This paper examines aspects of the international legal structure of multinational companies (MNCs). Specifically the use of tax havens is examined using a data base of all Irish registered companies.

Fiscal incentives play a key role in industrial policy in Ireland and other countries. It has been argued that recent strong economic growth in Ireland is largely due to attracting foreign direct investment. A report published by the agency responsible for industrial development in Ireland states: “Ireland’s economic success over the past decade was driven largely by the performance of the internationally traded goods and services sectors, and in particular the growth of foreign direct investment” and the main source of output growth has been US MNCs. A major reason given for the location of foreign investment in Ireland is a low corporate tax regime which was formerly 10% and is currently 12.5%. However, new member states of the European Union (EU) and Austria (Financial Times, 24 June 2004) have announced low corporate tax regimes in an attempt to attract foreign investment, and there is considerable tax competition for foreign direct investment from other low tax rate jurisdictions. Partly as a response, the tax system in Ireland has been changed “to create new [tax reducing] opportunities for foreign direct investment”.

This paper argues that fiscal incentives have a considerable effect on the legal structure of MNCs and on their financial behaviour, for example on intra-corporate movement of funds. The use of ‘profit switching transfer pricing’ is one aspect, but there are others, such as intra-firm loans, back to back loans and the use of ‘special purpose vehicles’. Corporate scandals associated with Enron, Worldcom and Tyco for example, and the collapse of Parmalat, an Italian based multinational company in the food sector, have drawn attention to the complexity of legal structure and financial flows within international companies. The collapse of Parmalat has been described as one of Europe’s worst financial scandals with €8 billion in missing funds (Financial Times, 2 January 2004).

There are two features of foreign investment in Ireland that are of considerable interest in examining the financial behaviour of multinational corporations.

First, Ireland is now an important centre for managing international funds and flows of funds within MNCs. The total stock of foreign investment in Ireland in December 2003 amounted to €1041 billion. This was approximately eight times the size of GDP in 2003. Of this €1041 billion, €749 billion (72%) relates to the Irish Financial Services Centre (IFSC). The total stock of non-IFSC foreign direct investment (FDI) increased from €79.6 billion in 2000 to €99.9 billion in 2003 (+25%) but the stock of IFSC foreign investment increased from €473 to €749 billion over the same period (+58%).

The IFSC was established in 1987 with its own regulatory requirements and a particularly favourable tax regime (a 10% corporate tax rate and no withholding taxes), for certain financial activities. In order to qualify a certificate must be issued by the Minister for Finance in Ireland. By agreement with the EU no new certificates were issued after 2000, and the special tax rate is due to end in 2005, but corporation tax will remain low (12.5%) and other tax benefits will remain. New business can be established as an agency relationship using an existing trading entity with a licence. In 1997 over 200 major companies used the IFSC as a centre for global treasury operations and by 2000 over 400 treasury operations (50% US owned) were managed on an agency basis at the IFSC.

The second interesting feature is that for the year 2002 the largest source of foreign direct investment into Ireland came from the Netherlands (€10.7 billion) compared with the next largest the U.S. (€7.8 billion).

The size of foreign investment in Ireland and the source country of the largest proportion of foreign direct investment (the Netherlands) are both connected to aspects of the Irish fiscal regime, that is, favourable fiscal incentives for financial companies which hold an Irish Financial Services Centre (IFSC) licence, and low tax rates for manufacturing and other firms. The IFSC has become an integral part of the operation of some MNC’s as they have an affiliate or associate with an IFSC licence, which manages aspects of group operations, for example, treasury operations or insurance via a captive insurance company. This paper focuses in particular on financial affiliates in Ireland of non-financial companies, by examining the legal form of ownership and financial aspects of the affiliate.

The data was obtained from a commercial data base which includes company accounts, legal structure, and other documents required by the companies Acts.

How companies react to tax rates is complex. Surveys of companies regularly show that tax is not the most important reason for locating in a particular country. However, other econometric evidence also shows that U.S. FDI flows are influenced by relative tax rates. A number of propositions relating to the effect of tax incentives can be identified from a United Nations Congress on Trade and Development (UNCTAD) study (1998). The first proposition is that because barriers to FDI have been reduced, taxation may become more important, but it is the general features of a tax system that are important rather than tax incentives. The second proposition is that tax incentives are a relatively minor factor in the location decision of MNCs relative to other factors but they may be important in specific cases. Two are identified: (1) incentives may have a marginal effect especially “for projects that are cost-oriented and mobile”; and (2) incentives may influence “the precise choice of location within a region or country” where there has already been a decision to make an investment within a given region or country. Hence surveys of firms and anecdotal evidence within a low tax area shows that fiscal incentives are an important influence on location. Investment determined largely by tax reliefs will have other features such as no or low linkages and increased mobility as costs change and as tax factors vary.

The most important determinant of business investment is the possibility of generating a profit. Tax considerations follow from a decision to undertake investment. Tax reliefs in general are of no value unless taxable profits are being earned. In some circumstances tax reliefs may be ‘sold’ to another firm with taxable profits for example by leasing rather than purchasing machinery. Large firms with numerous subsidiaries within a single tax jurisdiction may avail of ‘group relief’ to ensure that tax incentives can be used to reduce taxable profits. International firms may switch profits from one tax jurisdiction to another using ‘profit switching transfer pricing’ to achieve the same aim. Where production costs are internationally competitive, tax rates matter. Where production costs get out of line with competitor locations, tax rates are of far less significance. This is why some FDI in low tax jurisdictions such as Ireland has a ‘merry-go-round’ feature. Call centres, computer production, component manufacture and assembly type operations are vulnerable to rising cost levels and relocation to lower cost locations in spite of low corporate tax rates in Ireland. Some econometric evidence may find a relationship between U.S. FDI and tax rates because these results are skewed by ‘footloose industry’, which moves in accordance with tax rates but only where cost factors are competitive.