Corporation Tax in Northern Ireland: Government Response to the Committee's First Report - Northern Ireland Affairs Committee Contents


Appendix 2: Government response


The Government welcomes the report of the Northern Ireland Affairs Committee published on 24 May 2011 and is grateful for the work of the Committee on this issue. On 20th December the Government published its response to its consultation on Rebalancing the Northern Ireland Economy. As set out in that document the Government has established a joint ministerial working group, comprising ministers of the UK Government and the Northern Ireland Executive, to consider issues raised by the consultation. This group met for the first time on 15 December 2011.

No decision has yet been made on whether to devolve corporation tax. A decision will be taken following the conclusion of work developed by the joint ministerial working group, which is expected in summer next year.

The Northern Ireland economy

1. Largely on account of a long period of terrorist activity, Northern Ireland's economy has underperformed by comparison with the UK as a whole. However, in relatively more peaceful times, taxpayers in the rest of the UK might expect Northern Ireland to improve its economic performance and to take steps to enable it to do so. (Paragraph 11)

As a result of more than 30 years of conflict, the Northern Ireland economy has suffered in comparison to the rest of the UK, partly due to difficulties in attracting foreign investment. While the years of peace following the Belfast Agreement of 1998 have seen prosperity rise in Northern Ireland, it still lags behind the UK average and still has one of the weakest economies in the UK. As set out in the Coalition Programme for Government and at June Budget 2010, the UK Government and the Northern Ireland Executive have a common objective to "rebalance the Northern Ireland economy" to increase the size of the private sector and drive faster economic growth in the area. This is a long term objective for the next 25 years and will only be achieved through working in partnership with the Northern Ireland Executive.

2. We acknowledge the forthcoming reduction in the ability of Invest NI to use Selective Financial Assistance grants to attract foreign direct investment. There is a need to develop other incentives if Invest NI is to continue to attract foreign direct investment and bring new jobs to Northern Ireland. (Paragraph 15)

Invest NI is an agency of the Northern Ireland Executive. It is for the Northern Ireland Executive to determine the policy and funding of Invest NI.

Arguments for devolving corporation tax

3. Although there were exceptions, the vast majority of witnesses, particularly those involved in business, who gave evidence to the inquiry or whom we met in Northern Ireland, argued for a reduction in the corporation tax rate in Northern Ireland. Moreover, many of them said that previous policies had not had the desired effect and a significant reduction in corporation tax would be the dramatic change that business in Northern Ireland needed. (Paragraph 20)

The Government has received over 700 responses to its consultation. Responses showed strong support for the rebalancing agenda. Around three quarters of responses were in favour of corporation tax devolution, of which around two thirds were from Northern Ireland businesses or business owners. Additionally, the main Northern Ireland political parties have expressed their support for corporation tax devolution.

However, support has not been universal and a number of respondents pointed to the complex issues inherent in devolving these powers, many of which were identified in the consultation document as requiring extra work and consideration.

4. We welcome the publication of the Treasury's consultation paper and the debate that is taking place as to how best to support the Northern Ireland economy. In principle, we support the devolution of the power to vary corporation tax to the Northern Ireland Executive. However, we understand that there will be consequences associated with doing this and recognise that there are concerns that need to be addressed before this can take place. (Paragraph 41)

The Government is grateful for the Committee's contribution to this important debate and its extensive engagement on this issue. The Government recognises the Committee's support, in principle, for the devolution of the power to vary corporation tax to the Northern Ireland Executive.

The Government notes that a number of complex issues were raised in the consultation, in many cases mirroring the concerns identified by the Committee. It has established a joint ministerial working group on rebalancing the Northern Ireland economy, comprising ministers of the UK Government and the Northern Ireland Executive to consider these issues further. A decision will be taken on whether to devolve corporation tax following the conclusion of work developed by the joint ministerial working group, which is expected in summer next year.

EU rules on state aid and the Azores judgment

5. We are confident that the proposal to devolve the power to vary corporation tax to Northern Ireland can meet the criteria of the Azores judgment, although it is difficult to know for certain how the ECJ would apply the judgment in a new situation. It is essential that the Northern Ireland Office and the Treasury seek to reduce the risk of legal challenge through detailed and formal discussions with the EU Commission. (Paragraph 56)

Devolving any tax rate varying power must satisfy the "Azores criteria" as set out in the European Court of Justice judgment on Commission v Portugal. This judgment set out the conditions that would need to be met for regional differences in direct taxation not to involve State aid and to be compliant with EU law. As noted in the Government's consultation paper, it is expected that Northern Ireland would meet the Azores criteria of institutional, procedural and fiscal autonomy.

