APPENDIX
Sir David Varney
Varney Review of Tax Policy in Northern Ireland
HM Treasury
29 June 2007
Dear Sir David
Institute of Chartered Accountants in
Ireland Statement on Northern Ireland Corporation Tax Policy
I refer to our meeting of 18 June 2007 at Government
Buildings in Dublin where my colleagues and I met with you to
outline the position of the Institute of Chartered Accountants
in Ireland in relation to your current review of tax policy in
Northern Ireland.
The Institute of Chartered Accountants in Ireland
(ICAI) is the largest and longest established accountancy body
in the island of Ireland. It has over 15,000 members, and it is
the leading voice of the accountancy profession in Ireland. The
Institute was established by Royal Charter in 1888. Its activities
and those of its members are governed by its Bye-Laws and by Rules
relating to professional and ethical conduct.
The position of the Institute of Chartered Accountants
in Ireland is that it fully supports the introduction of a reduced
corporation tax rate in Northern Ireland to a level of 12.5%,
being the same as the rate applicable in Ireland. Without any
prejudice, for the sake of avoiding ambiguity in this letter,
we will refer to the respective territories as Northern Ireland
and the Republic of Ireland.
We presented you with our views on three key
areas, namely:
— An analysis of why a reduced corporation
tax rate in Northern Ireland is vital to Northern Ireland's future
economic growth.
— An analysis and rebuttal of the technical
arguments which have been presented over the years as a rationale
for not providing Northern Ireland with a separate corporation
tax rate.
— The experience of a low corporate
tax rate in the Republic of Ireland.
Dealing with each of these issues in turn.
1. An analysis of why a reduced corporation
tax rate in Northern Ireland is vital to Northern Ireland's future
economic growth.
Northern Ireland is unique relative to the other
regions of the United Kingdom in that it shares a land border
with the Republic of Ireland and its economic prosperity in the
global economy is closely linked to its interaction with the Republic
of Ireland through the evolution of an island economy. Northern
Ireland can benefit from its position of being both a political
and economic region of the UK and an integral part of the island
economy. The British and Irish Governments recognise this unique
inter-dependent economic relationship and have recently committed
to collaborate in spatial planning on the island of Ireland, to
the mutual benefit of North and South.
ICAI has already noted and welcomed the "Comprehensive
Study on the All Island Economy" published by the Secretary
of State for Northern Ireland, Rt. Hon. Peter Hain MP and the
Irish Minister for Foreign Affairs Dermot Ahern TD, on 27 October
2006. This very important Study sets out a vision of "a strong,
competitive and socially inclusive island economy with strong
island wide economic clusters, whose development is not impaired
by the existence of a political border".
In the recent past, as a result of political
instability there was a brake on the fullest realisation of economic
potential in Northern Ireland. This brake has now been removed
and the new reality in Northern Ireland is that all the people
for the first time can rally around and be loyal to a common focus,
a Power Sharing executive that hopefully will deliver a new and
better future that all can identify with and feel part of. This
new common loyalty is capable both of completely transforming
the political and economic landscape of Northern Ireland, and
providing a best practice model worldwide for conflict resolution.
Currently there is much international goodwill
towards Northern Ireland, particularly in the United States, the
European Union and the Republic of Ireland. The Republic of Ireland
is at present the fourth largest investor in the UK economy. This
goodwill can be transformed into Foreign Direct Investment if
we can transfer the economy from one heavily dependent on the
public sector to one driven by investment and entrepreneurship—an
economy characterised by self sufficiency rather than subsidy.
However the goodwill will not last forever; we have perhaps an
18 month window of opportunity to capitalise on it.
While in the recent past, the Northern Ireland
and the Republic of Ireland economies have had many similarities,
a fundamental difference has been the lower corporation tax rate
for trading companies in the Republic of Ireland of 12.5%. It
is recognised that the low corporation tax rate has been one of
the central reasons that the Republic of Ireland has been very
successful in attracting Foreign Direct Investment (FDI) to the
island and achieving a significant improvement in economic performance
relative to its island neighbour. This is illustrated below:
GDP Per Capita as a Percentage of EU15 Average
| 1972 | 2004
|
| % | %
|
| Northern Ireland | 72 | 84
|
| Republic of Ireland | 68 |
123 |
| | |
We acknowledge that Northern Ireland has achieved GDP growth
levels at 2 to 3% above GB in recent years and that employment
is at a record high. However this growth in GDP has been driven
mainly by public sector spending growth at approximately 5% per
annum, which represents approximately 61% of Northern Ireland
GDP (compared to 35% in the Republic of Ireland). The Northern
Ireland public sector employs one in three of all workers and
60% of all females in employment. Furthermore over 530,000 people
(41% of NI working age population) are not economically active
(compared to 12% in the Republic of Ireland).
