Despite being an island nation on the periphery of Europe, Ireland has succeeded in becoming the leading destination for foreign direct investment (FDI) in Europe. Ireland consistently ranks first globally for high-value FDI flows (see for example, IBM's annual Global Locations Trends report). There are a number of reasons why Ireland has gained such a foothold with respect to FDI in recent years. Membership of the EU and providing US multinationals, in particular, with a platform to access the 900 million strong EU market has been central to that success story. Cultivating an open economy with very few restrictions on trade and embracing globalisation has also been critical. One other influencing factor has been Ireland's tax policy which has created an environment which encourages, rather than punishes, investment from overseas.
An evolving economy
Ireland's tax policy was not always designed to attract FDI. In fact, one only has to look at the rules in play in the 1950s to see that restrictions were imposed on foreign ownership of firms and heavy tariffs were applied to protect Ireland's manufacturers. At the back end of the 1950s, 90% of all Irish exports were destined for the UK. Those protectionist policies led to limited economic growth and during the 1960s successive Irish Governments began to cut unilateral tariffs, a Free Trade Area was agreed with the UK and subsequently both countries joined, what was then, the EEC in 1973.
In the 1980s, Ireland's tax regime sought to attract certain manufacturing operations (throughout the country) and internationally traded financial services to certain designated zones (ie, the IFSC in Dublin and the Shannon Free Zone in the mid-West). These policies were designed to attract foreign investment in Ireland at a time when the country endured extremely high unemployment levels and slow economic growth. These policies were undoubtedly successful but also had certain limitations as they were limited to certain sectors and also only provided growth opportunities to those designated zones. Ironically, it was following pressure from the OECD and the EU that Ireland arrived at its current corporate tax regime which applies a flat 12.5% rate to all active trading income for activities carried out anywhere in Ireland.
The introduction of the 12.5% rate in the early 2000s was a game changer in many ways. It opened up Ireland's doors to other sectors outside of financial services and manufacturing and paved the way for Ireland to become a major hub for software and other high-tech services. Ireland, as one of only two English-speaking countries with full access to the EU market, as well as a young and well-educated population, became the destination of choice for a much wider range of US companies wishing to access the EU market. Ireland's trading relationships have undoubtedly changed over the last 20 years. While agriculture and the food sector are still vitally important to the domestic economy, Ireland is now predominantly a knowledge-based services economy with the high-tech, life sciences and the financial services sectors accounting for a substantial portion of the economy's overall output.
The growth in the Ireland / US relationship is borne out by the figures. In 2007, 28% of all corporation tax paid in Ireland was paid by US-owned companies, almost 18% of Irish exports were destined for the US and 11% of Irish imports came from the US. At the same time, almost 16% of exports were destined for the UK and over 30% of imports came from the UK.
What does the future hold?
There is no doubt we are living through a period of great global change. It would have been difficult to envisage that the UK would leave the EU even three years ago, while not many would have predicted that the US would introduce a headline rate of corporate tax of 21%, with other incentive regimes in the new US tax code reducing that rate even further in certain circumstances.
In addition to those developments in the UK and the US, there have been other significant international tax reforms, which will shape future investment trends. The organization for economic coordination and development (OECD) launched a base erosion and profit shifting (BEPS) project which has already adjusted some long-standing norms in the international tax arena. The EU has also been to the forefront of reform with their anti-tax avoidance directives and the possible introduction of a digital services tax.
One of the key principles underpinning the BEPS recommendations was that taxable profits of a multinational organisation should arise only where that organisation has substance and where value is created. Unlike some other FDI destinations, Ireland's low corporation tax rate has only been available to companies that have placed a sufficient degree of substance in Ireland. As a result, the BEPS project should not result in investment leaving Ireland or discourage future investment. If anything, Ireland's substance-based regime is ideally positioned for the post-BEPS era. Many multinational organisations have already relocated senior management to Ireland and hired other senior executives locally.
US tax reform
As well as incorporating many of the BEPS recommendations, the 2017 tax reform measures reduced the US corporate tax rate from 35% to 21%. Given the importance of the US trading relationship, US tax reform was closely monitored in Ireland. Since the changes were passed, many US multinationals have begun reviewing their global structures. Although, it is probably too early to be definitive, it appears that Ireland should remain the location of choice for US multinationals seeking to establish a European headquarters to access the EU market. Ireland's attractiveness to US multinationals was never just based on lower tax rates. Access to the EU market, the availability of a young skilled workforce including, in more recent years, the influx of a skilled labour force from throughout the EU, as well as the stable regulatory and political infrastructure have all been arguably more important factors in the FDI decision making process.
The UK's decision to exit the EU will undoubtedly have a significant impact on Ireland. The UK remains one of Ireland's most important trading partners. However, what sometimes gets overlooked is that only 15% of total Irish exports are destined for the UK market, while over 32% of Irish imports are sourced from the UK. Needless to say, if a "hard" Brexit were to occur and the UK leaves without obtaining a reasonable trade deal with the EU, opening up new markets outside the EU and the US would be important for the future growth and sustainability of the Irish economy.
With the UK still scheduled to leave the EU in just a few months (March 2019) and Ireland remaining a committed EU member, it seems inevitable that the relationship will change.
There's no doubt that the disruption and uncertainty which Brexit brings is an unwelcome development for the Irish economy on a macro level. However, it has had a positive impact on investment in certain regulated sectors, particularly in the financial services space. Since the Brexit referendum, a number of UK regulated companies have established parallel or secondary hubs in Ireland and are seeking authorisations from the Irish Financial Regulator. Such authorisations will assist regulated companies with their Brexit contingency planning, and will provide them with the certainty that they can continue selling products and services in the remaining EU market following the departure of the UK from the EU.
Over the past half-century, Ireland has gradually relied less on its trading ties with the UK. Now, more than ever, it will be important to forge new trading relationships in Asia and the Middle East, as well as continuing to build on the strong investment flows between Ireland and the US and the rest of the EU. Ireland is well positioned to adapt to the new paradigm of international tax rules which are being implemented in the EU and in other major trading partners. The Irish government has demonstrated its commitment to the 12.5% rate of corporate tax and it remains a cornerstone of its industrial policy. The changes proposed by the OECD and the EU will mean that aggressive tax structuring will no longer be tolerated and maintaining a transparent and low statutory rate of tax will be more important than ever, particularly with the US statutory rate now as low as 21%. However, as outlined above, tax is just one of a number of factors which determine the location of FDI. Ireland's continued membership of the EU together with the associated access to that market and its combined workforce through free movement of workers, allied with its ability to foster and develop a business-friendly environment, will be key to continuing the growth of trade.
This article was authored by Partners Mark O'Sullivan and Shane Hogan together with Senior Associate Brian Doohan and PSL Olivia Long.
Originally published in the American Lawyer Global 100 edition.
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