Ireland the best place to exploit IP

Heavily edited for the salient points, copyright of Wall Street Journal Online, November 7, 2005. Article by GLENN R. SIMPSON, Staff Reporter of THE WALL STREET JOURNAL.

Irish Subsidiary Lets Microsoft Slash Taxes in U.S. and Europe
Tech and Drug Firms Move Key Intellectual Property To Low-Levy Island Haven

DUBLIN — A law firm’s office on a quiet downtown street here houses an obscure subsidiary of Microsoft Corp. that helps the computer giant shave at least $500 million from its annual tax bill.

The four-year-old subsidiary, Round Island One Ltd., has a thin roster of employees but controls more than $16 billion in Microsoft assets. Virtually unknown in Ireland, on paper it has quickly become one of the country’s biggest companies, with gross profits of nearly $9 billion in 2004.
Ireland’s citizens may not have heard of Round Island One, but they benefit greatly from its presence. Last year the unit handed the government of this small country of four million citizens more than $300 million in taxes.

Much of Round Island’s income is licensing fees from copyrighted software code that originates in the U.S. Some of the rights to these lucrative assets end up in Ireland via complex accounting rules on intellectual property that the Treasury is now seeking to overhaul. The Internal Revenue Service said it is also looking closely at how companies account for such transactions.

In a statement, Microsoft said its European units “report and pay significant amounts of taxes” and that Microsoft “is fully compliant with the tax laws of the United States and all other countries.”

Microsoft leaves much of its profit in Ireland, including $4.1 billion in cash, avoiding U.S. corporate income taxes. But it still can count this profit in its earnings.

Round Island One is a key component in a drive by Microsoft to place its intellectual property and other assets into tax havens. In the past three years, Round Island has swallowed up other Microsoft units, from
Israel to India, moving much of their tax liability to Ireland. Within the U.S., the rights to many of Microsoft’s products and copyrights are managed by a subsidiary in Nevada, which, unlike the company’s headquarters state of Washington, doesn’t tax royalty income on intellectual property. The Nevada unit, Round Island LLC, is the corporate parent of Ireland’s Round Island One.

Companies built on knowledge and innovations are an ever-larger portion of the U.S. corporate tax base, displacing the old industrial concerns. But the newer firms’ principal assets — ideas, codes and formulas — are intangible, and thus easily exported to places where the huge royalties they produce can be shielded from American taxation.

Accountants and lawyers now avidly market such relocations. Round Island’s legal address is in the headquarters of a Dublin law firm, Matheson Ormsby Prentice, that advertises its expertise in helping
multinational companies use Ireland to shelter income from taxes. It represents other U.S. technology companies including Google Inc., which recently set up an Irish operations center that the firm credits in its SEC filings with reducing its tax rate. A Google spokesman said the company set up in Ireland to be close to its European customers. “Because that business is done outside of the U.S. it is taxed according to international law,” he said.

Microsoft’s other neighbors in Ireland include Oracle Corp., which also recently set up a network of Irish subsidiaries that helped drive its taxes down sharply. “The decrease in our effective tax rate…is attributable
to higher earnings in low tax rate jurisdictions,” Oracle said in its July annual report to the SEC. An Oracle spokesman declined to comment.

Ireland, through a blend of deft marketing, potent financial incentives and advantageous geography, has largely beaten out its many tax-haven rivals in the heated competition for offshore investment by technology companies. The flow of U.S. know-how has helped make Ireland an economic powerhouse, dubbed the Celtic Tiger, now one of the richest countries in Europe.

In the past four years, Ireland has stepped up its effort to woo U.S. high-tech firms by piling on new tax breaks for technology transfers, leading a string of major U.S. companies to announce research facilities here. The trend poses a quandary for U.S. regulators and policy makers in the face of a skyrocketing federal deficit and widespread tax shelters.

Irish officials say U.S. companies aren’t exporting their intellectual wealth to Ireland, just sharing it. “This isn’t about sucking knowledge out of the U.S. This is about building up capability elsewhere,” says Enda Connolly, a manager at the Industrial Development Agency of Ireland.

