 2016

Apple in Ireland: A Snapshot

The following table gives a summary position for 2012 of Apple’s Irish-registered subsidiaries (click to enlarge).

Apple Irish Subsidiaries

In 2012 Apple had seven Irish-registered subsidiaries.  Four of these are Irish-resident for tax purposes.  The three non-Irish resident companies (AOE, AOI and ASI) were central to the 2013 US Senate Investigation into Apple when it was shown that these companies are not tax resident in any jurisdiction.

AOE and ASI carry out activities in Ireland through branches in Ireland and these branches are subject to a state-aid investigation by the European Commission.  AOI is a holding company that has no physical manifestation outside the U.S.

Across all its operations, Apple’s reported taxable income in Ireland was €224.7 million.  On this it paid €31.4 million of Corporation Tax giving an effective tax rate of 12.8 per cent.  The taxable figure is primarily made up of trading profits which are subject to the 12.5 per cent rate but also includes passive income such as interest which are subject to Ireland 25 per cent Corporation Tax rate.

As of May 2012, these subsidiaries had 2,714 direct employees in Ireland.  According to figures given to the US Senate these employees were 3.5 per cent of Apple’s total headcount (or 8.7 per cent of the head count excluding Apple retail store employees – Apple has no retail stores in Ireland).  Apple estimated that it’s Irish employees received 2.1 per cent of total employee compensation in 2012.

The average amount of taxable income generated per Irish employee was €90,000.  In the year to September 2012, Apple Inc had earnings before taxation of $55.8 billion.  The taxable income reported in Ireland equates to around 0.6 per cent of Apple Inc.’s total pre-tax profits.

At the European Parliament TAXE2 Committee last week, Cathy Kearney gave the following update on Apple’s impact:

In Ireland we directly employ almost 5,500 people, an increase of 25 per cent in 2015. 93 per cent of our employees in Ireland are EU citizens and 44 per cent of those are non-Irish nationals. This is something we are extremely proud of.

Our overall operations in Ireland support a total of 18,000 jobs and last year we spent over €200 million with Irish companies.

Apple is now the largest private employer in Cork where we provide a variety of important functions including customer service, sales, finance and logistics.  We continue to manufacture products in Cork which is only Apple-owned manufacturing facility in the world.

Monday, March 21, 2016

Apple Sales International–By the numbers

The Apple subsidiary Apple Sales International (ASI) formed a central bank of the 2013 US Senate Investigation into Apple’s tax affairs and subsequently became one of the two Apple subsidiaries which are under the spotlight in the European Commission’s state aid investigation into the treatment by Ireland of Apple.  Here we look at the publicly available information to set out where ASI fits into Apple’s structure, what it does both within Ireland and without and what it’s current tax position in Ireland is.

The following chart summarises the ASI position at the core of Apple’s international structure (click to enlarge).

Apple Sales International Structure

We will focus on the four financial flows (marked in green):

  1. The research and development cost-sharing payment which ASI makes to Apple Inc. through which ASI gets a license to sell Apple’s products outside the Americas.
  2. The manufacturing fee which ASI pays to third-party manufacturers in China to produce Apple’s products.
  3. The sales revenue that ASI receives from the sale of Apple’s products to distribution and retail subsidiaries within Apple and also some customers (including internet customers).
  4. The fee that ASI pays its branch in Ireland for organising the logistics behind the manufacturing  and (up to 2011) the administration involved in the delivery and sales.

The most crucial aspect of the above structure is payment #1.  If this is close to the profit earned by ASI the structure achieves little and the income accrues to Apple Inc.  These payments were a central part of the US Senate investigation which revealed that the cost-sharing payments were actually very small relative to the profits earned by ASI – as shown in the following table taken from the Senate report.

ASI Cost Sharing Payments

By making payments of $5 billion to contribute to the R&D that Apple undertakes (of which 95 per cent is done in the U.S.), ASI was granted the economic rights to exploit Apple’s intellectual property outside of the Americas.  The legal rights owner remains Apple Inc.

The table also shows that the economic rights are hugely valuable.  By 2012, ASI was generating profits of $36 billion a year.  After the relatively small cost-sharing payment this is generated by two factors.  The first is volume and the second is the difference between payments #2 and #3 above.