We believe that the regional economic strategy outlined recently
by Minister Hanson would only close the wage gap of 75% of the
Great Britain private sector and Gross Value Added (80% of Great
Britain average) by 0.5%. This would not provide the necessary
catalyst to reduce the annual subvention from Great Britain of
£6.8bn.
The extent of underdevelopment in the private sector in Northern
Ireland is characterised by:
— 89% of local firms employing fewer than 10 people.
— Only 65 companies employing more than 500 workers.
— 10 companies accounting for 50% of all NI exports.
— Northern Ireland having the second-lowest level
of business formation of the 12 UK regions.
— Northern Ireland has the second lowest level of
business growth in the UK.
We believe that to complement investment in infrastructure
and skills in addressing this underdevelopment, it will be necessary
to offer a corporation tax rate similar to the Republic of Ireland.
This corporation tax rate is essential to successfully attract
sufficient FDI onto the island of Ireland. At the same time it
will provide the necessary government intervention to encourage
private sector investment in order to create wealth, and ultimately
fund services within Northern Ireland so that UK central budget
deficit funding can be reduced.
2. An analysis and rebuttal of the technical arguments
which have been presented over the years as a rationale for not
providing Northern Ireland with a separate corporation tax rate.
Over the years, various arguments have been presented why
a reduced rate of corporation tax in Northern Ireland would not
be a feasible proposition. We took the opportunity at our meeting
to rebut the arguments and would now summarise these as follows:
(a) A Northern Ireland corporation tax rate of 12.5%
would encourage tax avoidance through artificial fiscal migration
of profits
The aim of a low corporation tax rate in Northern Ireland
is to encourage economic inward investment into Northern Ireland
from large multi-nationals who would benefit from a low corporation
tax rate as a result of basing genuine economic activity in the
Province.
Whilst it is recognised that there would be a fiscal incentive
for existing businesses located in the United Kingdom to migrate
some or all of their operations to Northern Ireland, we believe
that such migration of economic activity is unlikely to occur
on a significant scale and therefore, the real concern would be
for a fiscal migration without an underlying migration of economic
activity.
We would point out that the existing transfer pricing legislation
contained within the Income Tax and Corporation Taxes Act 1988
(ICTA 1988) already contains transfer pricing legislation (based
on the OECD principle of arms length transfer pricing) which deals
with transactions between corporates located in the United Kingdom.
We believe that these rules in themselves should be sufficient
to discourage purely fiscal migration of profits to Northern Ireland
in respect of large UK based corporate groups who may consider
such migration as an attractive tax mitigation strategy.
Transfer pricing has always been an issue for the Republic
of Ireland vis a vis the countries of origin of Foreign Direct
Investment. Nevertheless, there has not been one arbitration case
on inter-company pricing dealt with under the EU Arbitration Convention.
This provides that where two Revenue authorities disagree on the
resolution of a transfer pricing issue, then each appoints experts
to get together to resolve the matter.
(b) Low corporate tax rates encourage tax avoidance
through individuals incorporating their businesses for purely
fiscal reasons
We acknowledge the concern that the tax base in Northern
Ireland could be eroded as a result of incorporation of business
entities for purely fiscal reasons.
We would point out that such incorporation has not proven
to be the experience in the Republic of Ireland since the introduction
of a low corporation tax rate. The rationale for the lack of incorporations
is outlined later in this letter but once again we believe that
any potential exposure to loss of revenue from "fiscal only"
incorporation can be addressed by an appropriate amendment to
the taxes legislation dealing with corporate entities.
In short, we believe that the introduction of a low corporation
tax rate will not cause an erosion of the tax base as a result
of entities incorporating for purely fiscal purposes.
(c) The EU Treaty may preclude the introduction by
the United Kingdom of a distinct rate of tax in Northern Ireland
The European Court decision of the Portuguese Republic v
The Commission of The European Communities—the "Azores
Case"[7] has received
considerable attention. Whilst it is outside the scope of this
submission to make a detailed comment on the case, we would refer
to the following points:
1. In the case, the ECJ confirmed that it is
possible for more than one corporation tax rate to be applicable
within the territories of a member state without such a regime
necessarily constituting a state aid or being in violation of
the EU treaties. In particular, in paragraphs 56 and 57, and in
paragraphs 63/64/65 and 68, the court described circumstances
in which regional differences in corporation tax rates within
a member state would be in compliance with EU law. These paragraphs
are set out in the attached appendix.
It can be seen from the extracts quoted that there are two situations
where a Northern Ireland corporation tax rate could be distinct
from such a rate or rates elsewhere in the UK without conflict
with EU law.