The Government accepts that further work would need to be done on any detailed proposals for implementing a devolved corporation tax regime and introducing the necessary adjustments to Northern Ireland's block grant. It is the Government's intention to engage with the Commission as this work is taken forward.

6. The Azores judgment, and the subsequent cases, indicate that the decision for Northern Ireland to have a rate of corporation tax, separate from the rest of the UK, could not be taken at Westminster. The power to vary the corporation tax rate would need to be devolved to the Northern Ireland Executive. Northern Ireland would bear the full financial responsibility for any reduction in tax revenue, and consequently Northern Ireland would not be compensated from HM Treasury for any tax loss. (Paragraph 57)

The Government agrees with the Committee's conclusions, although it notes that significant further work would need to be done in order to develop detailed proposals that would meet these criteria, and, in particular, to ensure that the Northern Ireland Executive would bear the full fiscal consequences of reductions in tax revenues resulting from a change in the Northern Ireland corporation tax rate.

Total corporation tax revenue in Northern Ireland

7. The Treasury urgently needs to set up a system which can accurately assess how much corporation tax is collected in Northern Ireland. (Paragraph 66)

The Government agrees that further work need to be done to provide greater clarity on the potential costs of a reduction in the rate of corporation tax in Northern Ireland and what systems could be introduced to allow this to be monitored if corporation tax were devolved. This issue will be considered as part of the work plan under the joint ministerial working group.

The only geographical data companies presently provide is their registered address, which may bear no relationship to the locations in which the company's activity is undertaken. A fully accurate assessment of the amount of corporation tax due on activity in Northern Ireland would depend upon companies operating in Northern Ireland supplying apportioned data on profits, losses, expenses and allowances. While this would be needed for a devolved system, the administrative burden it would create would not be justifiable unless the Government were committed to devolution.

Impact upon the block grant

8. The Northern Ireland Executive needs to know how much corporation tax is raised in Northern Ireland, how the corresponding reduction in the block grant will be calculated, including how the block grant is readjusted in retrospect, and how this is likely to impact upon the total block grant and public expenditure planning now and in the future. (Paragraph68)

Further work on these issues will be undertaken as part of the workplan agreed between the UK Government and the Northern Ireland Executive is being overseen by a joint ministerial working group comprising Ministers from HM Treasury, the Northern Ireland Office and the Northern Ireland Executive.

9. Any method of calculating the reduction in the block grant must strike a balance between many factors, most notably simplicity and accuracy. It must also conform with EU law. The calculation of the reduction in revenue in future years would be complicated by factors such as UK growth and inflation assumptions, the extra business which Northern Ireland would attract, and be adjusted according to the variations in what we know to be a volatile source of income. Furthermore, this may be complicated by any decision of the UK Government to increase or reduce the block grant, or change the Barnett Formula altogether. Any transitional arrangement would make assessing the amount of money going to the Northern Ireland administration, and therefore its own public expenditure planning for the next three to five years difficult. (Paragraph 71)

These are important points and will form part of the consideration being taken forward in the agreed workplan. It is essential that the process of determining any reduction in the block grant is transparent, equitable to both the UK Government and Northern Ireland Executive and based on the best data available.

10. Possibly the best way of devolving the responsibility for setting the rates of Corporation tax to the Northern Ireland Assembly would be for the Treasury to calculate how much corporation tax is raised in the province; then reduce the block grant by this amount; give the Assembly the power to set its own rate of corporation tax; and allow the Assembly to keep those receipts. This would provide a transparent system which would more readily satisfy the EU, and would also ensure that, if there were to be any increase in the corporation tax take then the Assembly would benefit. This would be the method of transfer we would prefer. (Paragraph 72)

Further work is needed on the administration of a devolved system of corporation tax in Northern Ireland and on the behavioural effects which might arise because of any difference in corporation tax rates between Northern Ireland and the rest of the UK including profit shifting and tax motivated incorporation. This work will form part of the wider workplan agreed by the UK Government and Northern Ireland Executive.