ASI pays a manufacturing fee to a third-party manufacturer to make the products that arise from the company’s R&D.  ASI then sold that product on to various related parties (Apple distribution and retail subsidiaries) and unrelated parties (such as large customers in the education sector and internet customers).  Under the arm’s length principle ASI must charge similar prices for all of these transactions. 

It is not inconceivable that ASI charges, say, $650 for some Apple product to a customer and pays a fee of $250 to the third-party manufacturer.  Do that on the scale of Apple and it is pretty easy to see how tens of billions of profits will build up.  However, it must be remembered that the iPhone was introduced in 2007 and the iPad in 2010 so these profits are a fairly recent phenomenon.  ASI’s profits were compiled here by Neil Chenoweth and focusing on the likely period for any recovery of taxes arising from the investigation by the European Commission (2004 to 2013) we see the following (in $US thousands)

ASI Company Outcomes

There is no figure available for 2013 but given the overall performance of the company a figure similar to that achieved in 2012 is likely.  The huge run-up in profits is evident.  The cumulative profits for the five years to 2008 of $7.1 billion are only one-fifth of the $35.9 billion of profits earned in 2012 alone.  If the 2013 figure was similar to that achieved in 2012 then the total profit for the ten years is around $113 billion.

ASI has a branch in Ireland which carries out the underlying administrative tasks behind the manufacture and delivery of these products.  According to the European Commission “the main activities of the branch relate to:

  • procurement of Apple finished goods from third-party manufacturers (including a third-party manufacturer in China), […],
  • onward sale of those products to Apple-affiliated companies and other customers, and
  • logistics operations involved in supplying Apple products from the third-party manufacturers to Apple-affiliated companies and other customers.”

The branch is paid for these duties and the pricing agreement with the Revenue Commissioners is one of the contested rulings in the EC investigation.  The pricing agreement is relatively straightforward with the EC letter telling us that:

  • In 1991, a basis for determining Apple Computer Accessories Ltd.’s (subsequently ASI) Irish branch net profit was proposed by Apple and agreed by Irish Revenue. According to that ruling, the net profit attributable to the ASI branch would be calculated as 12.5% of all branch operating costs, excluding material for resale.
  • A modified basis for determining net profit was agreed for the ASI branch in 2007 with a [8-18]% margin on branch operating costs, excluding costs not attributable to the Irish branch, such as […] and material costs.

The Commission go to lengths to mention that the eligible costs in the calculation exclude material for resale and we’ll come back to that.  So what is the result of this calculation?  We can see this by combining figures from the Commission and US Senate.

ASI Branch Outcomes

The turnover figure is taken as the midpoint of the range reported by the European Commission while the taxable income and tax paid figures are taken from the US Senate report.  The effective tax rate is derived from these figures.  The effective tax rate is above the standard 12.5 per cent rate because, as well as the income derived from support activities, the taxable income of the branch includes interest earned which is subject to Ireland’s 25 per cent of Corporation Tax.  This is confirmed by the European Commission who state that:

The taxable income in the table above was taxed at 12.5%, except for limited components taxed at 25% mainly represented by interest payments received.

One would think the key question here is whether the 12.5 per cent cost-plus agreement is appropriate for the Irish branch.  Transfer pricing is an art rather than a science.  Is a cost-plus agreement appropriate for the the type of activities undertaken by ASI’s Irish branch? Probably.  Even then, the margin to be used can be queried but doubling the margin is not going to result in a “material” finding given the figures reported above.

Perhaps the branch should be remunerated on a return on sales basis, i.e. profit should be related to the amount of sales the branch handles.  These are excluded from the cost-plus arrangement outlined above and the Irish authorities have (unsurprisingly) told the Commission that they are “satisfied” with this transfer pricing agreement:

  • As regards the agreements in the rulings in favour of ASI, the Irish authorities express the view in their letter of 25 March 2014 that ASI’s branch was considered to carry out routine, albeit important, functions in the procurement and onward sale and supply of goods for Apple. It would therefore have had no special valuable assets. Although the Irish branch arranged the procurement and onward sale and supply of goods (which did not pass though the Irish branch), the goods concerned derived their value largely from intangibles created in the US. There were also no indications that the Irish branch bore significant risks in relation to the activities of ASI.
  • Furthermore, according to Irish authorities’ letter of 25 March 2014, Irish Revenue was satisfied that the agreed margin on operating costs delivered a net profit commensurate with the value added by the Irish branch. On the basis of a branch-focused analysis of the operations undertaken in Ireland, it would have been clear that the main profit-generating functions and assets were not located in Ireland. All significant risks and all intellectual property would have been borne and economically owned elsewhere in the ASI enterprise or the Apple group and the profit attribution to the Irish branch would have represented full remuneration of its role in that process.

