Session 2010-11
Publications on the internet

To be published as HC 558-vi

House of COMMONS



Northern Ireland Affairs Select Committee

Corporation Tax

Wednesday 12 January 2011

Professor Rosa Greaves

Mr Phillip Kermode

Evidence heard in Public Questions 343 - 415



This is an uncorrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.


Any public use of, or reference to, the contents should make clear that neither witnesses nor Members have had the opportunity to correct the record. The transcript is not yet an approved formal record of these proceedings.


Members who receive this for the purpose of correcting questions addressed by them to witnesses are asked to send corrections to the Committee Assistant.


Prospective witnesses may receive this in preparation for any written or oral evidence they may in due course give to the Committee.

Oral Evidence

Taken before the Northern Ireland Affairs Select Committee

on Wednesday 12 January 2011

Members present:

Mr Laurence Robertson (Chair)

Lady Sylvia Hermon

Naomi Long

Mel Stride

Oliver Colvile

Mr Joe Benton

David Simpson

Gavin Williamson

Ian Paisley

Mr Stephen Hepburn

Dr Alasdair McDonnell


Examination of Witnesses

Witnesses: Professor Rosa Greaves, Professor of European Commercial Law and Head of School of Law, University of Glasgow, gave evidence.

Q343 Chair : Can I welcome our witness to the Committee? Thanks very much for coming today. You’re aware of our inquiry; we’re looking into the different rates of corporation tax that exist between the Republic of Ireland and the UK, and the impact that has on Northern Ireland. Obviously there are a number of options that as a Committee we’re considering, but we did want to talk about the legal aspects of the whole issue, so we’re very grateful to you for joining us today. I wonder if I could perhaps start; it might be useful if you’d like to make a very brief opening statement, just to introduce yourself; tell us a little bit about your work, please.

Professor Rosa Greaves: Thank you very much for inviting me to come to the Committee. My name is Rosa Greaves. I’m a Professor of European Commercial Law at the University of Glasgow. Within that broad term, the areas in which I have particular research interest and teaching are competition law, intellectual property law and the internal market-the movement of goods and services within the internal market. I’m also Head of the Law School, at least for the moment.

Q344 Chair : Thank you very much. When we talk about the legal aspects, they’re often referred to as the Azores Judgment. Perhaps you could give us your view of why the European Court ruled the way it did in terms of Azores.

Professor Rosa Greaves: To understand the situation, you have a situation where a tax measure in a Member State can be caught by the state aid rules-may be caught. In testing those rules, there are very strict criteria and one of them that always causes problems is geographic selectivity. Over the years, right back from the 1970s onwards, particularly in the case of Germany with the Länder, the court has been consistent, and the Commission consistently has always considered such a tax measure to be a state aid, not that it’s incompatible with the rules, but has classified it as a state aid because of that geographic selectivity-that it only applied to a little bit of the state. The state in terms of EU law is always the United Kingdom. Wherever there was a tax that would affect businesses in one section, one geographic part of the country, that would automatically fall into being classified as a state aid, and then there is a very detailed procedure to decide whether it’s compatible or incompatible with the rules.

The importance of the Azores case was that, for the first time, the full European Court of Justice-because it was heard by the full court-accepted that you could apply internal national constitutional realities, constitutional rules, to accept that there is now devolution in geographical areas of some of the Member States, but they then also set out three very strict conditions, which I think you’re familiar with. The problem is that, even in the Azores case, the Portuguese Government and the Azores did not meet those conditions. It was really a case where, as I keep saying to my students, the gate was opened but we don’t know how wide it is. Following that, there has been a confirmation of those criteria, for example in the Gibraltar case. The Gibraltar case, in my view, is at one extreme of the spectrum because there’s so much independence of Gibraltar. That decision was taken, i.e. reaffirming the criteria of the Azores case, but in the lower court, the general court not the European Court of Justice itself. There is now an appeal going to the European Court of Justice, and the European Court of Justice will decide on the Gibraltar case. I personally expect it just to confirm what the lower court has stated.

For our purposes really, it’s to decide whether the geographical area-be it Northern Ireland, Scotland, Wales or wherever it is-meets the conditions of the Azores Judgment. Is it institutionally independent? Is it procedurally autonomous? Is it financially and economically autonomous? The first one I think is very easy; it has shown to be quite easy to show the institutional one, because that basically means that you have your administration quite separate from central government. The difficulty comes with procedural autonomy and also economic and financial autonomy. I don’t know whether you want me to elaborate further on those two.

Chair : We’ll probably come to a number of the detailed questions as we go through.

Q345 Lady Hermon: Yes, I’m nodding my head enthusiastically. It’s very, very nice indeed to see you here this afternoon. I wonder if you would kindly elaborate. I think it’s actually very helpful. We’ve heard other witnesses before us refer to the Azores Judgment. To nonlawyers, it would be very helpful if you spelt out the three conditions, and if you would give us from the benefit of your knowledge and experience, and I mean that most respectfully, whether in fact you think Northern Ireland actually qualifies and does meet the conditions outlined by the ECJ in the Azores Judgment.

Professor Rosa Greaves: I will go through the various conditions. I’m not sure I can answer your last question, because I’m not familiar with the Northern Irish statute and act. Institutional autonomy, what does that mean? That means they must be politically and administratively separate from central government. When it comes to procedural autonomy, let me give you an example of the sorts of arguments that have been raised to say that, for example in the Basque country, they were not procedurally autonomous. There was an argument put, for example, that the fact that the Basque country government had to have a dialogue with the central government in Spain, as to fixing the taxes, would indicate that they did not have procedural autonomy. The European Court of Justice said no, that does not mean that, because you are part of a state, and therefore it would be natural that you would have to take the interests of the whole in your consideration. What procedural independence means is that the final decision is made purely by the regional authority. The regional authority decides whether they are going to carry that decision to reduce the corporation tax.

The more difficult one is the one about the economic and financial autonomy. What we see emerging from the discussions on the other cases, the Basque country cases and also Gibraltar, is what we’re looking at to have this economic and financial independence is there must be no possibility of the central government in some manner offsetting or compensating for the loss of the revenue from a lower corporation tax. That’s what they’re looking at. The court’s judgment talks about causal links. The difficulty of course is to establish how that arises. Let me just give you a little example, again in argument. In the Gibraltar case, the argument was being put that, because the British Government still has financial obligations, in terms of defence and other areas, that was already an economic assistance. Again, that was not accepted by the general court, by the lower court. They said that’s not true; that financial imposition on the UK Government is in fact part of international law and international obligations to protect Gibraltar. That’s why I keep saying the gate is open but we don’t know how wide it is. That is a crucial point. In the Portuguese situation, there was a constitutional clause of solidarity. Again the court has said solidarity as a principle in the constitution is fine, but in the Portuguese case was connected to financial compensation to the Azorean Government if they actually got it wrong and they were short of money to deliver the services.

Q346 Lady Hermon: If I were then to explain to you in very basic terms that, if the UK Government decided to give the power to the devolved assembly in Northern Ireland-the power to set corporation tax at whatever level they wanted and they had complete autonomy over that-and if the Northern Ireland Assembly decided to do that, the British Government would in fact reduce by the equivalent amount of loss of corporation tax the block grant to Northern Ireland-it would be reduced by the identical amount or thereabouts-would that satisfy? Would that go through the gate? Would it satisfy condition three?

Professor Rosa Greaves: I can’t see why the reduction or reducing the amount-that’s exactly the opposite of what I’m talking about. I’m talking about compensation; i.e. in a situation where the region has a rate of corporation tax that is lower than anywhere else. That has financial consequences, because there’s less revenue, and the central government does the opposite-it compensates.

Q347 Lady Hermon: It would be additionality. I know that’s a technical term in European Union speak. So the position of Northern Ireland losing its block grant to the equivalent amount of corporation tax actually may well be compatible with the Azores Judgment.

Professor Rosa Greaves: I can’t say that without having the detail of everything, because there are so many conditions, and do please remember that, even if we get to that stage, you still have the material selectivity; i.e. is what the Northern Irish decide to do, in cutting the tax, an action incompatible with the state aid rules? It will depend very much. For example, let’s say that they would reduce the corporation tax only for companies that produce textiles. Then you have selectivity again. The Azores Judgment is very much on geography. There are many other issues as to whether a particular tax measure is a state aid and an incompatible state aid.