Firstly it could be achieved by having several regional corporation
rates within the UK rather than one national rate from which the
Northern Ireland rate would be a derogation. Such an arrangement
would require a wider redistribution of fiscal powers within the
UK than would be involved in a simple enactment by either the
central parliament in Westminster or on a devolved basis by the
regional assembly at Stormont of a corporation tax rate applicable
to corporate income in Northern Ireland. Such devolution of power
would not appear to present technical difficulties in terms of
EU law, nor, as is discussed elsewhere in this letter any insurmountable
technical difficulties in terms of prevention of tax avoidance
within the UK. The decision as to whether such an approach presents
difficulties would seem to rest more on UK political considerations
than on technical or legal considerations. Political considerations
are outside the remit of this letter, however we do appreciate
that there would be an element of reshaping the entire UK tax
system to facilitate a reduction in tax rates purely for Northern
Ireland.
Secondly, a corporation tax rate applicable in Northern Ireland
which differs from that applicable in the rest of the UK would
be compliant with EU law if the Northern Ireland Assembly adopted
such a rate on foot of lawful powers to do so, and accepted the
political and financial consequences of that decision. To achieve
this it would be necessary that the Northern Ireland Assembly
should be given competence over the corporation tax rate applicable
in the province and that the financial consequences of such a
cut in the rate of corporation tax should be borne by the Assembly
and should not be compensated for by an increased subsidy from
central funds of the UK. We believe that this second situation
is entirely feasible.
It will require investigation and clarification with the EU Commission
as to whether the second situation outlined above would only be
met if the tax receipts from corporation tax arising in Northern
Ireland were to accrue directly to the Assembly. An alternative,
which would probably be more acceptable in both Westminster and
Stormont, and at the same time meet the EU Commission requirements
would be that any shortfall in tax receipts arising from the corporation
tax rate cut in Northern Ireland were directly reflected in a
cut in the funds made available to the Northern Ireland Assembly
from central UK funds. In the later case it is recognised that
a reduction in the corporation tax rate would need to be matched
by a reduction in the Northern Ireland `Block' subsidy.
2. The UK Government supported the Portuguese
case against the Commission and highlighted the issue of autonomous
self elected regional governments which voted for a reduced tax
rate in cases where the financial consequences of the decision
were borne by the region, without a linked and countervailing
subsidy from other regions or from the centre. It is also relevant
to point out that the Commission, in its statement in response
to the United Kingdom's intervention, denied that its approach
might hinder the exercise by Northern Ireland of the powers conferred
on them in tax matters.
3. The Commission and The Court did accept
that a regional tax rate could qualify for a derogation from Article
87 of the Treaty if as a result of size and geographical position
that the possibilities of a territory achieving economies of scale
were substantially limited for firms resident there, which were
subject to significant additional costs as regards production
and access to markets.[8]
As Northern Ireland has both high energy and transport costs in
comparison to the rest of the UK, we believe that this derogation
would be available to enable a reduction in the rate of corporation
tax
4. The introduction of a separate corporation
tax rate for Northern Ireland can also be achieved by means of
derogation from Article 87 of the EU Treaty, which precludes certain
forms of state aid by EU member states. Article 87 operates on
a highly regulated and institutionalised way which has evolved
by virtue of the powers prompted by the commission in Article
88. We would argue that Article 87 provides sufficient flexibility
to allow a distinct corporation tax rate to operate within Northern
Ireland without the United Kingdom being in contravention of the
EU Treaty. We believe that the Commission would look favourably
upon such a derogation as a result of the recent restoration of
devolved assembly in Northern Ireland and that this can be seen
as a means of copper fastening such devolution and generating
economic prosperity to a region which has historically lagged
behind the rest of the United Kingdom both in terms of economic
prosperity and levels of private sector employment.
ICAI acknowledges that the European Commission has already recognised
the uniqueness of Northern Ireland as a region within the UK and
its interdependent relationship with the Republic of Ireland.
For example, in 1972 Northern Ireland was allowed to have Category
1 status within the European Union, even though its GDP was 72%
compared to the qualifying baseline of 70% of the EU 15 average.
Furthermore over the last number of years, the European Union
has injected special European Peace Funds into Northern Ireland
and the six border counties of the Republic of Ireland.
(d) The introduction of a separate corporation tax
rate in Northern Ireland will result in a net loss of revenue
to the Treasury
It has been the experience in the Republic of Ireland, and
can be reasonably foreseen as a likely consequence of a reduction
in the corporation tax rate in Northern Ireland, that a resulting
increase in economic activity arising from a low rate of corporation
tax is reflected not only in a long term increase in corporation
tax receipts but also in significant increases in Income Tax (PAYE),
National Insurance, Local Authority rates and Value Added Tax
as well in other less significant levies and taxes.