The Commission wasn’t willing to accept this and, in particular, felt there was a disconnect between the revenues and profits of ASI as a company and the revenues and profits of ASI’s Irish branch.

  • Second, the profit allocation to the ASI Irish branch, agreed in the 2007 ruling, does not factor in the evolution of sales. In fact, [.] the sales income of ASI increased by 415% over the three years 2009-2012 to USD 63.9 billion. For the same period, the operating costs as reflected by the taxable income (which represents around [8-18]% of operating costs of the branch according to the ruling of 2007) increased by [10-20]% [.]. As a large part of the operating capacity of ASI as a whole seems to be located in Ireland, the discrepancy between the sales growth and the growth of the Irish operating capacity, cannot be explained.
  • That discrepancy could point to an inconsistency in the allocation of turnover between ASI and its Irish branch. The income of ASI of USD 63.9 billion for 2012 and the respective amounts for previous years [.] represent sales income, which is an active income and generates operating expenses. If the 415% increase in sales is only due to an increase in price and not an increase in volumes, it would not be inconsistent that the operating expense of the ASI branch only increase by [10-20]% over the same period.  However if the sales volumes increased, the operating costs of either the Irish branch of ASI or the operating costs that ASI incurs outside of Ireland should have increased significantly as well. At this stage, the increase in sales cannot be related to a comparable increase in operating costs, which could point to an inconsistency in the profit allocation to the Irish activities.

There seems to be a bit of a contradiction in the Commission’s position.  The Commission are concerned that ASI’s profits have grown substantially but that this is not reflected in a commensurate growth in the operating capacity of the Irish branch (reflected by its costs).  The Commission then argue that the increase in sales suggests an “inconsistency” in the profit allocated to the Irish branch.  But if the sales could increase without an increase in the operating capacity its suggests that the two are not related.  And when ASI’s volumes increase the expense that increases is its cost of sales, i.e. the fee paid to the third-party manufacturer in China.

The are a few answers to the “inconsistency”.  One is that the Irish branch of ASI is actually not central to the overall profitability of the company.  The second is that Apple’s structure changed in 2012 and the responsibilities of ASI’s Irish branch were reduced which is something the EC appear to have overlooked.  The US Senate report tells us that:

Prior to 2012, ASI sold to Apple retail subsidiaries and directly to internet customers.  Since the company re-organised, ASI now sells to ADI and Apple Singapore, and those entities sell to Apple retail subsidiaries, or internet customers.

The impact of this can be seen in the reduction the turnover of ASI’s Irish branch in 2012 in the table above.  ADI is Apple Distribution International, another Irish-registered subsidiary of Apple Inc.  ADI is not subject to investigation by the European Commission but after the 2012 restructure figures from the US Senate show that ADI reported €186 million of taxable income to Ireland and paid €23.8 million of Corporation Tax (effective rate 12.8 per cent).  In fact as a result of the restructure ASI no longer has a sales function and arranges only for the manufacturing of Apple goods and sells them to ADI or Apple Singapore who then manage the subsequent sales.  ADI won’t accumulate huge profits as the price is pays ASI will be close to the resale price. 

But maybe there is an argument that, up to 2011 at least, ASI’s Irish branch should have been remunerated on a return of sales basis.  It is far from clear that it should apply because it is not clear what activities of the Irish branch could have influenced the level of sales.  As we have already seen ASI’s revenues increased rapidly up to 2011 without a comparable increase in the operating capacity of the Irish branch. However, if it is was appropriate to use a return on sales approach and given the level of the sales even a small margin would generate significant profits. 

What might an appropriate margin be?  I can’t say but if we consider the Irish branch to be a fairly ordinary reseller than a margin of around three per cent may be appropriate.  To be honest I have no idea and am really only looking for a number to use as an example.  If we apply a three per cent return on sales margin to the revenues shown above then that would give a profit of around $5.5 billion for the years from 2004 to 20112.  Applying our 12.5 per cent Corporation Tax to that gives a figure of $700 million – in total.

