Corporation Tax in Northern Ireland
Written
e
vidence
from PricewaterhouseCoopers LLP
1.
What effect will the reduction in the corporation tax rate on a UK wide basis announced in the June 2010 Budget have on the competiveness of the Northern Ireland economy?
i.
We believe that the reduction in the corporation tax rate in the June 2010 Budget will, in itself, be of marginal benefit to the competitiveness of the Northern Ireland economy.
ii.
Whilst the corporation tax rate will be reduced gradually over the next few years, this is largely offset by reduced capital allowances, with the latter changes to be felt most by those industry sectors that are more capital intensive, such as manufacturing. In addition, National Insurance Contribution (NIC) rates will increase from April 2011 for both employees and employers, further impacting the majority of companies.
iii.
Research by PwC
into corporate performance in the 12 months to 31 March 2009 shows that the profitability of many of the UK’s largest companies fell. Consequently, the level of corporation tax paid also fell, while payments of other taxes remained steady or increased. The impact of the downturn was therefore to increase the tax burden for individual companies, with the average Total Tax Rate up by four percentage points in 2009, to 42 percent. This happens because payments of many taxes, such as business rates and NIC do not fall with declining profitability and thus become relatively more expensive. The PwC survey findings show that now, more than ever as we emerge from recession, it is crucial that the UK tax system is internationally competitive.
iv.
In Northern Ireland, with its particular problems, any increase in competitiveness will start from a low base. The public sector is equivalent to around 70 percent of GDP and the underdeveloped private sector remains inwardly-focused and lacks international competitiveness.
v.
Some 94 per cent of Northern Ireland’s VAT registered enterprises have fewer than 10 employees, while fewer than 45 companies, from a universe of just under 57,000 VAT-registered undertakings, have more than 500 employees. A mere 10 companies account for 50 per cent of all local exports, while the region has the second-lowest level of business formation and business growth amongst the 12 UK regions.
vi.
Northern Ireland’s GVA per capita is over 19 per cent below the UK average and, despite some recent modest improvement, is broadly where it was in the mid-1970s. This relatively disappointing GVA per capita performance is largely a factor of lower productivity and we note the comments of the Economic and Social Research Council, that:"…firms in Northern Ireland are significantly less orientated towards producing new goods and services and in some important sectors they are less internationally orientated than might be expected. Both factors contribute to such firms having lower productivity and competitiveness."
vii.
The Northern Ireland Executive’s Programme for Government, set out five priorities, including; Growing a Dynamic, Innovative Economy; with Public Service Agreement (PSA),1, entitled; Productivity Growth having the Aim: Improve Northern Ireland’s manufacturing and private services productivity.
viii.
However, the productivity gap between Northern Ireland and Great Britain has existed for three decades and PwC’s analysis of key performance indicators suggest that over a period of more than half a century, Northern Ireland has not materially closed the gap with GB. Over that period some 15 economic development strategies have set out to close this gap and all have failed.
ix.
We therefore conclude that, since the reduction in the corporation tax rate in the June 2010 Budget is UK-wide and is largely offset by reduced capital allowances and increasing NIC, it does not advantage Northern Ireland relative to the Republic of Ireland and will therefore not have a sufficiently market effect on competitiveness to narrow the prosperity gap between Northern Ireland and Great Britain.
2.
What would be the benefits of equalizing the corporation tax rate in Northern Ireland with that of the RoI?
i.
There is no certainty, considerable disagreement and occasional contradiction as to the likely quantifiable benefits of corporation tax harmonisation between Northern Ireland and the Republic of Ireland (RoI).
ii.
Our examination of the various arguments in favour of harmonising the rate of corporation tax between Northern Ireland and RoI, have failed to define the quantitative benefit over a specific period of time. In reaching this conclusion, we have examined a number of published papers and also note that the review commissioned by the last government and led by Sir David Varney also failed quantify the likely benefit, concluding that,
"…any reduction in the rate would have a short-term impact on revenue which would not be outweighed by long-term benefits."
iii.
Nevertheless, were a reduction in the level of sub-regional corporation tax to be offered to Northern Ireland such that it would equalise the rate between Northern Ireland and RoI, we believe that would increase in the attractiveness of the region for foreign direct investment.
iv.
However, while we believe that corporation tax harmonisation would be of benefit and we would welcome it in the absence of other options, we believe that there are other, perhaps more targeted options which have not received as much publicity and we elaborate on these in later chapters.
v.
In 2000, the former Irish Finance Minister Ray MacSharry was quoted as saying "…no financial weapon was more important than tax in attracting FDI;" and, indeed, this may have been the case at a time before globalisation became a driver of low-GVA production towards regions with low labour costs and even lower tax rates.
vi.
