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Ireland

Joe Tynan and Karen Kiernan
PwC
Ireland

The case for inward investment into Ireland remains strong, believe Joe Tynan and Karen Kiernan of PwC.

The sun still comes up, the wheels of commerce keep turning... and all the other usual clichés abound. And so continues to be the case for Ireland. Despite the economic downturn, bad publicity and even the wider Euro-zone crisis, Ireland is still open for business and attracting foreign investment. Inward flows of foreign direct investment (FDI) to Ireland increased to US$26.3 million in 2010, up 1.5% on 2009 and up a staggering 260% on the negative $16.4 million low of 2008 when global FDI flows collapsed as a result of the global recession, a World Investment Report from July shows. The 2010 inward FDI amount is only slightly behind the FDI peak in 2007, highlighting that Ireland is still an attractive location for foreign investment.

The reason for Ireland's continued success in attracting foreign investment is simple; the fundamentals have remained constant and any add-ons have enhanced the overall package available to foreign investors.

Critical success factors

No single factor is responsible for Ireland's continued success in attracting foreign investment. Arguably the combination of four key areas positions Ireland as a leading location for FDI: tax, talent, ease of doing business, and a free and open economy. In more recent years where cost reduction has been paramount, cost competitiveness has significantly moved up the priority listing with the result that a competitive tax regime and competitive cost base are now the most critical areas affecting the investment location decision.

Ireland's low corporate tax rate and competitive tax regime is long-established and envied by other players in the FDI space. Ireland offers a competitive tax regime for all sectors and investors which is recognised as being open, transparent and pro-active in adapting to the needs of international FDI.

Key advantages include:

• Flat 12.5% tax rate for active business profits;
• Attractive R&D tax credit regime;
• Efficient IP holding company regime;
• Competitive holding company regime including participation exemption on gains and effective exemption on foreign dividends and branch profits through a foreign tax mechanism;
• Generally no outbound withholding taxes under domestic provisions (as opposed to reliance on double tax treaty arrangements);
• No thin capitalisation or controlled foreign corporation (CFC) provisions;
• Access to EU directives and extensive tax treaty network, and
• Availability of various tax-efficient investment platforms.

By and large though, it is the much-vaunted low corporate tax rate that is often perceived as the real jewel in the crown.

Low corporate tax rate is here to stay

Comments made in the context of Ireland's bail-out in late 2010 led many to believe that Ireland's low corporate tax rate (the 12.5% rate) on active trading profits was under pressure to be raised as a trade-off for the bail-out from the EU/IMF. Not so. In fact the current Irish government (in power since March 2011) is as committed to the 12.5% rate as with previous successive governments, reiterating that the 12.5% rate is a cornerstone of Irish government and economic policy and is, most importantly, here to stay.

Since the 1950's Ireland has had a low corporate tax regime and it has been an essential part of Ireland's economic development policy, driving both growth in the domestic economy as well as attracting FDI. In line with a government decision of May 1997, the standard rate of corporation tax was reduced on a gradual basis from 38% in 1997 to a rate of 12.5% on trading profits from January 1 2003. Passive income and income from certain excepted trades (e.g. mining, petroleum activities and trading in development land) are taxed at a higher rate of 25%, as are company capital gains.

Ireland's 12.5% rate does not discriminate based on company size, industry sector, or ownership. It is open and transparent and is fundamentally a low tax rate applied to a broad base. For these reasons it was blessed by the EU as not being a State-aid or running counter to the EU Code of Conduct on Tax Competition.

Despite the relatively low tax rate, Ireland is not "low tax" in corporate tax revenue terms. As a percentage of GDP, corporate tax revenue is relatively high by EU standards – 2.8% in 2008, versus Germany at 1.9%, and an EU average of 2.7%. So our "low rate" is clearly successful in attracting investment and yielding corporate tax revenue.

The single 12.5% rate on trading profits has, over the years, become akin to a brand name associated with Ireland; it's single rate simplicity being a huge part of the attraction. Stability in the corporate tax rate and the Irish tax regime is critical to investors. Accordingly, the Irish Government has consistently reiterated, and continues to reiterate, that any changes (whether an increase or decrease) to the 12.5% rate is a non-negotiable matter. There is no debate; the 12.5% rate on trading profits is here to stay!

CC(C)TB – threat or opportunity?

On March 16 2011, the European Commission proposed a directive for a common system of calculating the tax base of businesses operating in the EU – the common consolidated corporate tax base (CCCTB). This is a single set of rules which companies operating within the EU could opt to use to calculate their taxable profits. Companies would file just one tax return for all their activities in the EU. Once the base had been calculated, pursuant to the "consolidated" piece of the proposal, the base would be redistributed amongst the relevant member states participating in the CCCTB using certain apportionment criteria (labour – payroll and number of employees, assets, and sales).

However, the CCCTB proposal has been met with resistance in one form or other from a number of the 27 EU member states. Ireland, the UK, the Netherlands, Poland, Bulgaria, Romania, Slovenia, Sweden and Malta formally voted against the present CCCTB proposal on the basis that they believe it does not comply with the EU principle of subsidiarity. The German parliament also raised objections to the "consolidation" piece of the proposal concluding that the apportionment methodology would erode Germany's tax revenue.

