Photo:bass_nroll, Creative Commons, Flickr

Guess which country is the world's biggest exporter of software? The US? Nope, guess again? No, not China, or Malaysia, or even Indonesia. The world's biggest exporter of software is a misty green island of four million people. That's right, Ireland. The country which had a famine while the rest of Europe was having an industrial revolution. The country whose economy, up until the 1960s was based mainly on farming and tourism. Ireland has created unprecedented success built on massive levels of investment from multinational firms, and most of that comes from the US.

American firms come to Ireland for many reasons. They like having their goods manufactured within the EU, as that makes it easier to sell into that market. They like the political stability, the infrastructure, and the minimal cultural differences. They like the well-educated, English-speaking workforce. Most of all, though, they like Ireland's company tax rate – a mere 12½% on trading income, and the wide range of tax treaties between Ireland and other countries that makes it easy to move profit around. For the past thirty years, successive Irish governments have tailored their tax system around foreign investment, a process known as tax competition. And they are very, very good at it.

Ireland's first strategy was Export Sales Relief (ESR), which involved charging zero% tax on profits from exports. This favored foreign companies locating there to sell into the EU. When ESR came to an end, and could not be renewed under EU rules, the slack was taken up by a widespread application of manufacturing relief. As long as the goods sold were manufactured in Ireland, the resulting profits were taxed at only 10%. Critically, "manufacturing" was not defined in legislation, and leaving case law to decide it meant an irreversible process that resulted in a commercially different product. This led to the rather ridiculous outcome of green bananas, artificially ripened in fruit warehouses being deemed to be "manufactured in Ireland" and qualifying for the 10% rate.

Manufacturing relief was due to run out in 2010, and again many EU members who had lost revenue to Ireland objected. The core problem lay in applying one rate to manufacturing, mainly foreign firms, and a higher, 40% rate to other firms in the economy. Ireland's response was to agree to apply the same rate across the board, but to set it at 12½%. By offering the same low rate to all enterprises local and multinational, Ireland slipped past OECD rules that might have designated the country as a tax haven, and retained its international status as a tax treaty partner. These treaties are important to multinationals, as they ensure that profits can be repatriated to the US with minimal adverse tax consequences. Manufacturing investment flooded in through the 1990s. The Irish economy was transformed, and by 2004, Ireland was the most profitable global location for US firms.

So who are the winners and losers here? When a US firm sets up a massive manufacturing plant in Ireland, this is good for the company, who pays less tax. It's good for Ireland, where people are employed. It's not so good for other countries, particularly developing countries, competing for investment, or for communities in the US, where manufacturing plants have closed down. Tax competition and tax avoidance rarely appear in discussions on company ethics. Perhaps it's time that changed.