Microsoft has just over 1,000 full-time employees in three suburban Dublin buildings, each with its own Starbucks outlet. About half of the Irish employees work on software “localization,” translating and modifying for local markets the programs produced by some 29,000 employees of Microsoft in the Puget Sound region of Washington state. “We have a very real business” in Ireland, said Michael Doyle, a Microsoft tax lawyer at its headquarters in Redmond, Wash. He said the company is using a well-accepted, widely used practice to share its intellectual property with offshore subsidiaries. “The IRS is keenly aware of this and they audit it regularly,” he said.

Ireland’s emergence as the top overseas destination for U.S. intellectual capital culminates a long effort to attract foreign investment. For decades after Ireland gained independence in 1921, its economy was largely agricultural. In 1969 John A. Mulcahy, a wealthy American from Ireland, used his one-third holding in Pfizer Inc. to persuade the U.S. drug company to set up a citric acid plant in Cork, according to a Harvard
Business School case study. Other U.S. manufacturers followed, attracted by tax benefits, a low-wage, English-speaking work force, and Ireland’s 1973 induction into the European Economic Community. Ireland grew adept at wooing U.S. businesses, dispatching teams of lobbyists to America. Young tech firms such as Apple Computer Inc. began flocking to the island in the 1980s.

Despite criticism from its neighbors, Ireland continued introducing incentives, including in 1983 a 10% tax rate on profits from software exports. The incentives spurred Microsoft in 1985 to set up its first plant in
Ireland to help supply Europe. But most foreign operations remained small, and through the mid-1980s “Ireland was a basket case economically,” says Mr. Connolly.

That changed with the 1990s technology boom, beginning with the 1990 arrival of an Intel Corp. microchip assembly plant in exchange for $157 million in incentives. Soon to follow were Dell Inc., Gateway Inc.,
Hewlett-Packard Co. and International Business Machines Corp. Pfizer’s drug-industry rivals also followed its path to the green hills of County Cork. The European Union’s free-trade rules let them build products in Ireland and sell them cheaply in Europe’s many higher-tax countries. Spokesmen for Intel and Dell said tax incentives, the skilled work force and Ireland’s location were all reasons for moving operations there.

Microsoft and others now are going further. Microsoft delivers its Windows products to European customers straight from Ireland, and the profits go straight back to Ireland. Since most of the profits from Microsoft programs are in the form of copyright licensing fees, “it is likely that low or nil taxes are payable in the other EU states,” says John Ward, a tax professor at the University of Ulster in Belfast, Northern Ireland.

Taxes paid to Ireland, though modest to giant Microsoft, are a big deal to the Irish treasury, amounting to $77 for each Irish citizen. Last year Microsoft also helped cover Ireland’s costs in its six-month turn in the EU presidency, donating software and forgiving some $60,000 in royalties. Bertie Ahern, the Irish taoiseach, a title similar to prime minister, spoke at Microsoft events twice this year. “The growth and success of Microsoft Ireland has coincided with, and played an important role in, a dramatic transformation in the Irish economy,” he said at an event at Dublin Castle last month.

Ireland sees intellectual property as the key to its future. Irish labor is now growing scarce, and costs higher. The development authority adopted a new strategy in 2000 of becoming “the foremost knowledge-based society in Europe.” Last year, Ireland enacted a new R&D tax credit and abolished a 9% tax on sale or transfer of intellectual property.

Lucent Technologies Inc. now is building a new research center here, attracted by “access to high-caliber engineering talent and scientists,” according to spokeswoman Mary Lou Ambrus. IBM is developing Lotus
Workplace in Ireland, Hewlett-Packard is designing new inkjet printers here. In March, Microsoft announced it is creating a new R&D center in Ireland to help work on the flagship products currently designed primarily in Redmond, including the planned new release of Windows, called Vista.
Pharmaceutical companies are also doing more research in Ireland.

“We’re transitioning the nation from being a supplier and producer of other people’s ideas to a place where you actually do that development,” says Mr. Connolly. The development officer calls offshoring of research a natural part of globalization, and “a good thing. Is that being done at the expense of the American taxpayer? I don’t think so.”
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There ya go – embryonic as it may be, the Irish VG industry is apparently located in the best possible place to make the most of its output… :D