What this means for the CCCTB proposal, in its present format, is still to be finally determined. But it is likely that the raised objections to the CCCTB proposal have dealt a serious blow to the present proposal ever seeing the light of day.

What seems to be more palatable, and what Germany favours, is a mandatory common corporate tax base without consolidation – a CCTB. In other words, a uniform system of calculating corporate profits from all companies in the EU, but where each member state would retain its taxing rights (at its own domestic corporate tax rate) on the taxable profits declared by companies resident in its territory calculated under new common rules.

Indeed, on August 16 2011, the leaders of France and Germany outlined plans for economic integration in an effort to restore confidence in the Eurozone. As part of these plans, the two countries have announced that they intend to adopt a common corporate tax rate and base by 2013. The broad principles of the French and German tax systems are very similar so the proposal may not result in a significant change in the tax base of either country.

While the proposal is an independent agreement between France and Germany, when and if France and Germany agree a common corporate tax base, there may then be pressure for other EU member states to adopt the same corporate tax base – again back to a CCTB.

The CCTB version of the plan would look, at least in principle, to be something that Ireland would engage in discussions on. Arguably the transparency of a common set of rules to determine the tax base throughout the participating states would highlight the benefit of Ireland's low 12.5% rate as compared with special regimes and ruling systems which are now in place in other member states. But the devil is in the detail and Ireland may be unwilling to agree to a common tax base if it has a knock-on impact (either upwards or downwards change) to the 12.5% rate. As outlined above, stability is the key to the 12.5% rate and Ireland will have to be mindful of the potential impact on the 12.5% rate of any CCTB proposal.

There is a long road ahead on CCCTB (or even CCTB). What is clear is that the EU is committed to some or other form of CC(C)TB and at this juncture any new proposal is unlikely to contain a consolidation clause. However, from Ireland's perspective it would appear that the "threat" of CCCTB as it was proposed in March 2011 seems to have passed and it will have to wait, along with the other EU member states, to see what a revised proposal may look like.

R&D tax credit mechanism

Enhancements to Ireland's tax regime over the last few years have positioned Ireland at the forefront of locations to develop, manage and exploit intellectual property. The government policy objective to develop Ireland as a global innovation hub has been instrumental in the development of the IP regime (which permits the amortization of acquisition costs incurred on qualifying IP) and the introduction of a Research and Development (R&D) tax credit.

In particular, in today's economic environment where cost is driving a number of the investment decisions, Ireland's generous R&D tax credit mechanism is a much-welcomed financial incentive that can help to improve Ireland's standings in the cost competitiveness stakes. Recent studies show that on average general costs of doing business in Ireland are back to 2003 levels (i.e. pre-boom levels) and that Dublin has fallen to 58th place, a fall of 16 places since 2009, in the rankings of the world's most expensive cities according to a Mercer survey. Layering the R&D tax credit incentive on top of the fall in general business costs can further decrease the cost of doing business in Ireland.

The Irish R&D tax credit mechanism is now recognised as being one of the most attractive R&D tax credit regimes globally; ranking seventh behind France, Spain, Canada, India, Brazil and Hungary according to a 2009 Canadian Department of Finance Study. In particular, the ability to monetise the tax credit immediately and the ability to include the credit "above the line" in the P&L ensures that there can be an immediate cash and/or P&L benefit for the R&D tax credit which can reduce the unit cost of R&D spend considerably – something that is critical for MNCs in today's environment.

The R&D tax credit mechanism provides for a 25% tax credit that can be offset against corporate taxes for incremental qualifying R&D spend over a base year spend (2003 has been set as the base year indefinitely). The tax credit is in addition to the corporate tax deduction at the rate of 12.5%, giving an effective tax benefit of 37.5% for qualifying expenditure.

The definition of what qualifies as R&D is broad, including basic research, applied research or experimental development, and provides an opportunity for a range of companies across a broad spectrum of industry sectors including those outside the typical domain of R&D, such as financial services, to benefit from the R&D tax credit.

The R&D tax credit may be monetised to allow companies to access cash tax benefits much earlier in the R&D/IP lifecycle. In the first instance R&D tax credits are offset against a company's present corporation tax liability. Any excess credits may then be carried back and offset against a corporation tax liability of the prior year; thereby generating an immediate cash refund of taxes paid. Any remaining R&D tax credits in excess of the present and prior years' corporation tax liabilities may be repaid over a three year cycle. The repayment is limited to the greater of the corporation tax payable by the company in the preceding 10 years or the payroll liabilities (PAYE/PRSI/Levies) for the period in which the relevant R&D expenditure was incurred.

In line with a recent clarification to the legislation, companies have the ability to account for the credit "above the line" in the P&L account under both US and Irish GAAP, thereby immediately impacting on the unit cost of R&D, which is the key measurement used by MNCs when considering where to locate R&D projects.

Accordingly, the potential impact of the Irish R&D tax credit mechanism should not be overlooked when making an investment location decision. There are real and immediate benefits to be realised under the Irish R&D mechanism which can significantly influence the decision of where to locate the R&D activity. Allied with the other key features of Ireland's tax regime and the falling cost base, the case for Ireland is strong.

Joe Tynan (joe.tynan@ie.pwc.com) is a partner and Karen Kiernan (karen.m.kiernan@ie.pwc.com) is a director in the foreign direct investment group of PwC