Written evidence from Alan Trench
1. This memorandum is submitted by Alan Trench
to the Northern Ireland Affairs Select Committee for its inquiry
into devolving corporation tax in Northern Ireland. I am an honorary
senior research fellow at the Constitution Unit at University
College London, and was formerly research fellow in the School
of Law at the University of Edinburgh. I am a solicitor admitted
in England and Wales (now non-practising), and have written widely
on various aspects of devolution in the United Kingdom, including
intergovernmental relations and devolution finance. I also have
experience of how decentralised and federal systems work in a
number of other countries around the world, including particularly
Australia, Canada, Germany and Switzerland. I have acted as specialist
adviser on devolution to the House of Lords Constitution Committee
and to the Lords Select Committee on the Barnett Formula (which
reported in July 2009), and am currently specialist adviser to
the House of Commons Welsh Affairs Committee. I am also author
of a blog "Devolution Matters", on which many posts
deal with issues relating to devolution finance.[5]
2. The purpose of this memorandum is to outline
what I consider would be the likely effects of devolving corporation
tax in Northern Ireland on the block grant that presently provides
the bulk of the funding for the Northern Ireland departments.
It attempts to address issues raised by members of the Committee
when they took evidence from Professor Rosa Greaves of Glasgow
Law School on 12 January 2011. I do not address wider issues of
the merits of devolving corporation tax in Northern Ireland, or
of a different rate of corporation tax there.
3. In her evidence, Professor Greaves identified
the jurisprudence of the European Court of Justice and Court of
First Instance on the question of whether, and to what extent,
differential corporate tax rates within a member state can constitute
an unlawful state aid under European Union law. She highlighted
the key criteria that emerge from the courts' decisions in the
Azores, Gibraltar and Basque Country (UGT-Rioja) cases: that a
government be "sufficiently autonomous" institutionally,
procedurally, and financially and economically. The Northern Ireland
Executive would probably have little difficulty satisfying the
first two criteria, because it is clearly constituted as a separate
government accountable to a separate elected Assembly, and within
the sphere of its devolved functions it has control over the decisions
it makes. The key area of difficulty would concern the question
of economic and financial autonomy. In the language of the European
Court of Justice in the Azores case, "the national tax rate
for undertakings in the region must not be offset by aid or subsidies
from other regions or central government. It follows that ...
[the regional government] assumes the political and financial
consequences of such a measure".[6]
This would mean that Northern Ireland alone would have to undertake
the risks as well as potential benefits arising from a differential
tax rate. The UK Government could not provide, directly or indirectly,
any sort of bail-out if there should be a shortfall in tax revenues
as a result of tax devolution.
4. The first implication of that requirement
is that there would need to be a reduction in the block grant
to allow for the devolution of tax revenues, corresponding to
the amount of tax revenue foregone by the UK Exchequer. This requirement
was noted by the Varney Review of Tax Policy in Northern Ireland
of December 2007, and the principle has been a key part of the
proposals for devolving part of personal income tax in Scotland
and Wales, adopted by the Calman and Holtham Commissions respectively.[7]
The Holtham Commission devotes a good deal of attention (in chapter
5 and annex 8 of its final report) to discussing how such a reduction
could be carried out, and the effects of various ways of doing
so.
5. Given the nature of corporation tax, calculating
the amount of such a reduction would be hard methodologically
and practically. We do not have up-to-date figures for tax revenue
generally collected in or arising from Northern Ireland, and those
figures we do have (produced annually for Scotland and published
in Government Expenditure and Revenue Scotland, and on
a one-off basis for Wales in the Holtham report using data for
2007-08) are based on estimates of revenues from those parts of
the UK, not actual revenues.[8]
The Varney report suggests it amounts to £500 to £600
million (Annex C, paragraph C.5). If the whole of the tax were
to be devolved, it would be this figure (rather than the net revenue
foregone by a lower rate in Northern Ireland compared with the
rest of the UK) that would need to be used. Assuming that figure
remains substantially correct—and it is at least four years
old—it would equate to a cut of between 6.5 and 7.8% in
the devolved departments' DEL budgets for 2006-07, and 5.6 to
6.7% on the latest available figures (for 2008-09).[9]
(I use 2006-07 on the basis that it is the year to which the figure
of £500-600 million relates.)
6. The first step would therefore be to get HM
Treasury to produce more accurate figures for corporation tax
revenues arising in or from Northern Ireland, and in doing so
to explain the basis on which it does so. The question of how
the tax might be calculated will be central to such a calculation.
In particular, it will be necessary to determine whether it relates
simply to the profits of companies incorporated in Northern Ireland,
or to businesses incorporated elsewhere with activities carried
out there and in other places and paying corporation tax in the
UK. If the former, what about profits deriving from activities
they carry out in other parts of the United Kingdom? If the latter,
on what proportion of their profits will the Northern Ireland
share of corporation tax be calculated?
7. The choice of a method of calculating the
appropriate deduction from the block grant would also need to
take into account how the reduction would be uprated or adjusted,
given inflation, shifts in overall tax income and so forth. An
important part of that would be to locate the transfer of risk
that arises from the reduction in the right place—one government
should not, in principle, be subject to risk factors which it
cannot control. Rather, risk and reward should be placed together,
in the hands of the tier of government that can control them.
