Occasionally, investors on the New York Stock Exchange come across a company with a long American history and most of its sales in the US – and an address in Dublin. Those are the multinationals who chose headquarters inversions to access Ireland’s corporation tax regime when the practice was in fashion in the early 21st century.
One of the Wall Street-listed groups then most active on the inversion scene found itself at the centre of a Vat dispute now adjudicated by the Tax Appeals Commission. Although its name is redacted in the newly published decision, The Currency has identified it as Covidien, a short-lived manufacturer of drugs and medical devices spun out of Tyco International in 2007 and acquired by Medtronic in 2015.
The ruling unveils how Covidien joined the group of American multinationals that became Irish without any of their senior executives or board members ever having to acclimatise to Dublin rainfall or understand the Gaelic games scoring system.
In the years following the Medtronic deal, Revenue looked back at the corporate structure of the evolving Irish-headquartered Covidien group and concluded that it owed €45 million in unpaid Vat. The assessment did not arise from sales of healthcare products, but from intercompany services bought and sold by its Dublin-based top holding company.
The group challenged the Vat bill before the Tax Appeals Commission, which conducted a nine-day hearing into the case in 2019. The group’s then Irish parent is simply identified as “the Appellant” in Tax Appeals Commissioner Mark O’Mahony’s 172-page determination, signed on April 29 this year and now published in redacted form.
All other names and dates are blacked out, but all details of the case and extended quotes from a company press release provide an exact match for the morphing Covidien PLC between 2011 and 2015.
When the healthcare division of the industrial conglomerate Tyco became a standalone business under the name Covidien in 2007, it was first headquartered in Bermuda. Then just before Christmas 2008, its board announced the group headquarters’ move to Ireland, where it already had a manufacturing base and around 2,000 employees.
The group parent moved its tax residency to Ireland and was then acquired by a new Irish company, Covidien PLC, which became its ultimate parent listed on the New York Stock Exchange. The corporate inversion meant the group was now liable for Irish corporation tax on its ultimate profits.
Some profits, however, were booked elsewhere – for example, the company holding most non-US intellectual property for the group was resident in an undisclosed location where the applicable tax rate was 10 per cent.
Overall, the “principal entities” carrying the group’s risk were also those with the largest chunks of its profits. They are code-named Companies E, F, G, H and I in the Tax Appeals Commission’s determination. The Commission heard evidence on this structure from a senior Medtronic executive with extensive experience in tax matters.
“The decisions on where to locate the principal entities were based on securing locations which were politically stable, had good patent laws, and had a well-educated workforce, and where authorities provided either incentives or had a reasonably low tax rate,” the Commission heard from the executive.
“The Appellant’s board was made up of its CEO along with independent directors who met a minimum of six times annually, most usually in Dublin,” according to his evidence. The board was active and its meetings in the Irish capital included “presentations from members of the senior executive committee which would feed into the decisions made by the board, which said decisions would then be communicated to the senior executive committee”.
Management “effectively outsourced” to the US
All this ensured Covidien’s effective place of management for tax residency purposes was in Ireland. The inversion did not mean, however, that Covidien’s C-suite permanently decamped to Dublin with all the staff performing the group’s central functions. Instead, they remained employees of a US subsidiary, “Company I”, which invoiced the Irish group parent for a whole list of core services detailed by another company witness before the Tax Appeals Commission:
- “Corporate executive”, which comprised the chief executive officer, the chief financial officer and the vice president of investor relations;
- “Business development”, dealing with acquisitions and new product development;
- “Human resources” at group level, such as setting benefits and stock options policies;
- “Internal audit”, including sending auditors to group offices and reporting to the US Securities and Exchange Commission;
- “Finance” including the consolidation of annual group accounts;
- “Tax”, covering US tax and international issues such as transfer pricing;
- “Legal” for intellectual property management and any global issues;
- “Treasury and risk”, ie capital planning and cash management for the entire group;
- “Operations”, especially quality control; and
- “Miscellaneous”, covering an IT shared services centre for the group.
According to Revenue, the Irish top parent of the Covidien group “effectively outsourced its management services function to Company I”. Dublin-based Covidien PLC then re-sold part of these essential services to the other principal entities in the group, whether they were in Ireland or not.
Two cascading service agreements governed these intercompany transactions and associated fees, which were calculated as “total services costs incurred in connection with providing the services to the service recipient (‘total service costs’), plus a markup percentage”.