Would Apple Inc. let me handle the logistics of dealing with the third-party manufacturers in China and handle the billing and delivery to customers that Apple virtually hand-deliver to me for a three percent margin on sales? I doubt it.  Maybe one per cent is a better margin and that gives a ten-year tax bill of around $200 million.

The Commission indicate that any margin above 0.2 per cent would result in additional tax being due to Ireland:

For example in 2011, the taxable profit of ASI represented only around [less than 0.2]% of the sales of ASI. Therefore if a margin on sales indicator would have been retained as a net profit indicator, the resulting taxable profit would have been much higher, for any benchmark sales margin above [0.2]%. In detail, the turnover of the ASI subsidiary is taken as reference as no branch turnover seems to be reported (other than the turnover provided by the Irish tax authorities in 2014 and which are according to the submission calculated on the basis of the taxable basis and not according to accounting figures). [T]he sales of ASI for 2011 amounted to USD 47.5 billion, which at the EUR/USD exchange rate 2011 average exchange rate of 1.3920, represents around EUR 34.1 billion. Comparing the 2011 taxable profit in Ireland of ASI of EUR [50,000,000 – 60,000,000] to this sales figure results in a margin on sales of around [less than 0.2]%.

ASI is hugely profitable but it is not because of anything that happens in Hollyhill in Cork.  As outlined above there are three factors driving the profitability of ASI:

  1. The cost-sharing agreement with Apple Inc.
  2. The agreement with the third-party manufacturer in China
  3. The price ASI charges when selling the products on

And we have ample evidence to show that none of these are or ever were part of the responsibilities of the Irish branch.  First the cost-sharing agreement which the US Senate succinctly describes in the following paragraph:

Cost Sharing Agreement. The cost-sharing agreement is structured as follows. In the agreement, Apple Inc. and ASI agree to share in the development of Apple’s products and to divide the resulting intellectual property economic rights. To calculate their respective costs, Apple Inc. first pools the costs of Apple’s worldwide research and development efforts. Apple Inc. and ASI then each pay a portion of the pooled costs based upon the portion of product sales that occur in their respective regions. For instance, in 2011, roughly 40 percent of Apple’s worldwide sales occurred in the Americas, with the remaining 60 percent occurring offshore. That same year, Apple’s worldwide research and development costs totaled $2.4 billion. Apple Inc. and ASI contributed to these shared expenses based on each entity’s percentage of worldwide sales. Apple Inc. paid 40 percent or $1.0 billion, while ASI paid the remaining 60 percent or $1.4 billion.

And later the Senate report tells us that the cost-sharing agreement was signed by US-based employees of Apple Inc.  No competence for the cost-sharing agreement rested with the Irish branch.

Apple’s offshore affiliates operate as one worldwide enterprise, following a coordinated global business plan directed by Apple Inc. In fact, the last two versions of Apple’s cost-sharing agreement were signed by Apple Inc. U.S.-based employees, each of whom worked for multiple Apple entities, including Apple Inc., ASI, and AOE.

The European Commission appear to agree with this when they note that:

All strategic decisions taken by ASI, including in relation to IP, are taken outside of Ireland. As with AOE, ASI is a party to the R&D cost sharing agreement with other Apple Inc. subsidiaries under which the total costs of the group’s worldwide R&D are pooled. ASI’s Irish branch has no authority to make decisions relating to Apple IP or the cost sharing agreement. No rights in relation to the Apple IP concerned are attributed to the Irish branch.

Next is the agreement with the third-party manufacturer which the US Senate told us was negotiated and signed in the US:

Foxconn is a trade name for Hon Hai Precision Industry Co., Ltd ("Hon Hai").  The individuals with primary responsibility for negotiating agreements with Hon Hai for products containing the A5 chip were U.S.-based Apple Inc. employees working in Operations [.] Individuals signing the relevant agreements for Apple Inc. were US-based Apple Inc. employees with the title VP, Procurement.  The individual who signed the relevant agreements for Apple Sales International was a U.S.-based Apple Inc. employee who signed the agreement in his capacity as Director of Apple Sales International.