Q348 Lady Hermon: If I could just follow up, then I’ll allow my colleagues to come in. Would you expect, if in fact the UK Government were to do this for Northern Ireland, is there precedent for other Member States being terribly aggrieved by this and would they challenge it? Would they encourage the Commission to challenge such a decision by the UK Government?

Professor Rosa Greaves: It’s interesting to see that in the Gibraltar case Spain supports the condition, but in the Azores case they supported the Portuguese Government. You can argue both.

Q349 Chair : How would they judge the financial compensation though because, as you know, we have a very complicated Barnett Formula?

Professor Rosa Greaves: That’s a question that I’m totally incompetent to answer. I can only guide you as to what they will be looking at. From a legal point of view, it’s this causal link. The court has said there must be a direct link between the compensation element and the loss. What they’re after is for the regional authority to carry the financial risk.

Q350 Naomi Long: On that point, obviously if the UK Government decided to allow the Northern Ireland Assembly to vary the rate of corporation tax, it would still be collected by the UK Government centrally. That would then be redistributed throughout the UK with the rest of taxation, through Barnett. The argument that I think Sylvia was putting forward was that Northern Ireland would get a reduction under the Barnett Formula to allow for the fact that they had a lower level of corporation tax. The question I had really was: is that link direct enough to satisfy the judgment? In your view, do you feel that that would be sufficient to satisfy that we were carrying the risk or would the fact that it comes into a central pot and is then redistributed be seen as some dilution of the causal link?

Professor Rosa Greaves: That’s a very interesting question, which I haven’t thought about: the collection, who collects it? Logically, it shouldn’t matter who collects it because we’re looking at market effect. I’m just trying to remember, and I’m not sure I’m absolutely right, but I think in the Basque situation there was something in reverse: that the Basque authority collected money and then paid it to the central government, but that was for services that were offered by the central government to the Basque. I would like to think about that. I’m not confident at all and it would be very unwise to be confident about saying what would be absolutely safe or not. I think there is an element here of we don’t have enough concrete cases to be able to sure what the limits are, and how much is that causal link you are talking about.

Q351 Mel Stride: You used the expression "possible causal link" between changes in taxation and compensation found in Azores, etc. That word "possible", would that mean that the fact that, at its own discretion, the United Kingdom might decide at some future stage to make a transfer to Northern Ireland, because of consequences that followed from the tax reduction, might potentially cause a problem here?

Professor Rosa Greaves: I don’t think so. I wasn’t thinking of the word "possible" in that sense. I can’t think now, but there may be many reasons why a central government may wish to transfer money to a region. Let’s say all of a sudden there is a huge increase of immigration to Northern Ireland, by millions and millions, and you want to give more hospitals or something else. Also, there’s the burden of proof and who’s got the burden of proof here to try to demonstrate that, on this particular occasion, transfer of the money was directly because there had been a reduction, a loss of revenue, from the autonomous region? I’m sorry I’ve used the word "possible"; I didn’t mean the word "possible" with the intention with which you’ve taken it.

Q352 Oliver Colvile: We were in southern Ireland, in Dublin, before Christmas, and we had a very interesting debate there with a number of the Treasury and the Foreign Office and all of that, in southern Ireland. One of the things that certainly became apparent to me was that southern Ireland has been very successful at putting together clusters and activity taking place to encourage investment of multinationals coming in, in a specific set of clusters. I have suggested, and there are others on this Committee who don’t necessarily totally agree with me, that this is something that potentially Northern Ireland might end up doing too. Would you perceive that going down that route of trying to encourage greater growth in places where Northern Ireland has got a strength would be seen to be against the Azores Treaty?

Professor Rosa Greaves: I don’t think it’s against the Azores Judgment. You also have to remember there are whole schemes to assist investment. State aid is permissible for environment protection, regional aid. There’s a whole scheme there to assist the clusters, as you call them. The issue here is not one of whether the Azores Judgment applies; it’s whether it should need to be notified to the Commission, and it should be asked to say that for these reasons and under the Treaty they are compatible with the provisions. I have no idea whether southern Ireland’s schemes and clusters have been notified to the Commission or whether they are selective.

Q353 Oliver Colvile: We’re in a different world now and most certainly have been for the last year or so, and there is not a great deal of public money around. Most certainly the EU hasn’t got vast sums of money to put through in the way of Objective 1 funding and all of those kinds of things. One of the reasons why I’m moderately attracted by what’s being proposed here is, if you are going to create an environment where you’ve got low taxation, then that is going to encourage people to invest in their businesses. If you can get the private sector to do it, should you give them a carrot? My personal view is that I think that’s probably quite a good idea to do. I’d be interested in your comments on this.

Professor Rosa Greaves: I’m not going to comment on that, because I don’t think that that’s a legal question. What I would say to you is remember that state aid exists and we have the EU rules because, when you create-in the terms of the Treaty-a state aid in one geographical area of the EU, you may be causing a problem in another geographical area of the EU. From the EU law point of view, the rules are there not to stop development and not to stop aid, but ensure that it doesn’t simply shift the problem in the market. From the EU point of view you haven’t resolved anything. From a national point of view you have, but not from the EU point of view.

Oliver Colvile: Funnily enough, I’m quite interested in making sure we look after our national interest rather than our European one, but that’s another matter.

Professor Rosa Greaves: I don’t blame you at all.

Chair : We had enough on that yesterday.

Q354 Mr Benton: Welcome. Can I just go back to something Lady Hermon was asking you before? I apologise in advance if I misinterpreted or misunderstood, but it’s not quite clear in my mind when we’re talking about the European legal dimension of this. Can I just ask you, if the British Government were so minded to consider a reduction in corporation tax, and then the ECJ were to-and I think this is the right phrase-call that decision in to examine it, would they be doing it purely on the basis that the Government has taken this action with a devolved government or would there be other reasons to call it in? Would it just be initially on the basis of the fact that it’s a devolved government? It might sound a trite question but it’s not clear in my mind. I think it’s important to know why the ECJ would call it in.

I wanted to ask you that as a followup, but then I wanted to move on as quickly as I can. Going back to the Azores case, before that judgment was announced, the UK Government felt it appropriate to intervene or to make comment on it. It’s quite significant. I would presume it made that request or intervened because somehow, the way things were going, there would be a danger to its own interests. I’m making that assumption. I wanted to ask you, on what grounds do you think, legally, the UK Government would have intervened on that. Could you perhaps explain any raison d’être behind that?

Professor Rosa Greaves: If I take your first question, I think your first question really is about competences. What you’ve got to remember is that there’s very limited competence at EU level on taxation. That’s the starting point. Then what we do have though, and sometimes it’s difficult to grasp, is that although there is little or limited competence, there are other areas of the Treaty where there is a lot more competence at EU level, which may interfere or may have to be applied to a tax measure. We have to find a way through it. The focus is on what they call "harmful tax competition", and that’s where the competition rules come into play, which include the state aid rules. It’s not the European Court of Justice; the European Court of Justice comes at the end of a long story. It starts at the beginning and, because this is hugely politically sensitive, the Council of Ministers has together come up with-for example-a code dealing with direct business transactions. That is a nonbinding process, where they hope politically they can resolve any tax measures that are being planned by a Member State that they think might be harmful tax competition for the market. Really, when a Member State is going to propose a different taxation for corporations for example, they would normally meet together in Brussels, look at it and get a view from their partners of whether that kind of tax measure is really harmful competition.

Portugal did that and the Council of Ministers was happy with it. The group was happy with it, because it’s not a legal issue; there it’s more of a political one. The consequences then after that are that the Commission has an obligation to make sure the rules of the Treaty are applied. Because this socalled aid from Portugal had not been notified to the Commission, the Commission used Treaty powers to investigate it. Then, after a long process testing whether the Portuguese aid within the Azores was actually a state aid according to the rules, they came to a decision that it was and they issued a decision, which is a binding act addressed to the Portuguese Government. In our case, it would be addressed to the UK Government. It’s that decision that triggers an appeal. You have two months to appeal. The Portuguese Government would appeal or the UK Government would appeal.

In the Portuguese setup we have the Commission against Portugal, because actually the Commission brought an action against Portugal for failure to notify. At that point, Member States have a right to intervene. Why did the United Kingdom intervene? The United Kingdom intervened because I’m pretty sure they knew that they have a similar constitutional devolution in the regions. In the same way, Spain intervened in Portugal’s case as well, because they know they have the Basque countries and the other countries, and so they want to influence the decision of the court.

I did have something on the United Kingdom’s arguments. The United Kingdom’s argument in the Azores case was that "regard should be made to the degree of autonomy of the regional or local authority before classifying the regional tax rate as a state aid." That I think answers that question as to why the United Kingdom went in.

