DONALD Trump achieved his first major legislative victory in December with the passage of the new US tax act. The act rewrites the fundamentals established in the era of John F Kennedy more than half a century ago. In terms of how business taxes are structured, it is genuinely historic.
Because of the significance of US multinationals to the Irish economy, details of the legislation were eagerly awaited here. In the rush to record a legislative victory for President Trump within a year of taking office, however, many of those details remain to be fleshed out.
These will be provided in US Treasury guidelines to be issued over the coming years as bugs in the system come to light. This means there is still a high degree of uncertainty as to the precise implications, either for individual firms or for countries like Ireland.
The reception by US companies has been extremely positive. The details that have made the headlines have all been skewed towards favouring them.
The most straightforward is the huge reduction in the federal corporate tax rate. At 35pc, the old rate was among the highest in the world.
The new rate of 21pc is much closer to that of other large economies. The former high rate led to all sorts of distortions as US corporations did everything they could to avoid it. One increasingly common response was to ‘re-domicile’ – which meant changing nationality.
This entailed ‘reversing’ into a foreign corporation in a merger with the US corporation.
Medtronic became an Irish company in this way. Burger King became Canadian. Many others became British.
Another factor driving the desire to change nationality was that the US taxed its corporations on their global profits, while most other systems tax companies only on their domestic profits.
The second major component of the Trump tax change entailed a shift in this direction. This move towards a ‘territorial’ tax system is something that Republicans have long supported. Together these two changes remove the incentive for US corporations to redomicile. In the long run, this should increase the attractiveness of the US as an investment location compared with overseas. Both changes will be damaging to the US exchequer. The Trump administration, however, will gain a much-needed short-term revenue boost through the third major change – a range of once-off taxes on profits that US corporations currently hold offshore.
Under the old system, payment of US taxes on foreign profits could be deferred. Tax was payable only when profits were repatriated to the US. Some $3trn (€2.43trn) in foreign profits is kept offshore; perhaps around half of it in cash.
These offshore profits could provide security for borrowing in the US, and the borrowings used to finance new investments or buy-backs of shares. Capital gains could be generated for shareholders while US tax bills remained unpaid.
Under the new legislation, these offshore profits are to be hit with a once-off tax, which removes the incentive to keep the cash offshore. The administration hopes that much of the cash that is returned to the US will be invested in job-creating projects, although not everyone is convinced.
The US corporate tax framework that the December changes replace was based on a 1962 compromise between the Kennedy administration and Congressional Republicans. The most complex issue in both frameworks was the tax treatment of intellectual property (IP).
IP assets such as patents and trademarks are inherently mobile. If they can be lodged offshore, then the licence fees paid for their use by the US company count as an expense and serve to reduce the company’s US tax bill.
Best of all for the company, of course, is if its IP assets can be lodged in a jurisdiction like the Cayman Islands that levies no corporation tax.
The importance of IP has grown massively over the years. Most multinational profits these days derive from the value of brand names and patents.
The Trump administration’s attempts to tackle IP offshoring are crucial to ensuring that the shift to a territorial tax system does not undercut the administration’s ‘America first’ agenda.
To square the circle, a host of subsidiary rules, of both the carrot and stick variety, have been introduced to deal with IP assets.
Among the sticks is a requirement that US corporations pay a minimum tax rate of 10.5pc on IP profits. This represents much less of a disadvantage to Ireland, with its 12.5pc rate, than to the Caribbean jurisdictions; although it is not yet clear if it wipes out the benefits from Ireland’s recently established Knowledge Development Box.
The ‘carrot’ on offer is a tax break for US corporations that keep their intellectual property assets in the United States. Export profits derived from these intangibles will be taxed at a preferential rate of around 13pc rather than the new federal tax rate of 21pc.
Ireland’s corporate tax rate will be only slightly lower than this preferential US rate, but even a very thin margin on vast amounts of profit can represent a considerable incentive to locate and export from Ireland. Clarity will likely have to await the publication of the US Treasury rules and guidelines.
These, in turn, will be influenced by the practices adopted by multinational corporations in the intervening period.
EU finance ministers have written to the US authorities to complain that this implicit export subsidy is in breach of World Trade Organisation rules.
This introduces further uncertainty into the calculations.
If the Trump Administration succeeds in preventing the offshoring of intellectual property from the US, it will, paradoxically, have achieved something that Congressional Democrats have long desired.
Where would this leave Ireland? A move away from IP and a return to that more old-fashioned world where foreign direct investment was sought for the employment, upskilling and upgrading advantages it brought might be no bad thing.
Ireland’s low tax rate will continue to make it an attractive European location, offsetting the natural advantages that accrue to countries like Germany and France on account of their size, centrality and infrastructure.
President Trump tweeted that his new legislation would allow tax returns to be “filed on a postcard”.
Hardly. The new business tax legislation is, if anything, more complex than the old. ‘Aggressive’ tax planners thrive on complexity. They have been rubbing their hands in glee since the publication of the ‘Tax Cuts and Jobs Act’.
There may be one further unanticipated benefit for Ireland.
The Government has questioned the European Commission’s demands that it collect the back taxes allegedly owed by Apple, insisting that these taxes are owed to the US rather than to Ireland.
Apple will now be paying the new once-off US tax on these and all its other offshore profits. The headline writer’s dream seems one step closer: ‘EU case against Apple crumbles’.
EU finance ministers have written to the US to complain that this implicit export subsidy is a breach of WTO rules
Frank Barry is Professor of International Business and Economic Development at Trinity Business School
US President Donald Trump signed a tax-overhaul bill into law in the White House late last year. Photo: AFP/Getty