In terms of attracting and retaining foreign direct investment (FDI), there is little doubt that Ireland’s tax regime has been advantageous, but it is important not to oversimplify this situation: "…during the 1980s, the period of the boom in US FDI, there were no changes in the Irish tax system, indeed the corporation tax rate actually increased in the 1980s, so it is not possible to invoke it as an explanation for the timing of the boom."
vii.
Since 2000, over 80 countries have cut their corporation tax rates to lure a declining volume of increasingly sophisticated global FDI, with Puerto Rico’s effective corporation tax rate for manufacturing companies as low as 2 per cent – in fiscal terms, a race to attract FDI, can also be a race to the bottom.
viii.
In 2006, a report by the Northern Ireland Economic Research Institute (ERINI) with assistance from Oxford Economics concluded that corporation tax harmonisation with RoI would allow NI to capture part of the RoI FDI inflow and could:
·
create 180,000 new jobs by 2030;
·
double the growth rate of the NI economy and eliminate the productivity gap with the UK in a decade;
·
recover of the initial loss of £300 million in reduced corporation tax within 6 years with substantial benefits to the exchequer thereafter;
·
increase private sector exports and employment; and
·
result in a substantial reduction of the level Westminster subvention
ix.
However, four years later in 2010, a report by the Northern Ireland Economic Reform Group
(whose members included Dr Victor Hewitt Director of ERINI and
Neil Gibson of Oxford Economics Ltd, co-authors of the 2006 ERINI Report) concluded that corporation tax harmonisation between Northern Ireland and the Republic of Ireland would:
·
Create 90,000 new jobs by 2030;
·
Cut unemployment, "…
much further than would otherwise be the case…";
and
·
reduce the level of Westminster subvention by £1bn by 2030.
x.
While the key authors of both reports were common, the intervening period served to significantly modify their long-term forecasts as to the likely impact of low corporation tax on the Northern Ireland economy.
xi.
In addition, there is some evidence that low corporation tax is of limited value in stimulating an indigenous, small-firms economy (such as Northern Ireland’s): "…low corporation tax rates are relevant where businesses are already profitable, but not… relevant to the growth of emerging companies…"
xii.
There is also an argument that low levels of corporation tax in regions of relatively high labour and operational costs (such as the UK and RoI today) have stimulated investment from foreign direct investment sectors that are most suited to transfer pricing: "…the industrial sectors that have boomed in Ireland are …particularly well able to avail of transfer pricing in minimising their global tax liabilities… they are ‘patent intensive’ rather than capital or technology intensive… [and] … four sectors exhibit characteristics that can only be explained as a response to the global tax planning incentives provided by the low Irish CT rate: cola concentrates, software reproduction, organic base chemicals and computers."
xiii.
Consequently, without the ability to accurately profile the size, sector, global-outreach and investment level of likely new FDI attracted by reduced corporation tax, it is impossible to predict the benefits of equalizing the corporation tax rate in Northern Ireland with that of RoI. That impossibility and the consequent lack of certainty as to the benefits suggests that corporation tax may be sufficiently unwieldy to form a single central focus around which sub-regional economic development strategy can be hung.
xiv.
Nevertheless, whilst we cannot endorse the enthusiasm of some commentators for a rate reduction to RoI levels, such a reduction would certainly be of some benefit, albeit one that is difficult to quantify. So the option was to choose between the status-quo or rate parity with RoI, plainly the latter would be preferable.
3.
What alternative measures could be introduced by the UK Government to make the NI economy more competitive
i.
In addressing this question, we accept as underlying principles the notions that, "measures … to make the NI economy more competitive", must individually or collectively, stimulate significant increases in key measures including, GVA-per capita, exports, pre-tax profits (declared in Northern Ireland) and employment.
ii.
We are also conscious of the relationship between corporation tax and PAYE, in that they contribute around 8 percent and 18 percent respectively of total UK tax revenues. Consequently reducing the level of corporation tax in Northern Ireland would impact on the overall UK corporation tax - assuming the measure was extended to existing undertaking operating in the region. However, as the primary reason for sub-regional corporation tax reduction would be to attract new FDI, there would be a net increase in new corporation tax take – albeit at a lower level. Likewise with PAYE, the new employment afforded by new FDI investment would similarly increase the PAYE tax take, which would, to some degree, offset the reduction in corporation tax.
iii.
In that sense therefore, the measures referred to above should serve to significantly stimulate both profits and employment.
iv.
Returning to the example of RoI, the central focus of Irish economic development strategy is flexibility; the ability to tailor incentives to the needs of those mobile investors that can make the greatest contribution to Irish wealth creation and to modify those incentives to reflect new technologies and global and national circumstances.
v.