Q355 Mr Benton: Just on the point of the comparison between the Azorean agreement, am I right in thinking that Azores then would constitute a devolved assembly in the same sense? The comparisons are all there, are they?

Professor Rosa Greaves: The Azores is very similar to Scotland. It has its own parliament, its own ministers, etc. It’s only in three areas-I think it’s education, defence and some other third area-that the exclusivity is in the hands of the Lisbon Government. It’s very similar.

Q356 Chair : It’s interesting that you raise Scotland though, because Scotland does have taxvarying powers. It does not use them, but they do have those powers.

Professor Rosa Greaves: It’s in income tax. Remember that we’re really more focused from the competition point of view on undertakings. That’s why the Code and everything else is named "direct business transactions".

Q357 David Simpson: My question is not as complicated as the rest of them, but apart from the Azores, the Basque country and Gibraltar, are you aware of any other country that has had discussions with the Commission in relation to tax powers or whatever?

Professor Rosa Greaves: I’m not 100% sure about tax, but certainly where we had similar things is Germany, with the Länder. The case of the Commission v Italy (1973) actually enabled the European Court of Justice to agree with the Commission that a tax measure could be classified as an aid, because initially one would have said there’s very limited competence in taxation, hands off; but the competence on tax has to be separated in your minds from other areas of the Treaty dealing with trade or with competition, which may have an impact on how the tax is formulated.

Q358 David Simpson: Chair, just to supplement: how far did those discussions go with Germany? Have you any more fine detail on it?

Professor Rosa Greaves: With the German case, I really don’t know. With the Basque country what has happened is that-this is a different procedure-in the latest Basque case, under a ruling in 2008, there was litigation in Spain itself, because the trade unions were unhappy with some of the tax reductions and brought an action in Spain. One of the pleadings was that the reduction in corporation tax was an illegal state aid, and so the court has a right and an obligation under the Treaty to ask the European Court of Justice to interpret Community law, not Spanish law.

This case came to the European Court of Justice in exactly the same way as the Azores case, but it was a different procedure-not a direct action when you have to say yes/no, but an interpretation, like a court of appeal interpretation of the law. They repeated the Azorean mantra and made it very clear that, in this particular case, where there was a procedural autonomy or an economic and financial autonomy or an institutional autonomy, it was a matter for the trial judge to decide on the facts. When it went back to Spain, it was the supreme court of the Basque country that then applied the ruling to the dispute, and they ruled that the Basque country had sufficient institutional, procedural and financial independence. We have an example of where a region was established to have that kind of independence. For me, the problem is that it was decided by a national court. I would love to settle many of these issues that you are raising about what exactly would deny the third condition, the financial and economic one, in particular. It needs a European Court of Justice decision to be final, but that doesn’t mean that we can’t speculate and can’t argue how far the gate is open.

David Simpson: There’s really nothing simple about this.

Professor Rosa Greaves: Never. There’s nothing simple in the law.

David Simpson: That’s very clear.

Q359 Lady Hermon: Would you mind if I just follow up on one point? For the sake of clarity here, am I right in thinking that, if the British Government were to decide that the rate of corporation tax were to be devolved to the Assembly, the procedure is they would have to have that agreed within the Council of Ministers at a political level.

Professor Rosa Greaves: It’s not binding, but it would be wise.

Q360 Lady Hermon: Yes, so it would be open to, for example, the Irish Government, our nearest neighbour, which has a very reduced corporation tax, to object, but that would not be binding. Correct, right? If the power was devolved to the Assembly, am I also right in thinking, from what you’ve just said, that that decision could then be open to challenge in the local courts in Northern Ireland-it is a preliminary ruling procedure-by someone or some group that was most unhappy about the reduced rate of corporation tax?

Professor Rosa Greaves: If within the legal rules they had an interest that gives them locus standi, yes.

Q361 Lady Hermon: It could go to the ECJ through that route.

Professor Rosa Greaves: The national court, the national judge, may wish to have the interpretation and has a right to refer to the European Court of Justice.

Q362 Lady Hermon: Am I right in thinking that you think that it might actually be a safe course of action to have a definitive ruling from the European Court of Justice?

Professor Rosa Greaves: I would think that is yes, but how do you get it-you can’t go to the court and ask about an imaginary case. The court will not hear it. This is one of the problems with European law: that the European Court of Justice is so dependent on which cases are actually referred to it, and that’s why sometimes we have to wait 20 years to have a principle.

Q363 Lady Hermon: So there is a realistic possibility that someone who was negatively affected by the reduction in corporation tax, who didn’t benefit, would have sufficient interest to go to the local high court in Belfast and challenge this.

Professor Rosa Greaves: I think if they have locus standi, this is what happened in the Basque country.

Lady Hermon: Thank you. That’s really interesting; that’s very helpful. For all of those Members of the Assembly who may take on board this decision, it’s always wise to know that you may be generating a legal challenge down the line.

Professor Rosa Greaves: You have to demonstrate locus standi first, and it’s not that easy.

Q364 Gavin Williamson: You very briefly touched on how tax revenues were raised in the Basque country. I’m not expecting you to be an expert in this, but I wonder if you could explain a little bit further as to how it is raised. It sounds as if it’s the total reverse of the Barnett Formula. Are there any similarities between Barnett, Spain and the Basque country?

Professor Rosa Greaves: I’m really very much out of my depth here. The Barnett Formula, I think I understand it.

Chair : None of us do.

Professor Rosa Greaves: Please correct me if I’ve got it wrong. My understanding of the Barnett Formula is that whatever the UK Government spends, a certain amount goes to Northern Ireland, a certain amount goes to Scotland.

Chair : That’s the best explanation I’ve had in the seven months I’ve been here.

Professor Rosa Greaves: It’s totally irrelevant to population and anything else.

Ian Paisley: It’s weighted.

Chair : It is weighted; there are certain adjustments made to it.

Professor Rosa Greaves: Now, the Basque country is really quite difficult because they have many different levels of agreements. First of all, they have their historical baggage with it, they have a particular economic agreement, and they also have a particular "federal system" in Spain under the 1978 Spanish constitution. What I have gathered so far is that there seems to be almost a transfer of money both ways, because there are certain services that are central services, which the Basque authority reimburses as central, but there are also some other things. You talked about the collection of taxes. General taxation, like the collection perhaps of customs duties or something like that, can be done by the Basque country in their geographical area and then transferred up to the central administration. I really wouldn’t like what I’ve just said to be taken as gospel, because I don’t know enough about the Basque structures.

Q365 Gavin Williamson: This is probably a little bit of an unfair question, but do you think, because of the fact that that’s the way it’s structured, it’s an argument that the Basque region is more autonomous than, let’s say, Northern Ireland? Therefore, there’s a stronger legal argument to say they can have their-

Professor Rosa Greaves: It may be that what you’re saying is true, but I don’t think it has any relevance to the tests, because of the way it’s done. What is important is that we’ve got the tests. Now everybody has a different situation and they ask, "Is my situation within this test? Can I justify it?" That’s the stage I think we are at.

Q366 Mr Hepburn: Just one very quick question to follow up an answer you gave to Sylvia: let’s suppose that the British Government has, in its terms, decided that it has met the conditions of Azores, has gone to the Council of Ministers and has had this informal stamp of approval, etc. As we’ve established, it is still open to legal challenge. What consequences might follow a successful legal challenge? If we assume that this had been running for six months, a year or so, what range of outcomes might be possible?

Professor Rosa Greaves: In theory, the Commission, if convinced, would start initiating an investigation, because this state aid has not been notified. If they think it’s a state aid, they would go through all of that. They would decide it has not been notified as a state aid, and they probably would issue a decision stating that the UK Government is in breach of its Treaty obligations. It wouldn’t be the Northern Irish Government or the Scottish Government; it’s always the UK Government. It would be in breach of its Treaty obligations, and the consequence normally in every single case-there’s nothing special about the tax measure-is that you have to pay back the money.

Normally what happens is that the state gives money out in state aids. What is very strange about the tax measure is that a government refrains from receiving money. There would have to be some sort of-I’m trying to decide what they would do. They would be looking at whether there is any element there that needs to be paid out or paid in, compensated, for whatever benefit has accrued. I’m thinking on my feet now, but there’s no way, I would have thought, that you could ever impose an obligation on a government to go and collect tax. Basically you would have to stop it. The obligation on the United Kingdom would be to adopt the necessary legal measures to stop that reduction in tax.

