Ireland closes notorious “Double Irish” tax loophole

October 14, 2014, 4:04 PM UTC
Small pond on a misty spring morning with house in view, Creagh House, Ireland
Stephen Robson--Getty Images

Ireland is to close a notorious loophole in its tax code that has allowed international companies such as Apple Inc. (AAPL) to slash their tax bills for years.

However, companies still using the scheme will have five years to rejig their operations, reducing the risk of a sharp and immediate increase in their bills, Finance Minister Michael Noonan told the Daíl, Ireland’s parliament.

The end of the loophole is a landmark in the clampdown by governments across the world on tax dodges by both individuals and companies. The Great Recession has made it imperative for governments to show voters that they are spreading the pain of cutbacks and tax increases fairly.

Under the so-called “Double Irish” loophole, a company based in Ireland could reduce its tax liabilities for certain items to close to zero by shifting income to an affiliated company in tax havens like the Cayman Islands or Bermuda.

The scheme has been particularly popular with companies whose chief asset is intellectual property. In a typical case, the Irish-based entity would market the company’s products across the whole of the E.U.’s single market, but it would pay nearly all its income in royalties to the company in the tax haven for the use of the intellectual property.

Such “transfer pricing” helps to keep the tax bill in Ireland down to a bare minimum. The E.U. accuses Apple of arranging a scheme like this with the Irish government, while Apple insists it has acted properly and paid all due taxes. Other companies, including Yahoo Inc., Pfizer Inc., Microsoft Corp and Google have all used the strategy at some time. The E.U. has similar investigations open against the tax regimes of Luxembourg and the Netherlands.

It’s the end of an era for Ireland, which, with few big native companies of its own, has relief for over 30 years on an aggressively low 12.5% rate of tax on corporate profits to attract high-quality jobs from multinationals.

The strategy has worked phenomenally well. Even U2 singer Bono claimed at the weekend that it had brought the country “the only prosperity we’ve ever known” (he was immediately rounded on by trade unionists pointing out that Irish wages are still below the E.U. average and public services have been ravaged by four years of austerity budgets under a €78 billion Eurozone-IMF bailout.)

But it has been a source of resentment for year by high-tax countries such as France and Germany, which accuse Dublin of using unfair tax competition to attract jobs and investment (and deprive their own treasuries of revenue).

Ireland’s position became practically untenable in 2010 during the bailout negotiations and the regime only survived because the creditors had to accept that raising the tax rate in the short term would have caused the economy to lose more jobs, making the bailout unworkable and leading to heavy losses for German and French banks.

As it is, the basic tax rate of 12.5% is set to stay for the foreseeable future. And Dublin will also offer a new “patent box” form of tax break, similar to schemes in the U.K. and the Netherlands, aiming to encourage research and development in Ireland.

So the incentives for “tax inversion”-driven mergers by U.S. companies, such as Abbvie Inc’s bid for Shire Pharmaceuticals Plc, won’t go away completely, but they will lose a key part of what has made them attractive so far.