While there are reasons not to make cutting Northern Ireland’s corporation tax rate the sole basis for economic development strategy; there is a compelling argument for giving the Executive the power to do it.
vi.
The new generation of mobile investor willing to pay relatively high UK and Irish labour costs wants more than low corporation tax. IDA Ireland today - as distinct from the IDA in 1987/88 when MacSharry was Finance Minister -is no longer pushing 12.5 per cent corporation tax as the sole rationale to invest. A basket of new incentives, including R&D Tax Credits, Patent Income Exemptions and Intellectual Property (IP) Tax Relief, are attracting high-value, high wage, wealth-creating clusters, where R&D and innovation are key drivers.
vii.
Finally- with one exemption-the EU does not permit sub-regional tax variation. To get the freedom to strike a regional rate of Corporation Tax, Northern Ireland must fulfil the conditions laid down in the Azores Judgement at the European Court.
viii.
But meeting the criteria of the Azores Judgement lets the Executive do much, much more than just cut Corporation Tax. They could create fiscal and tax incentives specifically targeted at the high-value, wealth creating overseas investors the region needs to deliver the productivity targets contained in the Programme for Government and the recent Independent Review of Economic Policy (IREP).
ix.
We would therefore begin with the assumption that Westminster would, through invoking the Azores Judgement give the Executive the power to strike a sub-regional rate of Corporation Tax. This would, as in the case of Gibraltar, give the Executive total sub-regional fiscal flexibility to encourage high value-added FDI to locate in Northern Ireland, to establish centres for R&D, training and marketing, with all the spin-off benefits for local educational institutions in terms of linkages and new revenue streams.
x.
The clear advantage of such flexibility – as the Irish have discovered – is that fiscal policy can be tweaked, or even radically altered, to suit likely future trends in investment and global policies. There is therefore no requirement – as is the case with corporation tax – to create speculative 20-year models based upon historic trends.
xi.
We would also draw the Committee’s attention to the report from the Milford Group, developed in 2000/01. Investing for the Future - the proposals from the business-led think-tank, recommended tax incentives to stimulate and reward investment in R&D, training and marketing. The Milford Group’s original proposals were supported by the then Ministers in the Northern Ireland departments of Finance and Personnel (DFP) and Enterprise Trade and Investment (DETI) and were subject to independent evaluation and endorsement by the Ulster Society of Chartered Accountants in November 2002.
xii.
In essence, they anticipated the Azores Judgement and proposed a series of tax incentives that would be fiscally neutral and which would have the following characteristics.
·
be readily understandable;
·
have a significant impact on post tax profits;
·
be attractive to viable and highly profitable projects rather than "cash hungry" low return projects; and
·
encourage investment and innovation
xiii.
The proposals used a series of worked examples to illustrate how tax incentives in Northern Ireland -as per their recommendations – could deliver significantly greater retained profits that a simple 12.5 percent corporation tax alternative as then prevailed in RoI. The Milford Group recommendations – first proposed in 2001 – were largely adopted by the Irish government in their incentives to stimulate IP, R&D and innovation, but were overtaken in Northern Ireland by the return of Direct Rule
4.
Is a reduction in corporation tax the simplest and quickest way to make the NI economy more competitive and how long would it be before NI realised the benefits?
i.
Cutting corporation tax may not be the simplest and quickest way to make the NI economy more competitive; however, the inability to accurately quantify the likely benefits, render certainty impossible. Nevertheless, we have outlined in previous sections some alternatives to a simple reduction in the headline rate of corporation tax.
5.
What are the legal barriers to the introduction of different corporation tax rates on a regional basis within the UK?
i.
See section 4 and our references to the European Court of Justice and the Azores Judgement.
ii.
In a second case, in July 2002 Gibraltar announced a new corporate taxation policy setting a zero rate of corporation tax for all companies but introducing new taxes on company personnel and property occupation which were capped at 15% of profits. The existing corporate forms which allowed zero taxation, the Exempt and Qualifying companies, would be abolished.
iii.
However, the European Commission subsequently ruled that the tax reforms proposed in 2002/03 were in breach of state aid rules
iv.
In December 2008, the European Court of First Instance ruled in favour of Gibraltar, stating that the European Commission was wrong to argue that the tax reforms proposed were in breach of state aid rules, and effectively giving the jurisdiction licence to set its own tax rules.
v.
The Court dismissed the EU Commission’s case, and stated that although the UK is representative of Gibraltar, Gibraltar does, however, have fiscal autonomy from the UK, and therefore can introduce its own individual tax system (a corporation tax rate of 10-12%).
vi.