Q367 Mel Stride: If they were to quantify the effective compensation that had been involved hitherto, your suggestion is that it would be very tricky to reclaim that.

Professor Rosa Greaves: I think it would be very tricky. It’s my personal view. I haven’t come across a case where that has happened. In the normal way, and the way it should be, is that the state notifies first. If there’s an advice you want, you notify because, by notifying, you are protecting yourself, and you are able to debate and argue through the process of the investigation.

Q368 Oliver Colvile: What do you think the UK Government should have to do to ensure devolving power to Northern Ireland is not classified as a state aid?

Professor Rosa Greaves: The general comment I would make, which won’t help you, is to just say exactly what we’ve been discussing; i.e. it’s to make sure that the Northern Irish Government is institutionally autonomous and procedurally autonomous, and that it carries the risk of that financial loss on reducing the taxation, because we’re talking about reducing taxation. Why I say it doesn’t help you is because there are so many "ifs" when you have a scheme where there is a block transfer or a transfer of money from a central government to the regions. You then have to examine in detail whether the formula or whatever happens is totally objective and not linked in any way-that nobody can put up an argument that it’s actually linked to the loss. I would test that-if I were a government, I would probably send that to the Commission to ask, "Does this meet the Azores test and the Gibraltar test?"

Q369 Dr McDonnell: Two very quick questions: we will lose the power in Northern Ireland to offer state aid in the form of grants in foreign direct investment in two to three years’ time. Since we’re generally agreed here that a corporation tax reduction would be regarded as state aid, what do you think of our chances of getting that through the Commission, taking all things into consideration?

Professor Rosa Greaves: I’m not very familiar at the moment with the current programmes that the Commission operates under state aid rules. What I can tell you is that there are a number of programmes like regional aid. There are programmes very much focused on aids that improve the environment, in the sense of reduction of pollution and all those sorts of areas.

Dr McDonnell: We’re familiar with those, yes.

Professor Rosa Greaves: There’s that kind of range and then it’s trying to see whether whatever the project is can be fitted into that programme and getting the clearance from the Commission on that.

Q370 Dr McDonnell: We’d like to think our recent difficult history could be used in some of those contexts to perhaps lever or persuade-

Professor Rosa Greaves: I don’t even know at the moment what the map is, but I know that there is a regional map of the whole of the European Union, where certain areas are specified and identified as requiring more assistance. There is another programme, for example, for peripheral places that are so far away that they need extra assistance.

Dr McDonnell: Northern Ireland qualifies there.

Ian Paisley: It used to be an Objective 1 region, but it was taken out.

Dr McDonnell: And is there not part of the west of the Bann that qualifies at all?

Ian Paisley: It lost that status in 2001, I think.

Professor Rosa Greaves: Some state aids do meet because, in the Treaty article that prohibits the aids, there’s also a section allowing for aids to be operated for a short time. You don’t want to carry on for ever and ever. For example ferries are often stateaided in their services, because you want them from islands where small populations live. Unless you help them, they wouldn’t run the service commercially.

Q371 Dr McDonnell: If we were to be successful and receive these powers, do you feel it will be possible to focus them on some business sectors and not on others? In other words, do you think it would be possible to focus on foreign direct investment but not, for instance, on the existing banks and utilities?

Professor Rosa Greaves: What you have to be very careful on with the state aid issue is that it’s both geographic and material selectivity. If you bring a measure of any sort that favours particular undertakings or particular industries, you are going into selectivity and then you’ve got problems, because what you’re doing is precisely what state aid rules are trying to stop, which is to assist one particular group in a geographical area of the whole EU, which may have repercussions in another area of the EU. I don’t know whether you would have a chance or not, but I do know that the correct way to avoid legal difficulties later is to notify that kind of project and put the arguments forward.

Dr McDonnell: Negotiate your way forward.

Professor Rosa Greaves: Put the arguments forward according to the law, according to not only the Treaty but the secondary legislation that’s been adopted and get the Commission to do it. This will have to be done through the UK Government, because it’s still the UK Government that is the Member State that the Commission recognises.

Chair : We’re running quite short on time now.

Q372 Lady Hermon: Thank you very much indeed. I have to keep this short. In its evidence to the Committee, the European Commission made reference to the fact that there is a code of conduct on business taxation. I’m quoting what they said so I’m sorry to take up this little bit of time. "Any proposal to reduce the general corporate tax rate of a Member State for a region like Northern Ireland, probably linked with specific conditions or requirements, needs to satisfy the delegations of the other Member States when they apply the Code principles." Would you just kindly explain to the Committee if this is binding? How binding is this Code of Conduct and what would be the ramifications if, in fact, we didn’t meet all of the requirements within that Code?

Professor Rosa Greaves: This is a Commission notice. The word itself, "notice", the modern version of the word "notice" nowadays is called "guidelines"-i.e. it’s not binding. At the end of the day though, if politically that is how they operate, then the law doesn’t come into it. Interestingly enough, if it does come into it, it’s in a strange way, because the Code is also not binding, and they politically have agreed that the Azores tax measure was fine; it was not harmful tax competition. Yet because the Commission took a different view and it went to the Court, the Court’s interpretation of the rules is binding.

Q373 Lady Hermon: Off the top of your head could you recall whether in fact the ECJ actually made reference to the Code of Conduct? Did they pay attention to it in their judgment? Sorry, I’m putting you on the spot.

Professor Rosa Greaves: In all these things, the Court will not say, "I’m not going to hear it. It’s not evidence." They will, but I don’t think it will deter them from knowing their responsibilities to interpret the law, the Treaty and the secondary legislation. In state aid, for example, there is secondary legislation like helping the shipping industry, for example, for many years. That is actually a regulation. Now the Court will apply, unless you challenge that it didn’t have any competence in adopting it. That will be absolutely. Sometimes you find that in the text of the judgment the Court will refer-another example not relevant here is a charter on human rights and things like that-they will mention it, but it doesn’t come into the reasoning.

Q374 Lady Hermon: If you were to offer advice to the UK Government in terms of the procedure to be undertaken if they decided to devolve, and if in fact the Assembly wanted the powers-that’s the point, if the Northern Assembly wanted the powers to vary the corporation tax-what is the proper procedure for the UK Government to avoid legal challenge down the line?

Professor Rosa Greaves: The devolution issue is not a matter for European law. It is the second stage, when the Northern Irish Assembly comes out and says, "This is what we want to do," my advice would be that that should be notified to the Commission.

Q375 Lady Hermon: By the First and Deputy First Ministers within the Assembly?

Professor Rosa Greaves: No, by the United Kingdom Government.

Lady Hermon: That’s very, very interesting.

Professor Rosa Greaves: That’s my opinion.

Q376 Chair : Very interesting, thank you. Just to finish off; we’re out of time for the session. In general terms though, just looking at article 87 of the Treaty, Northern Ireland certainly on two counts where there’s underdevelopment and secondly where, to use their words, there’s been a "serious disturbance"-Northern Ireland obviously has gone through problems that few other countries in Europe have gone through-plus there is a geographical remoteness; is it a special case?

Professor Rosa Greaves: Is it a special case? I’m not so sure about the special case, but I think behind those articles, those exemptions or exceptions, there is already a lot of experience at EU level. There are a lot of cases that have gone through and been accepted; others that haven’t. I would have to look at all of that on a specific measure, which you have already decided. It’s got to be fixed. I don’t think hypothetically it helps us to go any further, and then we go back through all the countries that have been helped and see what have been the criteria, the arguments and what has been taken into consideration. That is how, if I was a government, I would have formulated my application to the Commission to explain why I’m relying on those provisions.

Chair : Based on the precedents basically.

Professor Rosa Greaves: Yes, I would base it on the Treaty, which is the higher norm. It does allow those derogations. I have to demonstrate why Northern Ireland fits into one of them, and then I would use the ammunition of whatever has happened in the past to back up my case, but I’m not in a position to tell you right now.

Q377 Chair : We understand it’s a very, very difficult, complicated area of law.

Professor Rosa Greaves: It is and it’s evolving.

Chair : You’ve explained it, as far as it is explainable, very well indeed, so thank you very much indeed.

Professor Rosa Greaves: Thank you very much.

Examination of Witnesses

Witnesses: Mr Phillip Kermode, Taxation and Customs Union Directorate General, EU Commission, gave evidence.

