In August 2016, the European Commission issued a final decision in its investigation into the way Apple paid tax in Ireland. The sheer scale of the decision was dramatic and made headlines around the world. In the aftermath, analysts said that the ruling was limited to the specific facts around the Apple case and would not apply to other international companies in Ireland.
This may be true, but the reality is that this case is a significant wake-up call. It is an indication of a much larger issue.
The decision shows that foreign tax authorities:
- are envious of Ireland’s success,
- attribute some of that success to questionable tax practices and
- will do everything to expose and punish those activities.
Fairly or unfairly, this will inevitably bring more scrutiny on firms doing business in Ireland. Many firms are not well prepared to face that scrutiny.
In recent years there has been a string of developments in policy regarding multinational tax practices. Some examples are the OECD’s work on Base Erosion and Profit Shifting (BEPS), the European anti tax avoidance directive (ATA) and President Trump’s planned tax overhaul.
All of them have the noble intention of trying to reduce tax evasion and aggressive tax avoidance. While they aim to prevent firms from reorganising their activities for the sole purpose of reducing tax, they understand the economic reality that firms organise their international affairs to support their business interests – whether that is to enhance their supply chain, serve customers responsively or access specialised local talent pools. Increasingly, firms will have to answer questions about their choice of location. The OECD BEPS final draft proposes a Principal Purpose Test (PPT) that looks for non-tax reasons for establishing in a certain jurisdiction.
Purpose and Behaviour – Substance
Apart from the purpose of establishment, firms will be examined for their behaviour in Ireland. They will have to demonstrate that their Irish activities have real economic substance. However, there is no simple test of substance. Substance is not a black-and-white issue. It is more a combination of facts. Most firms will have the typical activities of running a business. Together, these activities will give a picture of the “Irishness” of the business.
Some examples are:
- Board of directors with Irish-resident directors holding regular board meetings to decide and direct the affairs of the company
- Irish premises as a place of business
- Books and records being maintained
- Well-qualified staff carrying on meaningful work
- All important decisions made locally
- Managing day-to-day customer relationships
Increasingly, substance is not about the mere presence or absence of these activities. It is about their quality and depth.
Other threats to substance
Moreover, even if the above activities are followed and documented, there can be unexpected threats to substance.
One example comes from confident international salespeople who are convinced they are making decisions in the field. Their negotiation behaviour could be construed as conducting business at the place of negotiation. While salespersons should be allowed flexibility and some clearly-defined autonomy, nobody should be allowed to doubt that all important decisions can only be made by the Irish firm.
Another risk to substance comes from smart senior executives in the parent company who take an interest in the activities of the Irish firm. Irish boards should resist any risk of being viewed as a “rubber stamp” for parent-company proposals. For “effective management and control” of the Irish firm, it is important to have strong local executives and directors who can withstand corporate pressure and manage the firm unambiguously.