11. It is essential that the UK Government clarify whether any mechanism can be devised that allows HM Treasury to return to Northern Ireland a share of the revenue raised that is not corporation tax if receipts from other taxes are reasonably clearly related to changes in the corporation tax rate. However, it would be wrong to disguise the complexities this would entail. (Paragraph 75)

The consultation paper 'Rebalancing the Northern Ireland Economy' stated that indirect tax effects could be considered when calculating the adjustment to the block grant as long as doing so complied with the Azores criteria and the UK fiscal framework. As the Committee recognises, designing an appropriate mechanism presents a number of significant challenges and considerable further work is needed to consider the issues involved. Possible mechanisms will be looked at by the working group set up by the UK Government and Northern Ireland Executive. However, no decision has been taken on whether to allow such effects to be taken into account in the event that corporation tax is devolved and the rate reduced.

Political support and agreement with the Northern Ireland Executive

12. There appears to be unity among the political parties in Northern Ireland on the devolution of the power to vary corporation tax. The Treasury's consultation paper makes it clear that the research that is necessary before a decision would be taken will require considerable resources and time, and they would be unwilling to divert these resources unless they were confident that the Northern Ireland Executive would use the power. It would be for the Assembly to assess the benefit and cost of changing the corporation tax rate. (Paragraph 80)

The consultation paper focuses on the proposal to devolve the power to set the rate of
corporation tax in Northern Ireland. It would be for the Northern Ireland Assembly to determine whether to exercise that power in the event that the power is transferred.

Phasing, certainty and the final rate

13. We conclude that in the event of the power being devolved, the important decisions on detail, such as the rate and speed at which the rate might be varied, would be for the Northern Ireland Executive. From the evidence we have received, we would strongly urge the importance of maintaining the lower rate. (Paragraph 85)

The consultation paper focuses on the proposal to devolve the power to set the rate of corporation tax in Northern Ireland. It would be for the Northern Ireland Assembly to determine whether and at what speed to exercise that power in the event that the power is transferred.

HMRC and the UK tax system

14. HMRC has been criticised recently for its effectiveness in settling disputes regarding corporation tax. HMRC needs to demonstrate it has the capability to manage a mechanism for administering different corporation tax rates within the UK. (Paragraph 90)

The Government is confident that HMRC's handling of business tax settlements means that businesses are paying the right tax. The National Audit Office examined HMRC's approach during the summer and their report endorsed the strong governance arrangements that HMRC has put in place. The wider issue of the nature of the tax regime necessary to support a devolved Northern Ireland rate and how it might be administered will be considered further as part of the workplan overseen by the joint ministerial working group.

Burden upon business

15. We agree that the burden on UK businesses overall must not outweigh the gain to Northern Ireland businesses. This is made more important by the probable time delay between lowering the corporation tax rate in Northern Ireland and the consequent realisation of the benefits. The Government have said they will not devolve corporation tax to Northern Ireland if it creates an administrative burden that outweighs the gain. We will pay close attention to the responses to the consultation as to what kind of mechanism might be introduced. (Paragraph 94)

Consistent with the Government's general approach to tax consultation, the consultation document considered devolution in high-level and principled terms. Further work will be needed on the detailed design of the regime to inform a fuller consideration of the administrative burdens.

Amongst respondents who commented in detail on administrative burdens of a separate corporate tax rate in Northern Ireland, there was widespread recognition that rules would be required to ensure a Northern Ireland corporation tax rate was available only to genuine economic activity in Northern Ireland.

The issue of how a lower Northern Ireland rate might be ring-fenced in a manner that balances protection against avoidance or manipulation against burdens on companies will be considered further as part of the workplan.

Tax avoidance, tax evasion and brass plating

16. We have heard expressions of concern about the risk of encouraging brass plating and tax avoidance generally if the corporation tax rate in Northern Ireland is lowered. Our evidence suggests that this risk is sufficiently well mitigated against for it not to present a persuasive argument. (Paragraph 102)

As has been seen in evidence to the committee there is a range of views on how profits qualifying for the reduced rate can be identified. The issue of how a lower Northern Ireland rate might be ring-fenced in a manner that balances protection against avoidance or manipulation against burdens on companies will be considered further as part of the workplan.

17. We note that if the corporation tax rate was changed in Northern Ireland, it would have to be a single rate applied across the board. This would mean that companies could receive a windfall gain without increasing economic activity. It would also add to the issues arising from corporation tax volatility. However, we conclude that such rough justice does not invalidate the wider benefit of adopting a lower rate. Indeed, it is important to ensure that companies already operating in Northern Ireland continue to do so in the face of strong competition from elsewhere in the world. (Paragraph 105)

The consultation paper focuses on the proposal to devolve the power to set the rate of corporation tax in Northern Ireland. It will be for the Northern Ireland Assembly to determine whether to exercise that power in the event that the power is transferred. As set out in the Committee's Report, Northern Ireland would need to conform to State aid rules, which prohibit tax rules conferring a selective advantage outside of certain prescribed circumstances.