Q378 Chair : We’ll continue with our second witness. Thank you very much for joining us. You’ve heard my brief explanation of what we’re about, what we’re looking into, so I don’t need to repeat that. We’ll get straight into questions if we may. Again coming back to the Azores judgment, it was found to be incompatible with EU state rules. How would you view that in terms of Northern Ireland, with regards to corporation tax, if there were to be a decision one way or another to try to reduce it?

Mr Phillip Kermode: First of all, thank you very much for inviting me. Obviously when I talk to you, I talk to you with one eye on the letter that you have already received from my commissioner, Commissioner Šemeta. You will also appreciate that I cannot give you an interpretation as to what would happen, as to what the Commission’s formal position would be, given that the Commission would have to exercise its powers in accordance with the Treaty. However, what is important-and Professor Greaves has covered this area in quite some detail and very clearly-is that you have a set of rules that have been defined by the Azores case, and that is what you essentially have to apply. You have to be sure that, in order to benefit from the socalled Azores exception, you fall into these three different categories. You must have effective autonomy in particular; you must not have any possibility of central government overview or change of what you’re doing; and you mustn’t effectively have a financial offset for what’s being done.

I have to admit that it is not straightforward; it’s not straightforward even for the Commission, because the Commission had a position on this that was effectively put into doubt by some of these decisions themselves. Maybe what I could say is that, if you are seeking to understand the Commission’s view on these things, the notice that Professor Greaves referred to earlier, which was put out in 1998, was an attempt by the Commission to define how state aid rules should work in the area of taxation. This was effectively discussed with all of the Member States, so it was an attempt to find an accommodation whereby everybody knew what the rules would be, but our experience in general with the European Court of Justice has been that, in the tax area, there has been considerable complication. I don’t say that as a criticism; I say it as a fact. It’s not just in the area of state aid. As you’re most certainly aware, there is little competence at EU level for direct taxation. What we have seen in the last 10 to 15 years has been, effectively, a form of bringing together what happens in the community by legal judgment, which has been basically destructive of many Member States’ tax regimes or at least specific parts of those tax regimes.

Q379 Ian Paisley: I must say for the record I find it really perplexing and quite frankly annoying that the Community can tell any region of Europe, any nation in Europe, how it should raise taxes and indeed how it should then allocate those taxes. What’s in the interest of the people should be a sovereign issue, but we are where we are in terms of this. You’ll understand that there has been, if you like, subsidiarity and devolution of powers in the UK context to Cardiff, Belfast and Edinburgh. Under the current regime, do you think that the current powers that are devolved to the Assembly in Northern Ireland would qualify as being sufficiently autonomous, given what you’ve heard and what you understand of devolution? You’re bound to be able to make a judgment. We don’t want to put you on the spot, and we understand that you don’t want to answer on behalf of your Commission, but no one’s listening to this now. You can tell us what you’re really thinking, you know.

Mr Phillip Kermode: I thought I was in the Houses of Parliament, not Chatham House.

Chair : For the avoidance of doubt, this is a public session.

Mr Phillip Kermode: Maybe what I could do is, perhaps in a roundabout way, talk to you about the relationship between what’s been done at EU level and what’s possible at national level. The EU, as I said earlier, has very limited competences in direct taxation, but the things that have to concern you when you’re looking at tax issues are, from an EU point of view, state aid, the Code of Conduct-and I would like to come back to that, because I’m not quite sure if it’s perfectly clear what the role of the Code of Conduct is-and the Court of Justice in relation to the Treaty freedoms. In other words, you cannot create a taxation system that has elements that are discriminatory in relation to nonresidents. That’s perhaps a simple way of putting it, but that’s essentially what it’s about: you cannot discriminate against other Member States.

These items come together to give you a framework, but there is no secondary legislative framework within the EU for direct taxation, with the exception of a very limited number of Directives, which have been put together in order to try to reduce crossborder double taxation. The question is of course whether this would change some time in the future. I just add in passing that the Commission has suggested that it will come forward in the next few months with a proposal for a common corporate tax base. That’s nothing to do with tax rates, but a corporate tax base. If this were to be the case and if this were to be adopted, well then we would be looking at a situation where, for groups of companies across the EU, you would have a formula for the apportionment of profits, taxed at the rates in the individual Member States. Now I come back to the question again: I honestly cannot give you a view on this. Maybe I could, but if I gave you a view, I would be probably without a job when I returned to my base.

Q380 Ian Paisley: Under the current economic climate, I wouldn’t want to put anyone out of a job, so I won’t push and I’ll respect your position. Are you saying to us that case laws actually inform the Commission as to what its position should be-i.e. in relation to Gibraltar? Effectively, if there was another case in play, i.e. Northern Ireland, that in itself could help inform the case law of Europe and perhaps will change in a nuanced way how the law is interpreted.

Mr Phillip Kermode: I think you can’t rule that out.

Q381 Ian Paisley: We really have to suck it and see; we have to try.

Mr Phillip Kermode: I think what Professor Greaves said is extremely relevant: the way to do this is by notification and discussion with the Commission department responsible for this. Here the Commission has a specific Treaty role. It’s a very specific role where the Commission has to take decisions, and these arrive in the court only when these decisions are effectively challenged.

Q382 Lady Hermon: I wonder at this juncture if you’d kindly elaborate upon the importance of the Code of Conduct. It would be helpful to the Committee, just at the very early stage of your evidence, please.

Mr Phillip Kermode: There is a difference between the Code of Conduct and state aid. That’s the first thing. State aid rules are set by the Treaty. The Code of Conduct is an arrangement between the Member States of the Union meeting in the Council. It does not concern the state aid rules per se; it has its own set of rules. It came about because of concerns about harmful tax practices, which were effectively ringfenced regimes-the use of lower rates to attract business.

Q383 Lady Hermon: I’m smiling because I’m thinking about Ireland. Were you thinking about Ireland?

Mr Phillip Kermode: The big difference here is that in the Irish case what you have is a general 12.5% regime. In the Code of Conduct, one of the issues is: is this a general regime or is it specifically targeted at foreign companies? This issue is discussed in the Code of Conduct group. What has happened over the years is the group was set up back at the end of the 1990s, and it effectively went through all of the legislation of the Member States, at least those things that were brought up. Most of that now is over but, from time to time, new regimes come up and they go through, but the Code has its own rules under which it says, if there is a regime that is the subject of state aid, the Code group does not look at it until such time as a state aid decision has been taken, so that you don’t have the two happening at the same time. It is a much more political arrangement. The Commission has a specific role to take a formal decision in state aid. The decisions that are taken in the Code of Conduct are taken by a group; they are validated by Ministers; but they will not as such end up in front of the Court of Justice.

Q384 Gavin Williamson: I was going to ask this a little bit later, but what is the exact legal status of the Code of Conduct?

Mr Phillip Kermode: That’s an extremely good question. In fact, it is not a formal Community instrument per se or Union instrument. It is, as I said, a decision taken by the Member States together meeting in the Council of Ministers.

Q385 Ian Paisley: Is it aspirational?

Lady Hermon: No, it’s binding.

Mr Phillip Kermode: It’s a form of peer review group, if I can say it like that.

Q386 Gavin Williamson: Professor Greaves touched upon the fact that it maybe referred to as a guidance.

Mr Phillip Kermode: Sorry, can I just be clear on this? The guidance I think we were talking about earlier was in fact the notice that the Commission brought out at the end of the 1990s. The Code group comes to conclusions based on these criteria that the Ministers themselves have validated.

Q387 Gavin Williamson: Is it something that can be changed? Is it always fluid?

Mr Phillip Kermode: It’s not fluid to the extent that there are specific criteria. In a somewhat analogous way to state aid, in the case of the Code you have a comparison with these criteria, but it is not a formal process of the type that state aid has.

Q388 Chair : It wouldn’t be judged by the European Court then, would it?

Mr Phillip Kermode: No.

Q389 David Simpson: The evidence from the Commission states, and I quote this, that it is important to determine if the lower corporation tax rate for Northern Ireland would be a "regionally selective measure and thus as regional aid" or "normal rate of taxation for state aid purposes". In your opinion, what constitutes a regionally selective measure?

Mr Phillip Kermode: I think the point here is just a very straightforward one, which is that, if you have a different rate in the region, that’s it. I’m just checking the text. Yes, part of the problem-and Professor Greaves has referred to it before-is this question of selectivity, so you have to determine to what extent your reference is taking into account either your regional or your countrywide approach.