In the process, the Tax Appeals Commissions heard that Covidien PLC itself generated a loss. The fees paid by and to the Irish holding company were not revealed, but Revenue’s assessment covered a portion of the services it purchased from Company I over a period of three years and seven months. This included regular payments and once-off services associated with two M&A deals.
At the standard rate of 23 per cent, the €45 million Vat assessment raised corresponded to nearly €200 million worth of Covidien’s transatlantic rent-a-CEO and associated services over the period – and this is only the disputed fraction.
Vat and “non-economic activity”
The clash between the pharma group and the tax authority erupted when Revenue questioned Covidien’s Vat returns. Under the law, companies must self-account for Vat when they import goods or services from outside the EU and pay the tax on those inputs required for their “economic activity.” The tax is deductible when they, in turn, charge Vat to their customers and pay it to Revenue.
According to evidence before the Tax Appeals Commission, Covidien PLC either did not pay Vat on the import of services from its US subsidiary Company I, or deducted it all from the amounts owed on the re-sale of the same services to other principal entities in the group.
Revenue, however, disagreed. It claimed that only a portion of the services Covidien PLC had purchased from Company I went into the supply of its own services to four other subsidiaries. The rest constituted an input for “the non-economic activity of holding the shares” in its myriad direct and indirect subsidiaries.
A key point in the tax authority’s case was that the Irish top parent of the group billed only its four most significant “principal entities” for services, but none of the other many subsidiaries involved in getting products to customers.
In December 2011, Covidien made public its intention to spin off its drugs manufacturing business while retaining its medical devices business. The de-merger resulted in the 2013 creation of another Irish-registered, US-focused holding company, Mallinckrodt PLC. It was dubbed “Project X” in the Tax Appeals Commission’s determination.
Mallinckrodt has since made regulatory headlines for other reasons, related to its insolvency in the face of opioid over-prescription and drug pricing litigation in the US.
The separation of Mallinckrodt from Covidien required significant input from senior managers and their support functions, leading to a spike in the amounts paid by Covidien PLC to Company I. Revenue argued that the Vat due on those payments was not deductible, because it did not feed into the supply of services. Nor did it qualify for an exemption available for capital raises, according to the tax authority, because the spin-off simply resulted in Covidien PLC shareholders receiving shares in the new Mallinckrodt PLC, with no fresh money injected.
When Medtronic acquired Covidien in 2015, Revenue again rejected the Vat deductibility of costs incurred by the Irish top holding company in preparing and carrying out the “K Transaction”, as it was code-named by the Tax Appeals Commission. The deal happened via a share cancellation scheme, with shareholders in both merging multinationals surrendering their stock and being issued with shares in the new, Irish-registered, New York-listed Medtronics PLC. It remains the new group’s top parent to this day. Tax inspectors found that Covidien had “received no payment” for the transaction and therefore declared that associated costs were not Vat-deductible trading inputs.
Revenue defended its position with European case law establishing that Vat on input costs is deductible only “if there is a direct and immediate link between the costs associated with the input services and the overall economic activities of the taxable person”. If not, the courts had directed other companies and tax authorities to apportion costs to Vat-deductible and non-deductible purposes.
Revenue argued that if costs such as those associated with Covidien’s share cancellation scheme to merge with Medtronics were recognised as inputs for economic activity, it “flew in the face of the proper application of VAT deductibility rules”.
Overheads and a three-cornered demerger
In its appeal, Covidien cited other UK and EU case law establishing that “general costs” or “overheads” are regarded as inputs into a firm’s economic activity. The multinational also showed that it had purchased the package of services from its US subsidiary as a single “composite service” and other cases had accepted that this may not be itemised.
Covidien’s arguments on the deductibility of its costs boxed Revenue into a corner: Either the holding company had an “economic activity” and it was allowed to deduct Vat; or else it was just a passive investment vehicle, but then it had no obligation to pay Vat on services imported from its US subsidiary at all – and deductibility was no longer an issue.
On the 2013 Mallinckrodt spin-off, Covidien detailed the transactions involved:
“The crux of the spin-off was the three-cornered demerger whereby the Appellant [Covidien PLC] declared a dividend in favour of its own shareholders (having satisfied itself that it had sufficient distributable reserves to do so) and then effected the distribution of that dividend by transferring the Spin Cos to Company J [Mallinckrodt PLC]. That company then issued shares in itself to the Appellant’s shareholders.”
