Foreign Income & Taxpayers
Ireland currently faces escalating pressure from the international community to scale back its business-friendly tax policies. For example, in a report published in late 2014, the European Commission accused Ireland of providing transfer-pricing rulings so beneficial that they rose to the level of unlawful state aid to Apple Inc. Additionally, the Organisation for Economic Co-operation and Development's (OECD's) Base Erosion and Profit Shifting (BEPS) project continues to gain momentum toward greater international tax law uniformity. In response, Ireland's finance minister announced changes to the residency rules for corporations in Ireland.
Approximately 1,100 multinational companies operate in Ireland; many of them use a technique known as the Double Irish to save on taxes. For U.S.-based multinationals, the Double Irish structure is particularly helpful because of the difference between U.S. and Irish tax law regarding tax residency. In the United States, a corporation is treated as a tax resident in the country under whose laws it was formed. However, Ireland treats certain corporations as tax resident in the country where central management and control is located. This difference allows a U.S.-based multinational group to incorporate a company under the laws of Ireland while structuring operations such that it is considered a tax-haven resident under Irish tax law.
The Double Irish structure involves two Irish companies, one of which is the subsidiary of the other. The Irish subsidiary company is a tax resident in Ireland under both U.S. and Irish law. However, another mismatch is created through an entity-classification election, commonly known as a check-the-box election under U.S. tax law, to be a disregarded entity (DRE), while remaining a corporation under Irish tax law (i.e., a hybrid entity).
The Irish parent company (IPCo) often purchases foreign intellectual property (IP) rights from its U.S. parent through a platform contribution transaction and then co-develops future IP through a cost-sharing agreement—both mechanisms described and allowed under the U.S. tax rules. IPCo then licenses the IP to its Irish resident subsidiary (OpCo), which is typically responsible for worldwide business activities in all territories outside the United States. OpCo pays a royalty to IPCo, which reduces the taxable profits in Ireland. But the royalty payment is disregarded for U.S. tax purposes because of the check-the-box election to make OpCo a DRE; thus, subpart F anti-deferral rules are not triggered by this royalty income stream. Hence, a large portion of the foreign earnings are taxed in a country with a low or no tax rate, while the remainder is subject to a low Irish corporate tax rate of 12.5%.
Contrary to Popular Belief, the Double Irish Is Not Dead
While either the United States or Ireland could have amended its tax rules to remove the legal asymmetries that make a Double Irish strategy possible, Ireland made the first change. Beginning on Jan. 1, 2015, Ireland amended its statutes to provide that new companies incorporated in Ireland will be treated as Irish tax residents by default. For previously existing companies, the current regime will grandfather structures in place before 2015 until the end of 2020, subject to limitations such as a change in ownership or the nature of the business.
After the announcement of this change in Irish tax law, many advisers and reporters rang the alarm bells that Ireland had imposed a death sentence on the Double Irish structure.
However, a closer examination of this change and other untouched areas of Irish law illuminates another route by which companies may be able to achieve similar benefits.
Ireland's treaties override domestic tax law provisions, and the recent change in statutory residence rules will affect neither Irish tax treaties nor the override. Under most Irish tax treaties, an entity that is resident in both Ireland and a treaty country will be deemed a resident where it is effectively managed and controlled. This provision is commonly known as a residency tiebreaker because it determines the ultimate tax residency of an entity otherwise considered a resident in both countries under their respective statutory laws (i.e., a dual tax resident). Thus, an Ireland-incorporated organization that is effectively managed and controlled in certain tax treaty jurisdictions may be considered a nonresident in Ireland.
Choosing a Treaty Jurisdiction
When analyzing Irish tax treaties to find where to place effective management and control of an Ireland-incorporated entity, multinationals should seek the alignment of three key factors. The jurisdiction should have (1) an attractive corporate tax rate; (2) tax residency under both local law and its treaty with Ireland, based on place of management and control; and (3) a royalty article requiring little or no withholding tax (although the royalties may also be exempt from withholding tax under Irish statute if not made with respect to an Irish patent and not made annually).
Additionally, an important difference between Irish and U.S. tax treaties is that Irish tax treaties generally do not have a limitation-on-benefits (LOB) clause. LOB provisions of U.S. treaties typically deny or curtail treaty benefits to entities that are not engaged in an active trade or business or that lack a minimum percentage of owners resident in either treaty jurisdiction (or an equivalent jurisdiction). While Irish treaties generally do not have LOB provisions, some do contain protocols discussing the application of treaty benefits. Ireland also has a general anti-avoidance rule multinationals should consider when planning a structure.