Again, I think all of this on the state aid side for us is relatively problematic, and yet in a way we have this formula. The only question is one of fact: to what extent do the facts of the situation allow you to say that these three tests have been met? As Professor Greaves said, we are in a situation where it’s still moving a little bit, and anything that can go to the court is of course subject to judicial review, and could be challenged in some way. It seems to me that what was decided in the Azores case is pretty clear, at least in terms of "these are the conditions". You have a formula to work to. As the Professor said, perhaps the best approach there is notification of what you want to do and discussion with the Commission, because I don’t think the Commission is in the business of saying, "We don’t want to help,"-at least I hope not.

Q390 Chair : Would the Commission only be interested where there’s a reduction? For example, VAT’s just been increased. Supposing it had been increased to 20% for Great Britain but not Northern Ireland. Would that be seen as state aid?

Mr Phillip Kermode: It could be, I suppose. It’s a question of who’s bearing the cost. One of the features, and it’s in the document that was produced back in 1998, is that there is an effective advantage paid to companies at the expense of the state budget. You could be looking at a situation here where, effectively, by not charging tax there is an advantage given out of the state budget. The VAT issue is even more complicated of course.

Chair : I don’t particularly want to get into that: it was just an analogy.

Mr Phillip Kermode: I only say that there is secondary legislation there.

Q391 Oliver Colvile: That is actually quite an important issue, isn’t it? That is that you’ve got VAT, a taxation regime that is very different in all countries throughout the whole of the European Union, but this is something that is almost a bit like a straitjacket on regional economies. It seems rather bizarre almost, to me.

Mr Phillip Kermode: As I said, the VAT issue is somewhat different. Here you have effectively a harmonised tax throughout the EU, because it’s based on Directives agreed by the Member States, and there is a specific Treaty basis for the harmonisation of indirect taxation.

Oliver Colvile: The levels are different.

Mr Phillip Kermode: The levels are different, but there is a minimum rate of 15%. The logic behind that minimum rate had to do with the internal market and the opening of borders. Once you opened borders and took away the control of borders, you had risks of greater crossborder distortions due to different rates, particularly in relation to goods. It is a harmonised tax, per se. If I could just add, if you look at how things work at EU level, you have a sort of scale. Right at this end, you have custom duties, which are completely harmonised: they’re applied by the EU and there is a regulation that applies directly, a Council regulation, that covers all the rules. The money is collected; it goes to Brussels and in part funds the budget.

Then next up you have indirect taxation, particularly VAT. There you have secondary legislation, harmonised by Directive, implemented in national law, which includes provisions in relation to rates, not only the standard rate but also the multiplicity, I’m afraid, of other minor rates. You have a similar but less developed area of certain excise duties, again linked to the internal market. Then at the end you have direct taxation where, up until now, the amount of secondary legislation is very limited. Some of the Directives are referred to in the letter from Commissioner Šemeta, but it is much less developed at EU level for various reasons.

Q392 Oliver Colvile: There was, in the recent things that went on in southern Ireland, quite a big move from both the French and also for the Germans for corporation tax in southern Ireland to be increased. That obviously didn’t happen: it didn’t work. But there’s an example of where two nations states decided to put pressure upon a smaller nation state, through the European Union, in order to do that.

Mr Phillip Kermode: It’s true that there was discussion of this. It was quite public. There was even some discussion in the European Parliament. Some members there were very keen to say there should be something done about tax competition on the corporate side but, at the end of the day, nothing has come out of this. The Commission, up until now, has consistently said that, when it comes to corporate tax rates, it considers that that is a subject for the Member States. There is no doubt that it causes friction. One of the underlying ideas of the Union is to be able to control this friction through various means. Leaving aside the rate issue for the moment, one of the functions of the Code of Conduct is to try and actually reduce this tension when it comes to what are harmful tax practices. As I said, it’s not covered by state aid rules per se, but it actually gives a degree of discussion and the peer review approach, which allows people to come to sensible conclusions.

Q393 Oliver Colvile: This is a more general state. While we always talk about our European Union partners, I think we should also be talking about our European Union competitors as well, because we as a nation state here in this country, in Britain, obviously are seeking to get as much a slice of the pie as we possibly can. I’ve got a quote, which I’ve been given here, and I’d be very grateful to know what you understand by this: "The selectivity would have to be assessed against the context of that intra-state body, i.e. against the ‘normal’ taxation in that region." What do you think that means?

Mr Phillip Kermode: I think what that means is that you have to judge the rate that you apply in the region against the rate that you apply in the country. This certainly was the basis for much of the argument that was developed in the Azores case. I think you have to look at it in a broad manner as well, in that, if there was a proliferation of rates with distortive effects, this could definitely harm things. Perhaps we should look just a little wider for the moment and say what has been happening in the EU over the last 10 to 15 years. One of the things we do see is a consistent reduction in corporate tax rates across the EU. Up until the financial crisis and the recession, this reduction in corporate tax rates was accompanied by a stabilisation, if not an increase in certain cases, in corporate tax revenues. The issue is relatively complicated. I think perhaps you’ve already had evidence on to what extent corporate tax, per se, is the main driver in this.

It’s a very complex issue, made even more complex in the modern world by the fact that, due to globalisation, you have this disconnect between the shareholders and the place where the business is being carried out. What interests many investors is not only the actual rate applied where a business is located, but how that money is brought back and what happens to it in the country in which the investors are resident. It has become a more complex equation. Certainly I appreciate what you say about the need for Member States within the Union to have a competitive approach, also vis-à-vis each other, and that was precisely what underlined the discussions in the Code of Conduct over the years: that it should be harmful tax practices, according to agreed criteria, that should be the subject of sanction, but not what would be fair competition. For many years, the discussion on rates was to say, yes, rates are rates. These are within the purview of Member States.

Q394 Oliver Colvile: The other part of that equation, surely, is not only low corporate tax, but increasing productivity. Has that worked in Europe? You may not be able to answer the question. I don’t know the answer to that either.

Mr Phillip Kermode: Europe is a mixture of many things, and I think you see considerable differences in productivity. There are a number of things I think you can say. For instance, we haven’t been able to identify an extremely clear link between an overall level of taxation and growth, so it doesn’t follow that, if you have a high overall level of taxation-I’m not talking about corporate tax now on its own-it doesn’t follow that you don’t have growth. There are examples, particularly in Scandinavia, where it seems to work quite well.

Oliver Colvile: My friend here will now hit me over the head. You have it in Hong Kong as well, where this has been a reduction in taxation, and that has soared to significant growth. It’s also produced a greater tax take.

Chair : Perhaps if we can stick to the legal aspects today that might be helpful.

Q395 Mr Benton: Given that the European Court of Justice found that the situation in the Basque region fulfilled the criteria of the Azores Judgment, I’d like to ask if the autonomy of the Basque region compares to the devolved government in Northern Ireland. Have you got a view on that? In your opinion, would it be necessary to make any changes, constitutionally or otherwise, if the UK Government was minded to agree to a reduction in corporation tax?

Mr Phillip Kermode: In essence, I can’t give you a formal Commission view on that.

Mr Benton: No, I’m asking for an opinion.

Mr Phillip Kermode: I assume that, as at present, you don’t have the authority to vary the corporate tax. Some changes would have to be made. Otherwise, I assume that we would have a notification on the table already and that we would be able to have a look at this.

Q396 Mr Benton: I think the position is that it’s under consideration, so there is nothing formally on the table. There are no proposals put forward. I think I’m right in that.

Chair : That’s right, yes.

Mr Benton: What we’re doing, the purpose, the whole reason behind our inquiry, is to look at all the ramifications. Given your particular expertise, I’m posing this question, because the whole area is fraught with complications and difficulties. All I’m seeking and the purpose of my question is to ascertain-in the light of these judgments, the comparatives between what’s happened in the Basque region and how they seem to have fulfilled the criteria-your opinion as to the disposition in terms of Northern Ireland.

Mr Phillip Kermode: I regret to say that I really don’t know the Northern Ireland position sufficiently well to be able to give you an opinion. One of the difficulties that we have in interpreting many of the Courts’ judgments is of course that they are applied in very specific circumstances in individual cases. Over the years, we have tried from time to time to draw general conclusions in other tax areas, from the courts’ individual pronouncements, but invariably there is some minor difference between what would happen in one country and what would happen in another. We tend to be rather cautious about that, so I apologise, but I cannot give you a clearer answer than that.

Q397 Dr McDonnell: Thank you for your answers so far. Is there any possibility, do you think, that the special circumstances that enabled us to draw down money, whether through the Regional Development Fund or the Social Fund or other special monies that we got, would be a consideration or would the corporation tax thing be just judged in isolation? In other words, would the special needs, special interests and the special attention that we’ve got over the last 15 years be helpful? Is that a hindrance? Is that neutral? Is that, in other words, irrelevant as we’re talking about corporation tax?