In passing, we learned that Covidien paid €9.5 million in professional services fees to its lawyers on that occasion. Although the name of the law firm was redacted, legal documents formalising the deal were filed by Arthur Cox at the time.
Covidien stated that the Mallinckrodt spin-off “was not an economic activity” because it did not receive payment for the assets spun out, instead just distributing them as dividend. In that case, the costs involved in the transfer were “not within the scope of Vat”.
In the alternative, if the transaction was part of its economic activity, Covidien argued that it should declare Vat on the services acquired to complete the deal but “that the costs associated with that transaction are deductible as overhead”.
On the Medtronic takeover, Covidien developed a similar argument. The firm added EU case law making certain expenses associated with capital transactions Vat-deductible. This was transposed into Irish law, which includes among qualifying activities “services consisting of the issue of new stocks, new shares, new debentures or other new securities by the accountable person in so far as such issue is made to raise capital for the purposes of the accountable person’s taxable supplies”.
Five €45m questions
Tax Appeals Commissioner O’Mahony asked five questions to resolve the dispute:
- “Was the Appellant engaged in economic activity?
- What was the supply received by the Appellant from Company I?
- Did the Appellant use the supply received from Company I for its economic activity?
- Is the Appellant entitled to a deduction in respect of the Project X costs? And,
- Is the Appellant entitled to a deduction in respect of the K Transaction costs?”
In answering question 1, O’Mahony accepted the executive’s evidence that “the business was structured in this manner because the Group was driven by ownership of intellectual property and the recognition of risk”. Below the “principal entities” carrying this risk, Covidien had “limited receptors”, usually known in transfer pricing jargon as limited distributors, which provide the interface with local markets but don’t carry significant risks nor decision-making.
O’Mahony quoted from a report provided by Covidien, which included typical features of many high-tech multinationals such as cost-sharing agreements between group subsidiaries tasked with developing new intellectual property and those generating business out of it, and the strict hierarchy between principal entities and limited receptors.
The Commissioner found that Covidien’s Irish top parent was an “active holding company” with a board making regular decisions for the entire group. Covidien PLC was “not just a passive holding company but was instead at all material times actively engaged and directly and indirectly involved in the management of its subsidiaries and sub-subsidiaries,” he wrote. As a result, it was “wholly engaged in economic activity at all times material to this appeal”.
Based on the services agreement between Company I in the US and its Irish parent, O’Mahony then agreed with Covidien’s submission in response to question 2 that it was for “a single, composite supply of services” that could not be divided between deductible and non-deductible inputs.
“That report was prepared for transfer pricing and corporate income tax purposes, and it is not of direct relevance to the issues of Vat.”Appeal Commissioner Mark O’Mahony
In answer to question 3, the commissioner found that the services Covidien PLC in turn provided to the four principal entities in the group did in fact cover the management of all the other, lesser subsidiaries. These four core subsidiaries were those charged simply because they were those centralising risk and profit, as detailed in the report submitted by Covidien. “I accept the submission and evidence of the Appellant that that report was prepared for transfer pricing and corporate income tax purposes, and it is not of direct relevance to the issues of Vat which arise in this appeal,” O’Mahony wrote.
As a consequence, he found that all services received by Covidien PLC from its US subsidiary Company I qualified as inputs for its economic activity and were therefore Vat-deductible. This meant there was no need to examine whether any qualified as deductible overheads, or should be separated out from non-deductible costs.
Finally, O’Mahony also cleared the costs associated with M&A deals for Vat deductibility as part of Covidien PLC’s regular economic activity. The decision and implementation of the Mallinckrodt spin-off “were all an integral part of the active management by the Appellant’s Board of the Appellant Group’s business as a whole. I therefore find that the planning and execution of Project X constituted economic activity on the part of the Appellant,” he wrote. The same applied to the share cancellation scheme leading to the merger with Medtronic, which he found to be “an integral part of the active management by the Appellant’s Board of the Appellant Group’s business as a whole”.
Having been directed to drop its €45 million Vat claim against Covidien, Revenue was preparing to challenge the Tax Appeals Commission’s decision before the High Court, according to a note at the end of O’Mahony’s determination.