Corporation nTax - Northern Ireland Affairs Committee Contents

Examination of Witnesses (Questions 378-415)

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 Commission 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'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.

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