Mr Phillip Kermode: Again, I don’t want to sound as though I’m not going to reply to anything, but I think we have a difficulty with the Azores Judgment-well, perhaps not a difficulty. It’s clear that, if we want to enter into a discussion of the regional selectivity, well then you must follow the Azores path. That’s the rule, if you like, in relation to regional selectivity. If you want to argue, on the other hand, that there is a different issue, then I think it’s something else.

My understanding was that what you were concentrating on here was the objective of the reduced corporate tax rate to the 12.5% level, very broadly. That relates to something that I think you said earlier, which was whether we could pick and choose. From that point of view, I think it would be very problematic. In particular it would be problematic from the point of view of the Code of Conduct exercise, with all the precautions to be said about how the Code works. That sort of situation is almost exactly what they have in mind, where you have a specific regime which is effectively ringfenced from the rest of the economy. When, in the south of Ireland, they went to the 12.5% rate, it was in part because their previous regimes fell foul of this sort of test. The problem was they had a 10% manufacturing rate. That was focused so, in order to deal with this problem, they went for a general rate.

Q398 Dr McDonnell: I’m not suggesting that we want to go back to the Social Fund or Regional Development Fund, but what I am suggesting is that, having that as a backdrop, that wouldn’t be considered in the corporation tax. You’re implying it’s considered on its own merits, in isolation.

Mr Phillip Kermode: Certainly from the point of view of the Code, that normally is the issue being taken into account. Again though, given the complexity of the legal situation and the fact that there is a degree of uncertainty, even among specialists, about the law, I would have thought that some form of discussion with the appropriate Commission services would be a good solution. I know that sounds a bit strange coming from me, as I’m the Commission’s representative here, but it is a difficult issue. As I said, the conditions at least have the merit of being relatively clear as to what you have to do. The devil is in the detail; the devil is in the factual position vis-à-vis each of these conditions.

Q399 Ian Paisley: Could I ask, just on that, if you don’t mind me coming across, and to come at this from a slightly different direction, as you know France and Belgium frequently flout European regulations and Directives, and get away with it. In many instances, they’re very, very bad Europeans.

Chair : You don’t need to answer that one.

Ian Paisley: That’s not a question; that’s just a statement. What would the penalty be on a Member State that decided to have some of this taxvarying power within its jurisdiction? Would there be a penalty? What’s it likely to look like and how long would it be to get to the point before that penalty was enacted?

Mr Phillip Kermode: Assuming that one was to do this and the Commission was to take a decision that it was state aid, then the Commission would seek to enforce that through the courts.

Q400 Ian Paisley: So it could be years?

Mr Phillip Kermode: It could take a little time; it could be reasonably quickly. I think the risk you have with that is not only what would happen when the court ruled, but the uncertainty it would create.

Ian Paisley: Yes, but longterm certainty.

Mr Phillip Kermode: Also for investors now; they would say, "Why get into this?" This we’ve seen even for the Code of Conduct, which isn’t legally enforceable. We’ve seen cases where what happens is these issues are under debate and people are concerned. Should I invest here if tomorrow I know this is all going to change? If there is one consistent message we get from the business community, it’s the need for stability, clarity and certainty about what they’re going to get.

Q401 Chair : That’s the message we’ve got, but the trouble is, with your own evidence, with respect, and the evidence we received earlier, we can’t get yes or no answers. You could end up doing absolutely nothing ever in the economy. How is one supposed to behave then?

Mr Phillip Kermode: What you have is a difficult position where there is a competitive battle going on for foreign investment in different countries throughout the world and within the EU. As I say, we have provisions in the Treaty and in the Code of Conduct that provide for a set of rules and it’s these rules that apply within the EU, in an attempt to make it reasonably clear. If you want even greater certainty, well then of course we could go down the legislative path, and legislate for EUwide taxation, but I suspect that that might not-

Chair : That’s going to take even longer than a court judgment.

Q402 Dr McDonnell: I want to follow on because, in the context of what you’re saying and the general discussion, to take it back to where we began, the problem is we have the 12.5% in the South, and I’m very happy with that. Most of the people I talk to in government in the South, indeed some of your former colleagues perhaps around government and the tax people in the South, are all very happy to give Northern Ireland a chance. The difficulty is how we square the circle. With all the good will towards Northern Ireland, how does the Commission reconcile the fact that Northern Ireland is struggling, has come out of a very difficult period, has got on its feet or certainly up to its knees, but in order to become a key or an equal player in economic terms in Western Europe, needs something to boost foreign direct investment. How does the Commission reconcile the fact that we’re in close proximity to 12.5%, and yet there are so many difficulties with us getting to that 12.5%? I think there’s a public will in Northern Ireland, in southern Ireland and in Britain that this should be tried. I think we’re fully aware that there are hitches and glitches and problems. You have been very informative in terms of outlining some of them, and added to our knowledge, but the point is: how can the Commission, in the context of fairness and equality, say, "Oh well, you’ve got a problem there, but you’re stuck with it"?

Chair : If I can add to that as well, the country that would be most affected in competition terms would be the Republic, and yet they have made it very clear through their embassy that they would not oppose reducing the corporation tax in Northern Ireland to 12.5%. Really a question, I suppose added to Alasdair’s, is who are you sticking up for? If Ireland’s not concerned about it, why should you be concerned?

Mr Phillip Kermode: The answer to that is the Commission is obliged to stick up for the Treaty. When it comes to state aid, the Commission has to implement the rules of the Treaty that apply to this particular area. It’s clear that the Irish experience with the 12.5% has been perceived as extremely positive. It was based, as I said earlier, on the idea that, by applying this general rate across Ireland, they were able to avoid any of the pitfalls that you would have now with this regional aspect.

I don’t think the Commission has any hidden agenda on this. I think the problem is a legal problem. Once the Treaties are in place and the Commission has an obligation, well then it must fulfil that obligation. Again, I think that the issue is one that should be explored-that is the whole question of the boundaries of the Azores case-in the case where you have a clear view of what you want to do. I also think one has to be clear about the advantages and disadvantages of lower corporate tax rates in the current climate. I’m not saying I’m against it or for it.

The Commission, as I said, has a view that corporate tax rates are for Member States to decide. I think that it’s not entirely clear that it it’s a oneway advantage. There are costs related to it as well. If I can just pick up one of those costs, it is a risk that, if you have a different regime in Northern Ireland than in mainland UK, that you will create a much more complex system for the interaction between the UK and Northern Ireland, particularly issues of transfer pricing.

Q403 Oliver Colvile: I am curious about this, but what we’ve been talking about really is how the European Commission ends up by looking at all of this. To my mind, it’s taking a very introspective look at itself, and we are in a much broader competition with China, with India and the emerging economies as well. Surely the European Commission and the European Union as a whole needs to stop being quite so introspective and actually look at how we can end up competing. Frankly, what’s happening now, certainly if you look at the financial services market, which is an issue that southern Ireland was most certainly interested in doing, a lot of those kinds of companies are now going to Dubai where there’s less regulation and there’s less taxation as well. It just seems to my mind that we’re behind the curve on this one, in quite a big way.

Mr Phillip Kermode: If I may say, there are limits on what we are able to do in representing the EU outside the EU, given the concerns about how far we can go on direct taxation. I can give you an example of cases where the Commission is at least trying to make its presence felt. In particular on the question of the Savings Directive, we have been pushing for a long time for places like Switzerland and Singapore to have equivalent measures to those that we have to ensure a minimum level playing field. Again, in a situation where the Commission doesn’t have a form of competence because legislation hasn’t been enacted in a particular area, there is a limit to what we can do. I think your point is well made that the competition issue is a worldwide one.

Q404 Gavin Williamson: I was going to ask very briefly about the third point of the Code of Conduct, which states, "The measure does not require real economic activity." Is that specifically to address concerns about tax avoidance and also potentially a concern that, if you have one area within a sovereign nation, in terms of the United Kingdom/Northern Ireland, a lot of businesses may locate there and not actually do anything? Is that what it’s primarily aimed at?

Mr Phillip Kermode: Yes, this is the case essentially of stealing tax base, without having any activity to justify it in the country in which you offer the special incentive or rate.

Q405 Gavin Williamson: Do you think the Republic has done that at all?

Mr Phillip Kermode: You mean through the 12.5% rate.

Gavin Williamson: Yes.