The fact that a reduction in the block grant has taken place and
is then proportionately maintained should be sufficient to satisfy
EU requirements, while the block grant is calculated on its present
basis of a historic baseline adjusted periodically to reflect
a proportionate share of changes in spending on comparable functions
in England.[10]
8. The Holtham Commission identified four chief
models for calculating such a deduction. These were:
- own base deduction (OBD): the deduction from
the block grant is indexed to the assessed growth in the devolved
tax base;
- indexed deduction (ID): the initial deduction
is indexed to an external variable such as the relevant UK tax
base;
- proportionate deduction (PD): the grant is reduced
by a given percentage; the initial deduction therefore grows at
the same rate as the grant itself; and
- fixed real deduction (FRD): the grant is reduced
by an agreed sum which is then indexed to inflation; ie the present
value of tax receipts is equated to a real annuity which is deducted
from the grant.
Holtham's analysis of the risk related to these models
shows that the least risk arises from the "OBD" method,
which ensures that the reduction from the block grant continues
to correspond to the revenue from the devolved tax if the devolved
and UK rates were to be the same, but in ways that might well
amount to a potential bail-out as understood by the EU jurisprudence.
The other approaches would entail greater risk, but those risks
relate more closely to decisions that would be devolved and they
would therefore be more in accord with the requirements of EU
law.
9. The choice of an appropriate basis for the
reduction from the block grant would be key to ensuring any devolution
of corporation tax would satisfy the requirements of EU law.
10. It is also necessary to look what might happen
if the block grant were to be reviewed so that it relates to relative
needs. There is considerable pressure for such a review; it has
been called for by the Holtham Commission, the Lords Select Committee
on the Barnett Formula, and the Commons Justice Committee.[11]
(It was also recommended for the longer term by the Calman Commission.)
These calls have been rejected for the time being by the Coalition
UK Government, which has said that "any change to the system
must await the stabilisation of the public finances".[12]
While such change may therefore be unlikely in the near future,
it is also not likely to be put off indefinitely.
11. It is hard to see how any revaluation of
the block grant so that it purely relates to objective factors
affecting relative demands for public services—demographic
factors, sparsity and the like—would raise concerns about
it being a means of providing a bail-out to a devolved government
relating to a loss of revenue from corporation tax. However, it
is possible that problems might arise if factors of income or
poverty were taken into account (as both the Lords Select Committee
and Holtham Commission have recommended). These factors would
suggest that it might be desirable to secure at least informal
clearance from the European Commission to confirm that the scheme
was not, in their view, state aid. It would more clearly arise
if the new system of funding devolved governments were to include
a grant or element of a grant that was a form of fiscal equalisation.
12. To avoid this, it would be necessary very
clearly to exclude corporation tax from the scope of any equalisation
scheme, which could only apply to personal income tax and perhaps
smaller devolved taxes relating to land (such as stamp duty land
tax, to be devolved to Scotland under the Scotland bill as part
of the implementation of the Calman proposals). Even then, there
remain problems if the objective of the tax is to produce an increase
in economic growth and overall tax revenues, even though the contribution
of corporation tax to Northern Ireland's revenues remains modest.
Arguably, a system that provides for equalisation of other tax
bases such as income tax, the income of which can be indirectly
affected by the corporation tax rate, might also constitute a
state aid. The EU case-law does not provide much guidance on this
point.
13. The effect of excluding such a bailout is
very clearly to transfer risks relating to Northern Ireland corporation
tax to the Northern Ireland exchequer. If corporation tax receipts
were insufficient—whether because of a lack of inward investment,
poor economic performance or other reason—services in Northern
Ireland would have to be cut.
14. A further issue would arise if devolved fiscal
powers included a power to borrow, to smooth out fluctuations
in tax revenues in the short term and to balance revenue and spending
over the economic cycle. This forms an important part of the recommendations
for Scotland set out in the Scotland Bill currently before Parliament,
and its accompanying Command paper.[13]
Reconciling the last of these powers—which is also the most
important, given the cyclic nature of corporation tax—would
be hard, given the "no bail out" rule. Its whole purpose
is to provide a form of limited bailout to protect public services
in a downturn. The approach adopted for Scotland makes this explicit.
To avoid other problems, such borrowing would not be by the Scottish
Government acting on its behalf, and accessing the capital markets
directly. It would be by HM Treasury acting as the banker to the
Scottish Government. However, such borrowing powers for corporation
tax would appear only to satisfy the EU requirements if the UK
Government does not guarantee the borrowing and the Northern Ireland
Executive would be solely responsible for it. That is incompatible
with the approach to managing public finance currently being considered
for Scotland, and which the Holtham Commission recommends for
Wales.
15. Determining the basis of which companies
or activities as undertaken in Northern Ireland would be significant
not only for calculating the reduction in the block grant, as
discussed in paragraph 5 above. It would also affect the conduct
of economic management of the UK as a whole. As such, one would
expect HM Treasury to seek to continue to shape the use of such
a power by the Northern Ireland Executive, given the Treasury's
role in macro economic management. One would expect the Treasury
to be concerned about the possible use of tax competition to undermine
tax revenues while generating only limited overall economic benefits.
