Joe Garza: Double Irish Elimination, Easier Said than Done
Last month, the Irish Finance Minister announced that the Double Irish, a well-known tax inversion tactic, would likely be eliminated starting in 2015. The changes could have major ramifications for several U.S. based tech companies. Much to our relief, this should have no effect on the production of Irish whiskey. It will, however, leave the United States government with a headache as it continues struggling to find ways of taxing corporate profits held in foreign subsidies.
With policy change on the horizon, tech companies are watching closely. Multinational technology companies such as Google and Apple have large amounts of intangible property which is especially well-suited for the Double Irish strategy.
“Governments must tread lightly when it comes to regulating against tax inversions.” remarked Joe Garza, a tax lawyer with clients in over 27 countries. “These tech companies create thousands of high-quality jobs and the last things a country like Ireland wants to do is send them running to a more tax friendly nation. Meanwhile, the United States expects other nations to do most of their regulating work for them to force more the tax dollars back home. That stance is inherently flawed.”
Further frustrating the U.S. Government is an important exception for companies who currently use the Double Irish strategy. They will be “grandfathered” in and allowed to use the scheme until 2021 giving the Irish government time to accommodate these foreign companies who are very important for their economy.
During a recent Senate sub-committee hearing formed to discuss the corporate tax issues facing the U.S., Apple CEO Tim Cook testified saying, “Apple’s Irish unit is simply an efficient way to manage cash that has already been taxed in other jurisdictions. It doesn’t avoid U.S. taxes.” Cook went on to say that he stands by Apple’s navigation of the tax code and that they have done nothing illegal.
To understand the changes are being proposed, we take an in-depth look at how the Double Irish has worked thus far.
Double Irish 101
The United States has one of the highest corporate tax rates in the developed world; a corporation organized under U.S. law faces a federal tax rate of 35 percent on its worldwide profits. Because foreign profits are not taxed until they are repatriated to the United States, several U.S. corporations have set up foreign subsidiaries to manage their global profits and minimize the amount subject to the steep 35 percent tax rate of the U.S.
The Double Irish involves a U.S. corporation creating two Irish subsidiaries. Joe Garza explained that Ireland is an ideal place for the tactic because, “Ireland has a unique combination of attractive traits: an English-speaking population, the economic and treaty benefits of European Union membership, a low corporate tax rate of 12.5 percent, and a well-educated workforce, particularly with respect to technology.”
Here’s how it works:
- A U.S. corporation, let’s call it Big Megatech, transfers intangible property rights (intellectual property such as patents) to a subsidiary, Little Megatech, which is organized under Irish law but controlled in Bermuda, a country with no corporate income tax. Little Megatech is a resident of Bermuda for Irish tax purposes even though it is formed under Irish law. Under Irish law, a corporation’s domicile is where its management is located, not where its incorporation occurs. However, U.S. law treats Little Megatech as an Irish company.
- Little Megatech now owns the intangible property rights and its income from such property rights is a foreign-source and not subject to U.S. tax unless it repatriates profits to its U.S. parent Big Megatech.
- Little Megatech then forms a new Irish entity, Little Megatech II, which elects to be treated as a disregarded entity under U.S. law. The U.S. government views these both subsidiaries as the same entity, but Irish law views them as distinct corporations.
- Little Megatech licenses the intangible property to Little Megatech II in exchange for royalty payments from Little Megatech II who makes sales to the public outside of the United States.
- Under U.S. law, the royalty payments from Little Megatech II to Little Megatech are ignored because they are disregarded as separate entities. But under Irish law, Little Megatech II, an Irish corporation, is treated as making royalty payments to Little Megatech, a Bermuda corporation. Little Megatech II can deduct these royalty payments as a business expense under Irish law, which greatly reduces their income. The remaining income is taxed at Ireland’s maximum 12.5 percent corporate tax rate on active businesses.
- Under U.S. law, the income of Little Megatech is foreign-source and not connected with the U.S., thus it is not taxed by the U.S. If Little Megatech repatriates the income to its U.S. parent, Big Megatech may owe U.S. tax. However, Little Megatech can hold on to the income for as long as it wishes and does not need to repatriate it.
Hungry for more? The Double Irish with a Dutch Sandwich explained
The Double Irish with a Dutch Sandwich is a variation of the Double Irish that utilizes tax treaties among European countries to procure even greater tax benefits. Named for the Netherlands based subsidiary that acts as the “meat” between the two companies formed under Irish law, the benefit of the Dutch Sandwich lies in the fact that it eliminates Irish withholding taxes on the royalty payments between subsidiaries that might otherwise apply.
In a Double Irish with a Dutch Sandwich, Little Megatech licenses its intangible property not to Little Megatech II, but rather to Little Megatech III, a subsidiary
incorporated in the Netherlands. In turn, Little Megatech III licenses the property to Little Megatech II in Ireland. In exchange for the license, Little Megatech II pays Little Megatech III royalties, which in turn transmits the royalties to Little Megatech the original subsidiary in Bermuda.
But why the interposition of the Netherlands? The reason is that, in the Double Irish, the royalty payments Little Megatech II makes to Little Megatech can be subject to mandatory withholding under Irish law. Such withholding taxes are common in the international arena, such as when U.S. companies pay dividends to foreign shareholders.
But due to applicable treaties and European Union rules, Little Megatech II can move the royalties in Ireland to Little Megatech III in the Netherlands with no Irish tax because both are European countries. Little Megatech III transmits these royalties to Little Megatech in Bermuda, with the only “toll charge” being a very small tax imposed by the Netherlands as a result of a treaty.
The planned 6 year grace period for the companies already using the Double Irish strategy only compounds the headache for the U.S. government. Attorney Joe Garza has little sympathy for plight regulators saying, “the hope is that the grace period will give the Irish government time to configure a less dubious arrangement, although they have no obligation to fight the United States’ tax battles for them.” A likely solution is already being used in the UK employs a “Knowledge Development Box” that allows companies to separate income streams stemming from intellectual property and pay a different tax rate on them.
Meanwhile the United States has said it will focus on its own fight against tax inversion. This year has already seen the Foreign Account Tax Compliance Act (FATCA) put into effect to find and punish wealth individuals who hide money overseas. Now U.S. Treasury Secretary Jacob Lew is making it a priority to crack down on tax inversions through new regulations in the coming year.
President Barack Obama praised the announcement despite critics who are concerned the new measures will scare businesses ever further from American soil. But with a grid-locked congressional system and the President’s attention shifting towards immigration reform, the chances of achieving the bi-partisan tax overhaul necessary to truly fight tax inversions look slim.
Until that happens, the Double Irish will continue to be a thorn in the IRS’ side for at least 6 more years.