Mr Phillip Kermode: I think the answer to that is in general no, because it’s clear that they’re making a reasonable amount of money from it, through companies that are clearly established there; they have substantial pharmaceutical and ITbased industries.

Q406 Gavin Williamson: The only reason I had asked is because it was touched on a little bit earlier that some nation states got quite exercised about that issue when the Irish bailout happened. I just wondered, if they got so exercised about it, did they get exercised about it because they felt that had been the case or whether they just don’t like competition? That’s not really for you to answer. I just thought you don’t usually get bothered about something unless you think it’s actually affecting you. I wondered whether it was because the jobs had moved from France and Germany, or whether it was felt that, actually, it wasn’t genuine: they were charging 12.5% just to steal the revenues and the companies weren’t always truly economically based in the Republic of Ireland.

Mr Phillip Kermode: There are two problems when it comes to tax competition across the world. One is you relocate a business and the jobs leave. The other is the actual profitshifting, which can be done in a variety of different ways. The main thrust of the Code of Conduct is on the relocation of business, per se, given these ringfencedtype regimes, in other words protecting your domestic economy and giving something special to somebody from outside. This is one of the criteria by which it is judged as well. Certainly this brassplatetype idea is something that most Member States don’t like at all.

Q407 Oliver Colvile: I have read my way through this letter from Commissioner Šemeta, and it refers to three corporate tax Directives and "longstanding and not yet closed discussion" relating to their application where a country or business sector has a specific corporate tax base. How are these discussions relevant to proposals to reduce corporation tax in Northern Ireland?

Mr Phillip Kermode: I’m afraid it’s a relatively small point. First of all, you need to be aware that these Directives actually do exist. The main point about them is that there are a number of Member States that use an antiabuse clause in one or other of these Directives to say, "We will not give the benefits of these Directives," which is no withholding tax, say, on payments of dividends or payments of interest, "if we think that there is a regional low level of taxation in a Member State."

Q408 Oliver Colvile: Does this mean that governments in whose jurisdiction a company is headquartered might forbid or take measures against the company if it benefited from a reduced corporation tax rate from its operations in Northern Ireland?

Mr Phillip Kermode: It’s potentially possible that what would happen is that, if you had a reduced rate, one or other of this very small number of Member States would say, "Well, no we don’t want to give the benefit of the Directive in this case." This is something we would wish to pursue. A Directive is a Directive.

Q409 Oliver Colvile: Do you think that’s happened in southern Ireland as well?

Mr Phillip Kermode: I think in the cases that I’m aware of, no, but I would have to check to be sure if there was a case. I would just remind you that the Republic rate is in fact not the lowest rate in the EU. There are lower rates than that.

Q410 Lady Hermon: Two points please, and I’d be most grateful for clarification on the first one. It is just picking up on the point that the Chairman made about 10 minutes ago, and that is that what we as a Committee want is certainty. Would it be fair to summarise the other part of your evidence to us that in fact there is definitely a code of practice; it is a political agreement, there are definitely Directives and there are definitely some court judgments? The difficulty that you have, I would suggest, in giving certainty to the Committee is that the European Court of Justice is actually unpredictable. We have the Azores Judgment, and the Northern Ireland executive and Assembly can go through the Azores Judgment and there are very good lawyers in Northern Ireland who can advise them, but we can’t predict until we do it whether in fact it could end up before the Court of Justice. Is that true?

Chair : Just before you answer, I think there may be a division fairly soon. As we’re almost at the end of the session, if there is a division, are we happy that we just end the session there, rather than drag everybody back? I’m sorry about that.

Q411 Lady Hermon: The second clarification then. I know that in fact we are 12, almost 13, years after the signing of the Belfast Agreement on Good Friday. We have stability and peace, thank goodness, although there is a dissident republican element still. Could Northern Ireland still plead special circumstances in Europe, given the appalling 30-almost 40-years of tremendous and harrowing violence that we experienced? Could we still, within the Commission at least, plead a special case for Northern Ireland? Those are two points, and I’m sorry to ask you to be brief, but the Chairman has hinted, and he would know better than I would, because he’s a member of one of the Coalition parties.

Mr Phillip Kermode: On the first question, it’s not the fault of the Court, I think. The problem is interpretation of what is relatively complex law. A lot of the Treaty provisions and secondary law are relatively complex pieces of legislation; the Court has to interpret them. It’s true that it is not always clear, even to the experts, how the Court will decide on some of these cases but, in essence, I don’t think it’s necessarily a problem with the Court. For instance, if a measure was notified and the Commission agreed with it, then the Commission would not take a decision against it. That would be the end of it, effectively.

Q412 Lady Hermon: Right, so the Commission wouldn’t take a decision. One of the points that in fact the Committee raised with Professor Greaves was whether in fact it was possible that someone who had locus standi in Northern Ireland and who was aggrieved by the reduction in corporation tax could still go to a local court, to the High Court in Belfast, and complain about the particular provision and take it to the European Court of Justice through a preliminary ruling. That would still be open to them to do that. Even if the Commission weren’t complaining, it would be an avenue of challenge.

Mr Phillip Kermode: You would have to look very carefully as to whether somebody had a locus standi to take such a case, but a preliminary ruling is always a possibility.

Lady Hermon: Yes, and the second issue?

Mr Phillip Kermode: On the issue of special circumstances, I don’t really have an answer to that. When it comes to the Treaty provisions themselves, and in areas where the Commission has an obligation to act, it has to take into account the Union interest. When it comes to political questions, it’s clear that there is a major issue that you have underlined-that there is a need, if you like, for some form of recognition of the situation. How that is done in practice I cannot say.

Lady Hermon: It may still be a relevant issue is what you’re saying, politically.

Mr Phillip Kermode: I wouldn’t say no.

Q413 David Simpson: You may have already dealt with this and it may seem a strange question, but in relation to the Republic of Ireland going to the 12.5% level, was there ever a case taken against them by any other part of the European Union when they were going to that rate?

Mr Phillip Kermode: No, I’m unaware of any case having been started, even in a national context, but I don’t follow that closely what happens at national level, but not to my knowledge, no.

Q414 Mel Stride: Northern Ireland clearly does need to look to taxation as the means of increasing foreign direct investment; it can look at other measures. I just wonder whether you could run through for us what those other measures might be in terms of what other EU Member States have done, and approaches that have been found to be acceptable by the Commission.

Mr Phillip Kermode: Not in taxation terms?

Mel Stride: Yes, excluding taxation changes-sorry, corporate taxation, I suppose. You might have tax credits, R and D credits and IP stuff.

Mr Phillip Kermode: It’s a very, very difficult one, because in fact, and I think you’ll see that from the conclusions of some of the experts, what counts for foreign direct investment is a whole collection of things. You can find countries around the world that have very, very low tax rates and they cannot get investment. You can find those with very high and they do. The question then is to what extent you have differing factors that count. You’re probably aware of a document that was published only the other day by PwC, in which they looked at this in some detail, and I would recommend you have a look at that. There are plenty of publications demonstrating how different forms of R and D credit, subsidy or other things are used, and I know there are publications there that give you basically the recipe of things that people have used.

Disentangling whether or not individual exercises like these have been useful is very, very difficult. What I mean by that is disentangling it from the context in which it is put; for instance, a highly educated workforce with communications proximity to certain markets. These sorts of things do count as well. It’s very difficult to give you the magic bullet, the recipe for how to do it. We have done some research on what’s going on in Europe in terms of taxation trends, and I would be quite happy to send you some literature on this, which is our overview of what’s happening in the EU.

Lady Hermon: Yes, that would be helpful.

Chair : The question was more, though, about what’s legal rather than what works.

Q415 Mel Stride: What would the Commission generally accept? What is the shopping list of items that are pretty well acceptable from the Commission’s point of view?

Mr Phillip Kermode: I don’t have a positive shopping list, and that’s partly because in the case, say, of the Code of Conduct, it’s a negative type of exercise. Harmful tax practices are targeted. In a way, that reflects the way things have developed over the years: an attempt to say anything that’s harmful is harmful; anything that’s outside is fair. If you try to define it the other way round, you risk getting a much more difficult discussion, because what is one man’s fair competition is not necessarily another. We see this particularly in antiabuse legislation throughout the world, where somebody’s abuse is actually somebody’s normal tax system.

Chair : Okay, a very useful session. Thank you very, very much for coming and for guiding as best you were able to do. Thank you very much indeed.

Mr Phillip Kermode: It’s been a pleasure, thank you.