Irish Investment in the US
Author:
Pat O'Brien
The first article in this two-part series looked at some of the factors that explain the well- known phenomenon of substantial capital and investment flows from the United States into Ireland. The flow of investment capital from Ireland to the Unites States has received less attention.1
The phenomenon of US foreign direct investment (FDI) in Ireland is well known. US investment in Ireland is well in excess of €60 billion and about 500 US owned businesses (about 50% of all of the foreign-owned companies operating in Ireland) directly employ more than 90,000 people. IDA Ireland is justifiably proud of its role in adapting the Irish offering to multinationals in response to both changes in the international economy and developments in the local market.
It is not surprising that Irish investment in the United States has not received the same attention. Regardless of the absolute volume of such investment (and it is significant), the relative importance of US investment in a country of five million people will always far outweigh that of investment from Ireland in a country with a population exceeding 300 million.
For a country that has gone through the extraordinary economic changes seen in Ireland over the past 20 years, it is not surprising that the increasing economic interaction between the United States and Ireland is seen first in the figures for trade (imports and exports) and only more recently in the figures for FDI and, in particular, for Irish FDI in the US.
When Ireland joined the European Economic Community (now the European Union) in 1973, the United Kingdom accounted for 55% of Irish exports. That proportion has been declining since and is now less than 18%. The US share of Irish exports was about 19% in each of 2005 and 2006. The United States is a much more important export market for Ireland than is any EU state other than the United Kingdom. This is well illustrated by the fact that Germany, Ireland’s third-largest export market, accounts for only about 7% of Irish exports.
The importance of the bilateral trading relationship is further illustrated by the fact that close to half of Ireland’s exports and imports excluding intra-EU trade are accounted for by dealings with the United States.
And what of FDI? Readers will not be surprised that outbound investment by Irish companies and residents began to increase in the late 1990s and that this was from a very low base. Reflecting the fact that Ireland was late to the party, the stock of FDI invested in Ireland is still very significantly in excess of Ireland’s outbound FDI. Notwithstanding this, the trend will be clear from the fact that the FDI outflow of €12.7 billion in 2004 was the first year that FDI outflows from Ireland exceeded FDI inflows.
Similar to trade balances, traditionally Irish investment was concentrated in the United Kingdom and, in more recent years, in the US. These two destinations now account for about 55% of the total stock of Irish outbound FDI. This development is reflected in the fact that, in recent years, the number of US-based employees of Irish multinationals has been running at in excess of 75% of the number of Irish-based employees of US multinationals.
The drivers of Irish FDI in the US are, one suspects, largely the same as the drivers of such investment between any two markets. These factors include the availability of capital and a desire to invest part of that capital outside one’s home market, the openness of the target jurisdiction to foreign investment and, particularly in the case of heavy goods, the economic imperative of manufacturing close to one’s significant markets. With regard to the last factor, it clearly makes as much sense for an Irish producer of building materials as it does for a Japanese manufacturer of motor vehicles to produce in the US for the US market. The case may be even more compelling when one considers that the North American Free Trade Agreement developments mean that one is looking not just at a target market of 300 million people but at a market which extends beyond the borders of the US.
At the micro or individual Ireland-based corporation level, examples of this interest in outbound FDI abound. In 2006, 25% of the sales and 27% of the operating profits of CRH plc were from the Americas. In the US, CRH operates in 42 states, is the third-largest aggregates producer, the largest asphalt producer, and a top-10 readymixed concrete producer. Slightly more than 50% of CRH’s 80,000 employees are in the Americas.2
In 2006, Kerry Group plc earned 27% of its revenues and held 27% of its assets in the Americas.3 In 2006 the food business of IAWS Group plc (the food business is its dominant business) earned 19% of its revenues from and held 23% of its assets in North America.4
What is the tax environment facing the intrepid Irish investor in the US? The first point to be made is that the US tax regime (both in terms of the level of tax rates and the complexity of the taxation system) may not provide an incentive for investment in the US, although the well-advised investor can, of course, seek to manage the business cost represented by US taxation. As we pointed out in our first article, the effective US tax rate on business profits can exceed 40%. Other significant differences between the Irish and the US tax regimes exist, which space allows us only to note here:
-In the US, taxes on business profits are levied at the federal, the state, and, in certain circumstances, at the local level. Quite apart from the impact on the effective tax rate, this multi-tiered taxation system also has the effect of potentially increasing tax compliance costs as compared with the Irish single-tier corporation tax system.