That just leaves the price that ASI uses when the products are sold on but that actually isn’t subject to negotiation or agreement.  Up to 2011 ASI sold to distributors, retailers and customers and although, there would be slight differences, in rough terms the prices should be comparable.  The arm’s length principle is that the price to a related party should be similar to that charged to a third-party.  And prior to 2012, ASI had plenty of third-party sales. As reported by Apple to the US Senate:

Of the $108.25 billion of Net Sales reported on Apple Inc.'s Form 10-K for period ending September 24, 2011, approximately $26.06 billion of worldwide Net Sales were recorded by Apple Sales International. Apple Sales International was the only Irish entity with third party sales.

We can se sure that ASI made plenty of profit on these sales to third parties (the difference between the fee paid to manufacturer and the sale price).  And because of this ASI makes plenty of profit of sales to related parties.  And it does.  As the first table shows, even after the restructure in 2011, ASI’s profit continued to rise and hit $36 billion in 2012.

Of course, the question the European Commission seems to have concerned itself with is not whether the appropriate tax is collected from Apple’s operations in Ireland but who is collecting the tax on this $36 billion?  The answer ultimately, of course, is the US but the US doesn’t collect it from ASI.  In fact, as Neil Chenoweth shows the tax rates on ASI are incredibly low.

ASI Tax Outcomes

From 2004 when it was just 0.80 per cent the tax rate on ASI fell throughout the period and by 2012 it was just 0.02 per cent (this is the €5.4 million of Corporation Tax paid by the Irish branch as a percentage of the companies $35.9 billion of profits).  The is because ASI’s tax provision is based on the costs it incurs in Cork rather than the sales it has around the world.

Has Apple found the elixir of tax minimisation?  Not really.  While ASI may not owe tax on those profits Apple Inc. does.  It is not our central thesis here and is a well worn track.  Apple Inc. owes US corporate income tax on the profits earned by ASI but can defer it until transferring the profits to a US-incorporated entity within Apple’s structure.  We will not see the tax paid on these profits in the accounts of ASI.  The tax paid will show up in the consolidated accounts of Apple Inc.

Apple accounts show that it makes a tax provision in its Profit and Loss statement of around 26 per cent of its pre-tax earnings.  However, if we look at the effective tax rates on its “foreign” and “domestic” (i.e. US)  earnings we see a wide divergence with the foreign tax rate being less than 10 per cent and the domestic rate seemingly more than 60 per cent.

Apple Tax Rates

The reason for the very large US tax rate is that the provision for US tax includes some of the US tax due on foreign earnings.  That is Apple owes very little foreign tax on the earnings of ASI – as they are generated by risks, functions and assets that are in the US – and makes a provision for some of the the US tax that is due on these earnings.  There are some who believe that this foreign/domestic split is real and that Apple is avoiding huge amounts of foreign tax but making sales abroad is not the same as making profits abroad.  The reality is that the foreign/domestic revenue split in Apple’s accounts does not reflect the position of its risks, functions and assets, so is not useful in helping to determine its tax liabilities. See section on ‘Shifting Profits Offshore’ on page 28 of the US Senate Report.  The tax should be due in the US but Apple have, somewhat artificially, been able to describe much of the income as “foreign” for US tax purposes.

Of course, providing for 26% tax and paying the tax are very different things.  In the case of ASI the payment only becomes due when Apple transfers the profit to a US-registered entity in its structure and it seems pretty clear that Apple is unlikely to do that anytime soon.  Should companies like Apple be able to defer, oftentimes permanently, the tax that is due on their profits?  No, but that is something for the US to remedy.  The point is that while the profits appear untaxed in ASI they are ultimately subject to tax in Apple Inc. 

But what if the profits of ASI were to be deemed taxable in Ireland?  All the noises are that this is a determination that the European Commission could make.  There seems little basis in fact to support it but I guess there are arguments that could be made.  These may be that:

  • ASI should be deemed tax resident in Ireland
  • ASI is an Irish-registered company
  • ASI has employees in only one country – Ireland
  • ASI only has substance through its Irish branch which is enough to deem the parent, which has no substance, taxable in Ireland
  • Such is the nature of the activities of the Irish branch that ASI’s sales should be considered to be fully completed by it

What happens if all of ASI’s profits are deemed taxable in Ireland? Without the exact calculations it is difficult to tell but if it does happen we will be really at the races and the talk will be of billions not millions. 

Assuming ASI performance in 2013 and 2014 tracked that of the overall company then the cumulative profit earned by ASI of the period from 2004 to 2014 is somewhere around €110 billion.  If we just do a crude approximation and apply a 12.5 per cent tax to that you get something approaching €14 billion.