Implications for the UK

18. We recognise there is value in UK fiscal unity and value in a tax system that is administratively simple to operate, both for HMRC and businesses. We are also aware that the Calman Commission in Scotland and the Holtham Commission in Wales are part of a broader debate around the devolution of tax powers to their respective parts of the UK. However, the situation in Northern Ireland is different from Scotland and Wales. Northern Ireland is the only part of the UK that shares a land border with another sovereign country, and that country has a corporation tax rate of 12.5%. (Paragraph 109)

Several responses to the Government's consultation expressed concern about the risk of breaking up the UK's unitary corporate tax system.

The Government is committed to strengthening the fiscal accountability of devolved administrations across the UK. The consultation on rebalancing the Northern Ireland economy forms part of this broad agenda. Here, as in the other devolved administrations, the Government is seeking a balance. It wants to ensure the empowerment of all devolved institutions. At the same time, it must maintain the success of the shared economy on which all countries of the UK depend.

In particular, the Government must ensure proposals maintain incentives for business to trade, invest and be headquartered in the UK, that they do not impose unreasonable administrative burdens and that they support the competitiveness of the UK as a whole.

Northern Ireland has a set of historical, geographical and political circumstances which are quite different from those in Wales and Scotland; principally that it shares a land border with another EU country and one which has a substantially lower Corporation Tax rate than the UK. The legacy of the Troubles has led to underinvestment by the private sector in Northern Ireland, and Northern Ireland also has a larger public sector than elsewhere in the UK.

19. We are not persuaded that, as a result of a lower corporation tax rate, there would be a significant amount of movement of businesses from other parts of the UK to Northern Ireland. However, there is a risk that investment, either foreign or GB based, will go to Northern Ireland that might otherwise have gone to or remained in other parts of the UK. (Paragraph 115)

Several responses to the consultation argued that economic inefficiencies could arise as firms react to considerations other than commercial factors when making location and investment decisions within the UK. There could also be risks for deprived regions elsewhere in the UK. The Government will need to consider this issue further before taking a decision on whether to devolve corporation tax powers to the Northern Ireland Assembly.

Enterprise zones

20. We recognise the potential in offering targeted incentives on top of corporation tax to incentivise particular sectors. However, we conclude that now is not the time to consider devolving further tax powers to the Northern Ireland Assembly. The complexities of doing so would be likely to stall change. Targeted fiscal incentives should continue to be legislated for and administered on a UK wide basis. (Paragraph 127)

Other tax options, in particular capital allowances, R&D tax credits and an employers' National Insurance holiday, received support from some respondents although a few voiced concern about State aid and the capacity of some measures to have a transformative impact on their own. Several suggestions were made on the administration of individual measures, which the Treasury and HMRC will consider alongside other submissions on these policy areas. The joint ministerial working group programme will include work on alternative tax measures alongside its main focus on corporation tax.

21. Transport tax rates must not deter businesses from coming to Northern Ireland; any consideration of applying a per plane tax to freight must take into account that businesses could be lost to the Republic of Ireland if this is introduced. (Paragraph 128)

The Government recognises the important contribution of air freight in the economy. As the Budget consultation on APD made clear, the Government does not propose to extend APD to air freight services at the present time.

22. A skilled workforce is essential to take advantage of any expansion in the sectors that Northern Ireland wants to attract. Education and planning are already devolved matters, and the Northern Ireland Assembly must make its own decisions about where and how to invest in skills training, and how to reform its planning system. (Paragraph 135)

As set out in the consultation document, rebalancing the Northern Ireland economy will only be achieved through a combination of excepted, reserved and transferred policy leavers. The consultation paper sets out a number of non-tax options, including policy options available to the Northern Ireland Executive that might contribute to the rebalancing agenda. These include regional and industrial policy, planning, local taxation, innovation and skills, and labour market policies. In devolved areas such as these, it is entirely for the Northern Ireland Executive to determine its own priorities and policies. We will continue to work in partnership with the Executive to ensure that we deliver our shared objective of rebalancing the Northern Ireland economy, sharing expertise and knowledge, while respecting the devolution boundaries.



 
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