Given the foregoing, and the successive rulings of the ECJ that, subject to the appropriate implementation of the Azores Judgement, we believe that there would be no legal barrier to the use of the Azores Judgement to facilitate the Northern Ireland Executive to reduce the headline rate of corporation tax.
6.
What would be the effect of reduced tax revenue in NI?
i.
As separate sub-regional statistics for corporation tax raised from undertakings operating in Northern Ireland, it is impossible to be precise, but various estimates suggest that the impact of reducing corporation tax to 12.5% would be between £150 - £200m per annum.
ii.
However, as previously stated, the successful attraction of new FDI as a result of reducing corporation tax to 12.5% would be offset by additional taxation – PAYE, VAT and Income Taxes - remitted to Treasury.
7.
What evidence is there from other countries that having different corporation tax rates on a regional basis is effective?
i.
As has been explained, referencing to other regions and seeking to transfer that experience to Northern Ireland for the purpose of extrapolation, is unhelpful and may tend to mislead.
ii.
We must accept that, for over half a century, Northern Ireland has failed to close the prosperity gap with GB and has, over that period, become increasingly dependent on increasing levels of public expenditure, while the private sector has remained largely grant-dependent and has failed to become internationally competitive.
iii.
A series of economic development strategies undertaken under direct rule has failed to have any material impact on this situation and only a radical departure from historic and failed policies can have an impact.
8.
What are the implications for other regions if there were different levels of corporation tax within the UK?
i.
A national fiscal regime which permitted a derogated sub-regional differential tax rate would create the potential for what is sometimes called 'brass-plating' and the temptation to attribute, to a lower tax sub-region, a level of profit which may not be commensurate with the value added, or risk borne, by the activities carried out in that sub-region.
ii.
Of legitimate concern are the risks (fiscal, commercial and structural) to other, non-derogated regions – and ultimately to Treasury - that organisations which are already UK-based migrate their businesses in whole or part to the sub-region. However, that concern arguably does not give due weight to the primary objective of a sub-regional tax rate, which is to address the non-fiscal features which weigh against Northern Ireland when it is competing in the global FDI market.
iii.
Many countries which operate sub-regional tax regimes have had to address this concern - Germany, the US, Canada and Switzerland among them. None of them have developed a simple solution. Indeed, many appear to have relied significantly upon other, non fiscal, factors to limit this risk.
iv.
The creation of a lower tax rate regime for Northern Ireland is likely to raise the same concerns for the UK Treasury. Solutions which seek to address this will, ideally, be straightforward to understand and implement and provide a reasonable degree of certainty to both taxpayer and Government. However, the experience of other countries suggests there are likely to be difficulties in achieving this, and hence compromises to be made. Nevertheless, amongst the possible mechanisms to address this concern are –
·
reliance upon non-fiscal factors to limit the risk;
·
amending, where necessary, current UK Transfer Pricing legislation so that it covers sub-region to sub-region transactions;
or
·
'capping' the profit which enjoys the preferential sub-regional tax rate.
v.
Each of these possible mechanisms could be supported by a 'claw-back' regime which ensured that companies which sought to unfairly exploit the regime would be subject to a retrospective removal of the tax incentive. This could be further augmented by a tax penalty regime. The overall intention being to ensure that only the profit fairly attributable to the activities carried on in Northern Ireland enjoys the reduced tax rate.
vi.
Considering the second point above, the UK treasury already has in place powerful and extensive legislation aimed at protecting the UK tax base against unfair erosion resulting from the pricing of UK: non-UK product and service flows. It is possible that this legislation could be amended to address sub-region to sub-region transactions. To simplify the additional compliance costs associated with this there could be exclusions for UK-owned businesses, certain industry sectors and/or small/medium-sized enterprises. Certain aspects of the UK tax legislation already differentiate between small/medium-sized enterprises and ‘large’ enterprises.
vii.
Considering the third point above, the regime could provide for a 'cap' on the level of profits which would benefit from the preferential tax rate. In the interests of simplicity, certainty and reducing compliance costs, this cap could be linked to the Gross-Value- Added, or a similar measure, by the activity carried on in Northern Ireland.
viii.
For example, the amount of profit benefitting from the preferential tax rate could be capped by being linked to the level the Northern Ireland-based workforce or by being linked to the aggregate Northern Ireland-based payroll/PAYE cost. In the further interests of simplicity, certainty and reduced compliance costs these measures could, perhaps, be benchmarked to industry or sector averages, where appropriate. UK tax legislation already incorporates a tax relief (Research & Development Tax Relief) which, whilst complex, does incorporate (in connection with the cash tax refund aspect of the relief, available to small/medium-sized enterprises) a linkage between the relief and the claimant company’s PAYE cost.
21 September 2010
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