ASI Notional Tax Due

And you can’t just rock up to the Revenue Commissioners in 2016 and say you want to pay tax due for 2004.  At the very least interest will be applied and the interest rate used by the Revenue Commissioners since 2009 has been the equivalent of eight per cent per annum.   If we apply eight per cent interest to this notional €14 billion of tax due over the ten years then the total liability approaches €20 billion.  If the interest rate set out in the EU’s state aid regulations is applied the total would be around €16 billion (as the interest rate is linked to market rates which have been significantly lower than eight per cent for much of the period.)

Is this something that could happen? It seems so though I still consider it unlikely.  Is this something that should happen? No.  There is almost no basis for any argument that 60 per cent of the profits of Apple Inc. over the period in question were generated by risks, functions or assets in Cork.  Even thinking that someone might suggest it seems foolish.  And if Ireland does take a big chunk of tax out of Apple’s profits then we can be sure there will be another hearing of the US Senate on this matter.  And this time they won’t be calling us a tax haven; they’ll be calling us a tax thief!

Thursday, March 10, 2016

Samsung in the UK and Ireland: where’s the outrage?

The ongoing debate over corporation tax has seen a lot of attention focused on US companies such as Apple, Google, Facebook etc.  It hasn’t been exclusively about US companies but has been predominantly so.  It can be hard to find non-US comparators for the likes of Google of Facebook but for Apple we can look at one its rivals in the consumer electronics market: Samsung Electronics from South Korea.

Samsung Electronics operates in the UK and Ireland through its subsidiary Samsung Electronics (UK) Ltd.  This company’s 2014 accounts state that:

During the year the company’s (the ‘company, being Samsung Electronics (UK) Limited) principal activities were as follows:

  • Importer, distributor and lessor of electronic and electrical goods
  • European head office
  • Purchase and sale of components and capital equipment
  • Provision of research and development services to the ultimate parent company
  • Importers and distributors of telecommunications systems

All of the above operations are UK based with the exception of two small research and development facilities in Israel and Finland and a branch office in Ireland.

How much revenue is generated by these activities? Quite a lot actually. 

Samsung Revenue

Samsung Electronics (UK) had revenue of £3.423 billion in 2013 and £2.605 billion in 2014 with almost all of this associated with activities in the UK and Ireland.  The reports states that:

The principal drive for the decline in turnover has been the performance of the company’s Mobile Phone division.

Samsung Electronics is a massive company that generates substantial profits.  Here is its consolidated income statement for 2013 and 2014 (in US dollars).

Samsung Consolidated Income

Profit before income tax was 16.8 per cent of revenue in 2013 before falling to 13.5 per cent of revenue in 2014.  The performance of Samsung Electronics (UK) is consolidated into the above income statement but if we look at the accounts for Samsung Electronics (UK) we can get its income statement.

Samsung UK P&L

Here we can see how the £3 billion or so of revenue transfers into profit. Profit on ordinary activities before taxation was £59 million in 2013 and £72 million in 2014.  This profit was 1.7 per cent of revenue in 2013 and 2.8 per cent of revenue in 2014. 

If you want to do silly things with the level of income tax reported you can say that tax was 0.4 per cent of revenue in 2013 and 0.6 per cent of revenue of in 2014.  That, of course, would be meaningless as tax is paid on profits not revenues.  But still the frothing at the mouth that Apple and Google have recently generated seems somewhat absent in the case of Samsung.  This can be seen with internet searches of [Apple tax UK] and [Samsung tax UK].

Is Samsung getting a “special deal” to allow it to pay £15 million of corporate income tax on £3 billion of revenues in the UK and Ireland?  No, this is the way corporate tax works.  By far the biggest cost for Samsung Electronics (UK) is buying the products it wholesales and retails in the UK and Ireland. Samsung UK doesn’t make the phones and other consumer electronics devices it sell; it has to buy them centrally from Samsung. And Samsung must charge Samsung UK the same price it would charge if it was selling them to a third party. 

Hence the largest cost for Samsung Electronics (UK) is cost of sales which is equal to about 80 per cent of turnover.  Is this transfer price right? I don’t know.  But it is what it is, a transfer price.  Where does it end up?  It goes where the value is added which in the case of Samsung is in offering a phone that people want to buy. 

