Corporation Tax in Northern Ireland

Written evidence from Algirdas Šemeta, Member of the European Commission

First of all I would like to stress that at this rather early stage of your inquiry I can only provide you with a number of preliminary and general comments from a European viewpoint of direct taxation issues. The principal areas for remarks and comments are (i) the state aid aspects, (ii) the Code of Conduct on harmful tax competition and (iii) the corporate tax Directives.

(i) State Aid Aspects

As already mentioned in your letter, there are important aspects from a fiscal state aid point of view to be taken into consideration. The main question is whether the reduced corporate income tax rate for Northern Ireland would fall to be considered as a regionally selective measure and thus as regional aid, compared to the "normal taxation" in the United Kingdom, or whether the planned lower taxation for Northern Ireland itself may be considered to be the "normal" rate of taxation for state aid purposes. Both the Acores and Madeira and the Basque Countries cases examined by the Court of Justice were subject to similar discussions of regional selectivity regarding their corporate income tax rates which were lower than in continental Portugal or in the other parts of Spain. These cases were brought before the Court of Justice and in the judgments [1] the Court has stated that where an intra-State body is sufficiently autonomous in relation to the central government of a Member State, the selectivity would have to be assessed against the context of that intra-state body, i.e. against the "normal" taxation in that region. The Court determined that a region would be sufficiently autonomous to set its own corporate income tax rates where it fulfilled the following requirements:

· Institutional autonomy: a region should enjoy a political and administrative status separate from that of the central government.

· Procedural autonomy: no intervention from the central state.

· Economic and financial autonomy: the respective region should bear the political and financial responsibility/risks for the measures introduced.

In the Basque cases the Court considered the three requirements to be fulfilled. On the contrary, in the Acores case it declined the economic autonomy insofar as compensatory financial transfers were made from the Portuguese central state. The court applied the same criteria in the Gibraltar case [2] in which it also accepted that the Government of Gibraltar had sufficient autonomy from the United Kingdom to introduce its own tax legislation.

I would suggest that for issues pertaining to "regional selectivity" your Committee liaise with the Directorate General of the Commissioner responsible for Competition.

(ii) Code of Conduct

Assuming that the state aid issues were satisfactorily addressed the application of the principles and policy lines from the Code of Conduct work on harmful tax measures would have to be considered. Here, from long practise of analysing and discussing specific tax regimes under the specific Code of Conduct principles and criteria, the Member States and the Commission have gained experience in appraising such difficult and complex taxation schemes from a tax policy viewpoint. 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.

The Code of Conduct for business taxation aims at eliminating harmful tax measures. In principle, this concerns tax measures that provide for an effective level of taxation which is significantly lower than the general level of taxation in the country concerned and that affect or may affect, in a significant way the location of business activity. The Code spells out five criteria for assessing whether such potentially harmful tax measures are actually harmful. These criteria are the following:

1. The measure is reserved to non-resident entities;

The criterion is whether advantages are accorded only to non-residents or in respect of transactions carried out with non-residents. This criterion contains two alternative elements: the first element is whether the measure is de jure only open for (criterion 1a) or in a majority of cases de facto used by (criterion 1b) non-residents, or transactions with non-residents.

2. The measure has been isolated from the domestic economy (ringfencing);

The criterion is whether advantages are ring-fenced from the domestic market, so they do not affect the national tax base. Also for this criterion, a de jure and de facto distinction is applied. In practise this means that if all or a majority of beneficiaries are non-residents (or transactions with non-residents), the domestic tax base is completely or partially ring-fenced from the effects of the regime.

3. The measure does not require real economic activity;

The criterion is whether advantages are granted even without any real economic activity and substantial economic presence within the Member State offering such tax advantages.

4. The measure is not in line with internationally accepted (OECD) rules;

The criterion is whether the rules for profit determination in respect of activities within a multinational Group of companies differ from internationally accepted principles, notably the rules agreed upon within the OECD (e.g. the OECD Transfer Pricing Guidelines).

5. The measure lacks transparency.

The criterion is whether the tax measures lack transparency, including where legal provisions are relaxed at administrative level in a non-transparent way. In practise, it is assessed whether a measure has been fully set out in legislation or in regulations or guidelines, and it must be ensured that its application is not subject to any discretion at administrative level.

(iii) Corporate Tax Directives

In the area of the three corporate tax Directives (Parent-Subsidiary Directive, Interest and Royalty Directive and Merger Directive) the possibility to have a regional corporate tax rate lower than the general tax rate of the Member State appears to be less of a legal issue. However, I have to inform you that there is a longstanding and not yet closed discussion on the question whether a region or a business sector with a specific corporate tax regime (differences in tax base and/or rate) is allowed to benefit from the application of these Directives. In these three Directives there is always a subject-to tax requirement to be fulfilled as a precondition for the application of the Directive (e.g. in the Merger Directive [3] Article 3(c) states as one of the three conditions to be fulfilled by a company to fall in the scope of the Directive that it "is subject to one of the taxes listed in Annex I, part B, without the possibility of an option or of being exempt, or to any other tax which may be substituted for any of those taxes." In Annex I, part B, the entry concerning UK reads "corporation tax in the United Kingdom"). While it might appear that from the wording of the provisions there should be no problem for companies resident in Northern Ireland benefiting from the Directives if there were a specific corporation tax in Northern Ireland, I can tell you that at least three Member States do not allow foreign companies resident in EU members States with more advantageous regional corporate tax rate than the general corporate tax rate to benefit from the provisions of the Directive. The legal argument for taking such a position is the anti-abusive provision found in each of the Directives and the political argument is that the Directives are aimed at tackling double taxation or higher taxation in cross-border situations and that such measures are not necessary when the residence State already provides advantageous tax provisions to specific types of companies or companies resident in a region with beneficial rates. As a matter of fact I find this situation unsatisfactory. However, until a solution to this problem is reached, a regional difference in corporate taxes adds an element of uncertainty to the tax treatment of cross-border transactions and operations in the Union.

Under bullet point 7 your Committee asks what evidence is there from other countries having different corporate tax rates on a regional basis. A relevant lesson can be drawn from the experience in Germany from the abolition of trade income tax at local level. The small local community of Norderfriederichskoog in the German Land Schleswig Holstein applied a 0% trade tax rate in its area at the beginning of this millennium. In the year before 2004 there was a run of companies to choose this village as the place of registration so that at the end 460 companies were registered in the village compared to 40 inhabitants. In 2004 Germany stopped this practise by introducing a minimum tax rate for trade income tax in Germany. Other examples of differences in regional rates can often be found in ‘low revenue generating taxes’ like capital duty in Spanish provinces, property tax or local charges in several Member States but not, to my knowledge, on the scale like considered by your Committee.

2 December 2010