This has certainly been the Treasury's approach to the similar
situation of direct financial assistance to industry, where it
has instigated a Concordat annexed to the Memorandum of Understanding
to regulate the use of such financial assistance.[14]
The concordat is mainly procedural, requiring consultation about
both policy and its application in larger cases, and so forth.
It also refers to agreed limits for such assistance (without specifying
what those limits are or where they can be found). It would be
surprising if the Treasury were not to take a similar approach
to devolved corporation tax as well. Indeed, co-ordination of
fiscal policy will be an important issue for any form of fiscal
devolution, and Strengthening Scotland's Future proposes
the establishment of an "Intergovernmental Bilateral Committee
on Fiscal Devolution" between Scottish and UK Governments
for the devolved income tax powers proposed in the Scotland bill.
(In my evidence to the Scottish Affairs Committee on the Scotland
bill, I have criticised this as being inadequate.) However, there
is a potential tension between such co-ordination within the UK,
and ensuring the sort of political and fiscal autonomy that the
EU case-law requires. It is unclear how the Treasury might address
this issue, but it is clear that it would need to do so in the
light of concerns about corporate tax competition that have been
expressed by the European Commission and a number of other member
states. That said, I understand that there is extensive policy
co-ordination between the Spanish central state and the Basque
Country, which does not appear to compromise the autonomy of the
Basque Country in these matters for the purposes of EU law.
16. Finally, it is worth noting what might happen
if the UK Parliament should resume direct rule from London following
a collapse of devolved government. In such circumstances, the
criteria of institutional independence and autonomy in decision-making
would no longer be satisfied, and any differential in corporation
tax would clearly be a selective state aid under the jurisprudence
of the EU courts. One would therefore expect the European Commission
to require the UK Government to put an end to the differential
corporation tax within a short time. The advantage that reduced
corporation tax could offer would necessarily be directly tied
to the durability of devolution, and one would therefore expect
companies attracted by a lower rate of corporation tax to factor
political stability of devolved government in Northern Ireland
into their calculations in deciding whether and how to take advantage
of it.
17. In conclusion, it is worth summarising the
key points made above. In order to devolve corporation tax in
a way that complied with EU law, it would be necessary to reduce
the block grant that currently is paid to fund public services
in Northern Ireland. Calculating that would not be straightforward.
It would also be necessary to ensure that there was no way that
compensation payable from the UK Exchequer would be payable if
there were a shortfall in tax receipts. The effect would be to
transfer a significant degree of financial risk to the Northern
Ireland Assembly and Executive, as well as the economic lever
devolved control of corporation tax would afford. Such a change
would in turn close off certain options for fiscal equalisation
that might form part of a wider revision of devolution finance
in the foreseeable future.
24 February 2011
5 http://devolutionmatters.wordpress.com/category/devolution-finance/ Back
6
Case C-88/03 Portugal v. Commission, [2006] E.C.R. I-7115,
paragraphs 67-68. Back
7
Sir David Varney Review of Tax Policy in Northern Ireland
(London: HM Treasury, 2007), chapter 3; Commission on Scottish
Devolution, Serving Scotland Better: Scotland and the United
Kingdom in the 21st Century, Final Report (Edinburgh, Commission
on Scottish Devolution, 2009); Independent Commission on Funding
and Finance for Wales, Funding Devolved Government in Wales:
Barnett & Beyond, First Report to the Welsh Assembly Government
(Cardiff, Welsh Assembly Government, 2009); Independent Commission
on Funding; Independent Commission on Funding and Finance for
Wales, Final Report: Fairness and Accountability-A New Funding
Settlement for Wales, (Cardiff, Welsh Assembly Government,
2010). Back
8
See Independent Commission 2010 op cit, table 4.1, p. 40. Back
9
Spending figures taken from HM Treasury Public Expenditure
Statistical Analyses 2010 Cm 7890 (London: The Stationery
Office, 2010), table 1.8. Back
10
The machinery for this is set out in HM Treasury Funding the
Scottish Parliament, National Assembly for Wales and Northern
Ireland Assembly: A Statement of Funding Policy Sixth Edition
(London: HM Treasury, 2010). Back
11
Independent Commission 2009 and 2010 op cit; House of Lords Select
Committee on the Barnett Formula The Barnett Formula 1st
Report of Session 2008-09, HL 139 (London: The Stationery Office,
2009); House of Commons Justice Select Committee Devolution:
A Decade On Fifth Report of Session 2008-09, HC 529 (London:
The Stationery Office, 2009), chapter 6. Back
12
HM Government The Coalition: our programme for government
(London: The Stationery Office, 2010), p. 28. Back
13
Strengthening Scotland's Future, Cm 7973. Back
14
Concordat On Financial Assistance to Industry, annexed to Memorandum
of Understanding and Supplementary Agreements Between the United
Kingdom Government, the Scottish Ministers, the Welsh Ministers
and the Northern Ireland Executive Committee, 2010, Cm 7864. Back
|