Importing, distributing and wholesaling are not high-value-adding activities.  Designing and branding a phone that people want to buy adds value. If Samsung, presumably, does most of this in South Korea then most of the tax due on its profit is owed to South Korea.  Just like most of the tax that Apple and Google owe is due to the US. The fact that the US has a system that allows these companies to defer the payment of this tax, sometimes indefinitely, is a related but different matter.  The taxing right is the US’s to choose what they want to do with it.

Under the present system countries can tax the value-adding activities that take place in their jurisdiction.  And should go to all reasonable lengths to ensure that the right tax is paid on these activities – but this can only be under the rules as they stand.  There is no merit in complaints on the basis of sales or global profit margins.  But there have been plenty of complaints against Google and Apple on these bases.  But why the relative silence on Samsung? 

One reason is that to argue that companies are getting “special deals” you have to be selective in who you shout about.  If you start shouting about everybody then it must be that your beef if with the system and not the individual companies.  And that would be fair enough.  But that is not what is happening.  The complaints are usually along the lines of:

Google has £4.5 billion of sales to UK customers; Google has a profit margin or 20 per cent so it makes £1 billion of profit from these sales and therefore it should be paying £200 million of corporation tax to the UK (one source).


Apple has £10 billion of sales to UK customers; Apple has a profit margin of 20 per cent so it makes £2 billion of profit from these sales and therefore it should be paying £400 million of corporation tax to the UK (one source).

These then are used to declare that the amount of tax paid by these companies is “wrong” and that they are getting some form of special treatment.  If they were presented as an alternative way of determining corporate income tax liabilities that would be fine but they are presented as something that the companies should be doing and that HMRC should be enforcing.  But it cannot be enforced because it is not in existing law.  Location of customers and global profit margins are simply not features of corporation tax law.

So by all means present these approaches as an alternative but using them to suggest that tax payments under the existing system are wrong is misleading –at best!  And, of course, while these alternatives might bring in more tax from companies who sell to customers in the UK there would be offsetting losses of tax from UK companies who sell to customers outside the UK.  What is the balance of the two?  And small countries with successful companies would be absolutely battered by this system.  And you cannot have a system that picks and chooses which approach to use based on the nature of the company.

Anyway the main point is why don’t we hear the following:

Samsung has over £3 billion of sales to UK customers; Samsung has a profit margin of 15 per cent so it makes around £500 million of profit from these sales and therefore it should be paying £100 million of corporation tax to the UK.

Where is the outrage that Samsung are only paying one-sixth of that?

Tuesday, March 8, 2016

Calculating Google’s profit in Ireland – it’s not too difficult

Here are the top line figures from Google Ireland Ltd.’s profit and loss accounts for the three years to 2014.

Google Ireland Ltd P&L

There are two items to be considered in the transition from turnover to operating profit: cost of sales and administrative expenses.

The cost of sales item is relatively straightforward and quoting from Google Ireland’s accounts it is described as:

Cost of sales consists of traffic acquisition costs.  These costs consist of amount ultimately paid to Google Network Members, as well as to partners who directs search queries to Google’s websites.  These amounts are primarily based on revenue share arrangements under which the Company pays its Google Network Members and other partners a portion of the fees it receives from advertisers.

There is little to dispute here.  Google places ad on the websites of third-party hosts and pays them a share of the advertising revenue.  For the three years shown above Google Ireland paid out around 30 per cent of the revenue it received to sites that hosted its advertising.

OK, so now we are as far as gross profit.  The next item is administrative expenses.  There is a little complication here as the actual process is somewhat the reverse of what is shown in the profit and loss account.  The P&L shows operating profit as been the result of the subtraction of administrative expenses from gross profit.  In reality, though, the operating profit figure is determined first and the administrative expenses figure is reverse engineered to give the operating profit figure.

By far the largest component of administrative expenses is the license royalty that Google Ireland Ltd. pays for the rights to sell advertising using Google’s platform and technology.  There are no details on this fee in Google Ireland Ltd.’s accounts but the accounts of the payee, Google  Netherlands Holdings Ltd. do tell us how much is paid by Google Ireland Ltd. each year.   These figures were:

  • 2014: €9,221.6m
  • 2013: €8,482.5m
  • 2012: €8,554.7m

Using these we can get the levels of administrative expenses excluding the royalty payment.