-With relatively few exceptions capital allowances are granted in Ireland over eight years straightline. In the US, tax depreciation allowances are given at different rates on various categories of assets.
-While any US investor should be in a position to secure an exemption from Irish dividend withholding tax, withholding tax on dividends repatriated from the US can be significant. Under the Ireland-USA double tax treaty, the (under US domestic law, 30% rate) reduced rate will be 5% or 15% depending on the ownership level.
-A US investor selling shares in an Irish company or liquidating such a shareholding will not be subject to Irish capital gains tax unless the value of the shares is derived from certain Ireland-based land or similar assets. An Irish investor selling shares in a US company should typically not be subject to US capital gains tax on dispositions of US shares UNLESS the underlying assets of the US corporation are a majority (by value) real property interests. Liquidating the US company is a different matter—the liquidation is taxable to the company liquidating (gains are recognised and tax levied on the difference between fair value of the assets and their adjusted tax basis), not the shareholder, and the proceeds of liquidation are usually not subject to dividend withholding tax.
-Not everything is greener in Ireland! Tax depreciation of purchased intangibles is widely available in the US but may be claimed only in relatively rare circumstances in Ireland.
From an Irish tax perspective, the treatment of an Irish corporate investing in the US is relatively straightforward. Capital gains on the eventual disposition or liquidation of the shareholding in a US affiliate should be exempt from Irish capital gains tax under the ‘participation exemption’ provisions introduced in the Finance Act 2004. In the case of dividends, the credit available against Irish taxation on dividend income for the various taxes paid in the US (both taxes on profits and withholding tax on dividends) should be sufficient to determine that no further corporation tax is payable in Ireland, notwithstanding that the dividend income would be subject to corporation tax at the 25% rate applicable to non-trading income. The difference in the US marginal tax cost (as noted above, this can easily be 40%, plus the cost of outbound dividend withholding of, for example, 5%) and the Irish tax rate on the returns (potentially nil on capital gains and 25% on dividends) is of note as it presents an incentive to the Irish investor to work to reduce the economic base of tax in the US through one of many relatively known (and generally accepted) techniques, such as:
-Gearing or leveraging the US— there are various US limits on interest deductibility, including common law debt/equity ratio limits, earnings stripping limitations imposing statutory ‘interest cover’ limits, etc., but inter-group funding, even with Ireland as the lender (taxed at 25% on its interest income, but getting relief in the US at around 40%), can reduce the US tax base.
-Using toll or contract manufacturing, non-US ‘global procurement,’ limited risk distribution arrangements, or inter¬group leasing arrangements to permit the Irish parent (or non-US, non-Irish affiliate) to retain elements of entrepreneurial risk. Of course, taxing authorities in both the US and Ireland carefully review transfer pricing arrangements between related parties to determine that the transactions are priced on an arm’s-length basis.
With the absence of controlled foreign corporation legislation in Ireland, the continuing evolution of EU law (e.g., Cadbury-Schweppes, etc.) would seem likely to result in increasing interest in the use of intermediary holding, trading, or finance companies by Irish multinationals making or increasing their FDI in non-Irish operations, including, and perhaps in particular, into the US, given that tax rates elsewhere in the world are falling at a more rapid pace than is the case in the US, where the corporate rate has remained basically unchanged for more than 20 years. This will no doubt add to the complexity but, hopefully, increase the after tax returns of Irish FDI into the US.
Notes
1 Unless otherwise indicated, statistics in this article are sourced from Enterprise Ireland’s “Ireland Economic Profile” (August 2006) or from the United States Commerce Department’s Bureau of Economic Analysis.
2 Source: 2006 Annual Report of CRH plc. While the term “the Americas” extends beyond the United States, it is clear from the Annual Report that CRH’s activities in the Americas are heavily skewed towards the United States.
3 Source: 2006 Annual Report, Kerry Group plc.
4 Source: 2006 Annual Report, IAWS plc.