Ireland, a country known for U2 and Guinness, is more known in the business world as a tax haven. Ireland is in the same group as Luxembourg and Bermuda; countries with no physical resources as well as human capital. However they leverage their business regulation in order to attract companies by offering a business friendly environment and low taxation on companies incorporated.
Take Ireland, who has been under the international crosshair for a while due to its “Double Irish” tax law (“Dutch sandwich” in the Netherlands), and no that is not a drink. This little loophole is the reason Apple paid an astounding 2% on its profits in Ireland where the corporate tax rate is 12.5%. The key to the law is the fact that parent companies and subsidiaries are separate legal and tax entities.
If companies were able to move goods and services around in an arm’s length way between each other, wouldn’t it be good to channel the profits towards a country with a low or 0% tax rate.
For example, imagine subsidiary X in Ireland and Manager Y that controls it in tax haven Bermuda. Every time the subsidiary makes a profit it gets transferred to Y. Therefore it gets taxed less or not at all – since that profit counts as Manager Y’s profits. Since there is no need to repatriate the capital back into the US, this results in a low single tax rate. Had the subsidiary been based in a country such as the US, that same subsidiary would like be facing a tax bill in the 40% range. This explains the large cash position that Apple has overseas, much more than the cash position in the US.
Of course, not every company can take advantage of this double Irish loophole. The rules benefit mostly technology and pharmaceutical companies. Why? Because these companies own intellectual property. Why is that important? In transferring the profits from subsidiary X to Y, the company require a “legitimate” reason to pay Y. Even the rules state that companies cannot simply transfer profits from Ireland to a low tax haven for the sole purpose of paying lower taxes. The loophole around the legislation is to come up with a legitimate reason for having to pay Manager Y in Bermuda.
Thus the strategy is to have Manager Y own the intellectual property and then a “royalty” contract is established between X and Y. In this way, subsidiary X sends the royalty to Y thereby counting as Y’s profit and a cost to X.
Fortunately, diamonds are forever but tax havens are not. In 2015, Ireland reversed the Double Irish tax law and now requires companies incorporated in Ireland to be tax residents in Ireland. For companies who incorporated prior to the ruling they will get an extra 5 years of the benefits of the law until 2020. Nonetheless, this does not mean the end to an era for these companies since the corporate tax rate in Ireland is still 4 times less than that of the US. Google says they remain committed to Ireland.