Google Other Expenses

From this we can see that for the past three years Google Ireland’s operating profit has been around 6 per cent of its expenses (excluding the license payment).  And, albeit in rough terms, this is how the profit of Google Ireland is calculated – it is determined on a cost-plus basis.  We don’t know the precise formula used and there are likely to be some non-qualifying items in the “other administrative expenses” figures shown above.  A cost-plus agreement of eight per cent of qualifying expenses may be what is applied but we can’t tell that from the published accounts.

Is there anything untoward about this? Not at all. Cost-plus agreements are a standard feature of transfer-pricing agreements.  Is the cost-plus agreement the appropriate one to use?  Well, there is no right or wrong answer to this.  If you want to argue the toss the OECD have this useful guide to the methods available.

We can get some insight into the expenses incurred by Google Ireland from its accounts.  We that depreciation is around €50 million a year with compensation of employees coming in at around €300 million a year.  But even with the items listed most of the expenses are in the balancing item of “residual expenses” in the table below.

Google Other Expenses Breakdown

Google Ireland’s accounts don’t tell us what these “residual expenses” (my description) are but we can see them in the revenues of other Google companies such as Google UK, Google France, Google Italy etc.  These are the amounts that Google Ireland pays to subsidiaries in the countries in which it sells advertising for “sales and marketing services”.  A scout around the accounts for the various Google Ireland subsidiaries throws up the following figures for payments received from Google Ireland Ltd. over the past few years.

Google Other Expenses To Markets

It can be discerned that these payments make up the bulk of Google Ireland’s expenses (excluding the license fee).  By adding in all the markets which Google Ireland sells into would get us pretty close to the total required. 

Ireland is free to challenge the cost-plus method used to determine the operating profit in Ireland and the other countries can challenge the basis used to determine the basis used to determine the operating profit of the Google subsidiaries in their country or look to see if Google Ireland has a permanent establishment, or taxable presence, in their jurisdiction.  HMRC have just completed a six-year audit on this basis in the UK and both the Italian and French tax authorities are looking at Google’s structure.  See previous discussion of these here.

Google Ireland’s operating profit is a function of its expenses.  These expenses include the staff and other costs that are incurred in Ireland and also possibly the payments made for “sales and marketing services” to subsidiaries in the markets into which Google Ireland sells.  If these expenses go up (i.e. the company gets bigger) then Google Ireland’s operating profit will go up.  Google’s profits in Ireland are not a function of revenue though are continually presented in that fashion.  And Google then pays 12.5 per cent Corporation Tax on those profits. It’s not that difficult.

Friday, March 4, 2016

On the distribution of income

There are lots of silly things that can be done with income distribution statistics.  Here is another to add to the list.

Decile Shares of Equivalised Disposable Income

The above tables shows the share of equivalised disposable income going to each income decile in the 28 Member States of the EU.  Two countries are highlighted: Ireland and Sweden.

Some commonly used summary statistics of the income distributions in both countries:

1: Gini Co-efficient (zero being complete equality)

  • Ireland: .307
  • Sweden: .254

2: 80/20 Quintile Share (zero being complete equality)

  • Ireland: 4.7
  • Sweden: 3.9

On both measures Sweden has a more equal distribution of equivalised disposable income than Ireland.  However, the table above shows that these summary statistics can miss some of the detail.  In this instance it is the share of equivalised disposable income that goes to the middle of the income distribution.

In Sweden, 37.6 per cent of equivalised disposable income accrues to those from the fourth to seventh deciles; for Ireland it is 34.1 per cent.  If the share of income in this middle range of the Irish income distribution matched that of Sweden then these households would have around €3 billion extra of disposable income or nearly €5,000 per household.  This would come from a reduced share at the top of the income distribution.

Sweden doesn’t follow the “ideal” position in the table above of starting in the top left corner with a relatively high income share to the lower deciles and moving to the bottom right corner for a relatively low income share for the top deciles. Sweden starts off the in middle of the ranking for the bottom deciles and then rises to having the highest income shares in the middle before moving to having the lowest income share for the top decile.  Ireland pretty much starts at the same position for the bottom decile but moves in the opposite direction through the deciles.

Of course, there can be a multitude of reasons why the income share in the middle of the distribution is much greater in Sweden than in Ireland – earnings, taxes and transfers among others all play a role.  We don’t address those here but are merely pointing out that the difference exists.