Where the consequences of a reduction in the CT rate in Northern
Ireland had to be reflected in the pattern of expenditure by the
Assembly or in the pattern or rates of other taxes in the province
in the short term in particular, it would be both necessary and
appropriate to consider to what extent any increases in the proceeds
from these other taxes, or indeed all of the receipts from these
taxes within the province should be made available to the Assembly
to finance its expenditure, with a reduction in the transfer from
central funds of the UK correspondingly. If the consequences of
a CT rate reduction is to be borne by the Assembly, it may be
necessary to link the central funding to the Assembly in a wider
context than CT alone.
However, it should be possible to take a more narrow view
of matters, if that is considered essential for UK political reasons,
so as to ensure that the consequences of a cut in the CT rate
is reflected in Assembly controlled expenditure in the province.
In the short term such a cut in rate is likely to result in a
reduction in receipts from CT, notwithstanding that in the longer
term it should lead to an increase in CT receipts. Were the approach
taken of having a CT rate in Northern Ireland which was lower
than the national UK rate (which as pointed out above is only
one possible approach to achieving an EU compliant local CT rate
in Northern Ireland), it would be desirable to analyse the short
term options available to the Assembly in terms of impact on expenditure
or on alternative sources of local finance.
3. The experience of a low corporate tax rate in the Republic
of Ireland.
The experience in the Republic of Ireland over the last 10
years has clearly demonstrated that progressive tax policies contribute
to economic success. The reduced rate of Corporation Tax is one
component of a succession of tax policies which have operated
in the Republic.
— Rates of VAT have remained high in comparison
to European norms, to an extent which has seen the total VAT take
in the Republic exceed the total income tax take.
— The income tax base both for corporates and individuals
has been broadened. For example, accelerated tax depreciation
is a thing of the past, reliefs for pension contributions are
subject to limits derived from the capital value of the pension
fund.
— Ceilings have been removed from the employer's
contribution to national insurance
— Capital Taxes rates now equate to the standard
rate of income tax
Another factor which is most commonly overlooked is that
rates of corporate tax on passive income stand at 25%. Therefore
the composite rate applying to companies is, on national figures,
in the order of 16%.
All these matters are interlinked. When the Capital Gains
Tax rate dropped from 40% to 20% the amount of tax raised immediately
doubled. The Republic of Ireland now has both an effective venture
capital industry and a thriving financial services industry. The
introduction of the 12.5% rate of Corporation Tax hugely benefited
these sectors.
(a) Close Companies
We have already identified for you that incorporation is
not used as a vehicle for tax avoidance, owing to the close company
regime operating in the Republic of Ireland. The surcharge on
undistributed investment income together with the surcharge on
professional services income mean that the effective tax rate
on small family companies wishing to shelter income from the higher
personal tax rates is an effective 40% for investment company
income. This compares to our 41% individual tax rate. Of course
individuals also have PRSI to pay, currently 5% up to income of
€100,000 and 5.5% on incomes over this level. The equivalent
tax rate for service companies is 25.62%.
However individuals need to take salary and dividends from
their companies, which also attract income taxes at the marginal
rates.
(b) Tax Treaties
A reduction in Corporation Tax rates does not necessitate
the re-negotiation of tax treaties. Tax treaties do not mention
actual tax rates. Ireland's treaty network has worked very successfully
despite the operation of a number of different corporation tax
rates at different times for different sectors.
Conclusion
We understand that you are carrying out a broad based consultation
with the relevant stakeholders in the Northern Ireland economy.
We are aware that you have already been provided with both qualitative
and quantative analysis including the report prepared by the Economic
Research Institute of Northern Ireland entitled "Assessing
the Case for a Differential Rate of Corporation Tax in Northern
Ireland". To this extent, we do not propose to provide any
additional economic data in respect of this submission.
We do however urge you to recommend that Northern Ireland
be granted a differential corporation tax rate from the rest of
the United Kingdom. We would recommend that this corporation tax
rate be equivalent to that applicable in the Republic of Ireland,
being 12.5% for economic profits derived from economic trading
activities. (For the avoidance of doubt, we would accept that
the existing corporation tax rate should continue for profits
and income derived from non trading and investment activities).
We are of the opinion that there are no technical or legal
grounds why such a corporation tax cannot be applied to Northern
Ireland and if such reasons exist, we are firmly of the opinion
that amendments to the Taxes Act would be sufficient to overcome
any concerns of inappropriate loss of tax revenue.
Northern Ireland would not only benefit from a low corporation
tax rate but absolutely requires it in order to enable it to grow
and prosper under the terms of the devolved powers that now exist
in the Northern Ireland Assembly.
We look forward to the publication of your report in the
Autumn.
Yours sincerely
Eamonn Donaghy FCA
Chairman, ICAI Northern Ireland Tax Committee
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Case C -88/03 Back
8
Article 299(2) EU Treaty Back
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