Several jurisdictions may meet these criteria, including Bahrain, Malta, and the United Arab Emirates (UAE), which includes Dubai. These countries have attractive corporate income tax rates. Bahrain taxes only entities engaged in the hydrocarbons sector. Dubai has a nominal tax rate of 55%, but in practice it collects taxes only from hydrocarbons companies and banks. Entities based in the Dubai Free Zones may receive specific tax exemptions.
Malta has a 35% statutory rate; however, companies incorporated outside Malta (nondomiciled) but managed and controlled in Malta (resident) should be taxed only on income received in Malta. Malta also provides an income tax exemption on royalties received as a result of licensing qualifying patents. Each of these countries also has similar residency tiebreaker provisions in its treaty with Ireland—based on place of effective management and control. Lastly, the UAE and Bahrain treaties provide for 0% royalty withholding tax rates, and the European Union (EU) Interest and Royalties Directive brings the Malta royalty withholding to zero.
With the initial criteria satisfied, the next step is to examine the treaty protocols to determine any extra steps to claiming benefits. The Malta protocol is silent on residency issues. The UAE protocol is ambiguous. Article 5 of the Ireland-UAE treaty has a residency tiebreaker clause based on place of management. However, paragraph 2 of the protocol adds that, notwithstanding the language in Article 5, a person shall be regarded as a UAE resident if that person "shall pay income tax or corporate tax in the [UAE] on income, by reason of domicile, residence, place of management or any other criterion of a similar nature, where that person is in receipt of income" (paragraph 2(a)(iv)). It is unclear whether simply being liable to pay tax is enough, or if a person must actually pay taxes.
Moreover, paragraph 3 of the protocol also states that a "company which is incorporated and has its place of effective management in the [UAE] shall" be entitled to a UAE tax residency certificate (emphasis added). The treaty is unclear whether a company that is not incorporated in the UAE but has its place of effective management there may also receive a tax residency certificate (i.e., is the protocol a safe harbor or a limitation?). In practice, the UAE has issued tax residency certificates only to companies incorporated in the UAE. The Bahrain protocol is clearer on this point. It states that a "company which is incorporated, or has its place of effective management, in Bahrain shall" be entitled to a Bahrain tax residency certificate (emphasis added). The use of "and" versus "or" may make all the difference.
Finally, multinational groups should consider qualitative factors, such as where their current offices, entities, or operations are located. Another factor is the longevity of the structure. As the EU and OECD continue to apply pressure against tax incentives, Malta may amend its tax laws before the Persian Gulf states do so in response to international pressure.
Final Thoughts
While many have declared the recent change in Irish tax law as the death of the Double Irish, those reports are greatly exaggerated. However, this scenario underlines the importance for every multinational group to have a sound exit strategy prepared for a time when tax laws change and opportunities evaporate.
Recognizing that capital is mobile, Ireland appears to be developing a range of options through signing in recent years the tax treaties discussed above, while also encouraging on-shoring of IP through a newly proposed "knowledge development box," favorable IP depreciation deductions, the research and development refundable tax credit regime, and a commitment to the 12.5% corporate tax rate on trading profits.
The OECD recently published a report on Action 6 of the BEPS Project, titled Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. The OECD set out to "ensure that profits are taxed where economic activities generating the profits are performed and where value is created." A final report is expected in September 2015. However, the extent to which adopting a U.S.-style LOB would actually change things is uncertain. A multinational group may still satisfy a typical LOB through putting some full-time employees on the ground (which may be an acceptable cost, considering the overall tax savings) or by having a parent company traded on a "recognized stock exchange." (For more on this, see "OECD's Draft Proposal on Treaty Shopping, Treaty Abuse Situations," The Tax Adviser, March 2015.)
Considering the OECD's BEPS project, the EU's investigations into the tax ruling practices of member states, and the United States' current focus on tax reform and changing rules to discourage companies from keeping profits offshore, multinational groups should prudently consider their options.
EditorNotes
Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Bethesda, Md.
For additional information about these items, contact Mr. Anderson at 301-634-0222 or kdanderson@bdo.com.
Unless otherwise noted, contributors are members of or associated with BDO USA LLP.
