A summary of how the “Double Irish Dutch Sandwich” tax structure operates
Given the recent spotlight that has been shone on Ireland’s position in International Tax Planning, it may be timely to review the modus operandi of the “Double Irish” structure, which in the past used a Dutch BV, extending the title to a “Double Irish Dutch Sandwich” structure.
Typically, a US headquartered corporation company arranges for the rights to exploit intellectual property (IP) outside the United States to be owned by an offshore company, which in this structure is Irish incorporated but not Irish tax resident (“IRNR Co”), however is tax resident in a zero tax jurisdiction, such as Cayman or Bermuda. This is possible to achieve because Irish tax law provides that Irish incorporated companies are not deemed to be Irish tax resident in certain circumstances (i.e. where they are related to a company that trades in Ireland or where the ultimate parent company is publicly quoted in a country with which Ireland has concluded a Double Taxation Agreement [“DTA”] AND where their central management and control occurs outside of Ireland).
The transfer of the rights to exploit non-US IP out of the US group and into IRNR Co is achieved by entering into a cost sharing agreement between the U.S. parent and IRNR Co, taking into account the provisions U.S. transfer pricing rules. The IRNR Co will then have the right to receive all of the profits from exploitation of the rights outside the U.S., without paying U.S. tax on the profits unless and until they are remitted to the U.S.
IRNR Co then sub-licenses the right to exploit the non-US IP owned by it to a second Irish company (“Irish Trading Co”), which is tax resident in Ireland, in return for substantial royalties or other fees. Irish Trading Co enters into an Irish Centric Central Entrepreneur Structure, allowing it to receive income from exploitation of the asset in countries outside the U.S. (normally EMEA and AsiaPAC). The Central Entrepreneur structure means that Irish Trading Co takes on the entrepreneurial risk in the group, with subsidiaries in high tax jurisdictions (e.g. France, Germany etc) taking on low risk functions and therefore limiting the group profit taxable in these higher rate jurisdictions. Although Irish Trade Co receives a high level of income through the royalty streams from its EMEA and AsiaPAC subsidiaries, its own taxable profits are low because it obtains a tax deduction for royalties or fees paid to the IRNR. The remaining profits in Irish Trade Co are subject to tax at the low Irish rate of 12.5%, but the effective tax rate in Ireland can be lowered even further through effective tax planning at the level of Irish Trade Co (IP planning, R&D tax credits etc). As the IRNR is tax resident in a tax haven, it is not subject to tax on the royalties it received from Irish Trade Co.
For companies whose ultimate ownership is located in the United States, the payments between the two related Irish companies might be non-tax-deferrable and subject to current taxation as Subpart F income under the Internal Revenue Service’s Controlled Foreign Corporation regulations if the structure is not set up properly. This is avoided by organizing the second Irish company as a fully owned subsidiary of the first Irish company resident in the tax haven, and then making an entity classification election for the second Irish company to be disregarded as a separate entity from its owner, the first Irish company. The payments between the two Irish companies are then ignored for U.S. tax purposes
Traditionally, Ireland administered a withholding tax of 20% on patent royalties paid to a company that is tax resident in a non-EU or non-DTA location. In the absence of further planning, this could have meant that tax at 20% would have applied to the patent royalties being paid between Irish Trade Co and IRNR Co. This issue was traditionally overcome by interposing a Dutch entity between IRNR Co and Irish Trade Co as, under domestic Dutch tax law, the Netherlands does not levy withholding tax on royalties paid to any foreign entity. Irish Trade Co pays royalties without withholding tax applying to the Dutch company. The Netherlands taxes income from royalties on the basis of a “spread” system, meaning that the royalties are all within the scope to Dutch tax but under Dutch tax law, only approximately 5% of the royalties received are taxed at the headline Dutch corporate tax rate of 33%, resulting in a very low effective tax rate in the Netherlands (circa 1.65%). The Dutch company then pays the royalties (less the small amount of Dutch tax) on to IRNR Co without the imposition of withholding taxes.
However, since 26h July 2010, this position has changed in respect of foreign (i.e. non-Irish) registered patents where certain criteria are met.
The Irish tax authorities issued a Statement of Practice as part of a suite of incentive measures to increase Ireland’s attractiveness as a location for intellectual property. The Statement of Practice, which took effect from 26th July 2010, allows patent royalties to be paid by an Irish tax resident company to a foreign company, including an entity that is resident in a non-treaty jurisdiction, without Irish withholding tax.
As mentioned above, the previous requirement was that 20% withholding tax was required to be operated on payment of patent royalties where it was being paid to a patent holder who was resident in a non EU/DTA State. This change, which was introduced by administrative practice, directly follows the change in the Irish Finance Act 2010 which exempted Irish companies from having to deduct withholding tax on paying patent royalties to a company resident in an EU/DTA State.
The exemption from the requirement to deduct withholding tax is available in the following circumstances:
– the recipient is the beneficial owner of the royalty payment and is a company which is neither resident in the State nor carrying on a trade in the State through a branch or agency; and
– the royalties are payable in respect of a foreign patent under a licence agreement that is executed in a foreign territory and subject to the law and jurisdiction of a foreign territory, and;
– the payment is made in the course of the Irish paying company’s trade and the payment is not part of a back to back or other conduit arrangement.
A foreign patent is defined as a patent originally registered outside the State in relation to an invention developed outside the State. Advance approval is required from the Irish tax authorities and the application should be made to the tax office of the Irish company paying the royalty.
Therefore, with planning, it may be possible to avoid withholding taxes on patent royalties paid from an Irish company to a company that is tax resident in a non-EU and non-DTA jurisdiction, where pre-execution planning ensures that the above conditions are met. Even where the payment of the patent royalty is to a company that is tax resident in an EU or DTA State, the Statement of Practice removes the requirement to rely on a treaty provision and, in some cases, that can produce a better result than a specific treaty provision.
The Statement of Practice is available for viewing here.
As Google CEO Eric Shmidt was recently reported as saying, in response to parliamentary comments in the US and the UK to such structures, all publicly listed companies should always operate within the law, however it is the legislators job to make the law, and it is the CEO’s job to deliver value to the company’s shareholders. This is, of course, a moot argument from a US tax perspective, as all