Written evidence from PricewaterhouseCoopers
LLP
1. What effect will the reduction in the corporation
tax rate on a UK wide basis announced in the June 2010 Budget
have on the competiveness of the Northern Ireland economy?
(i) We believe that the reduction in the corporation
tax rate in the June 2010 Budget will, in itself, be of marginal
benefit to the competitiveness of the Northern Ireland economy.
(ii) Whilst the corporation tax rate will be
reduced gradually over the next few years, this is largely offset
by reduced capital allowances, with the latter changes to be felt
most by those industry sectors that are more capital intensive,
such as manufacturing. In addition, National Insurance Contribution
(NIC) rates will increase from April 2011 for both employees and
employers, further impacting the majority of companies.
(iii) Research by PwC[2]
into corporate performance in the 12 months to 31 March 2009 shows
that the profitability of many of the UK's largest companies fell.
Consequently, the level of corporation tax paid also fell, while
payments of other taxes remained steady or increased. The impact
of the downturn was therefore to increase the tax burden for individual
companies, with the average Total Tax Rate up by four percentage
points in 2009, to 42%. This happens because payments of many
taxes, such as business rates and NIC do not fall with declining
profitability and thus become relatively more expensive. The PwC
survey findings show that now, more than ever as we emerge from
recession, it is crucial that the UK tax system is internationally
competitive.
(iv) In Northern Ireland, with its particular
problems, any increase in competitiveness will start from a low
base. The public sector is equivalent to around 70% of GDP and
the underdeveloped private sector remains inwardly-focused and
lacks international competitiveness.
(v) Some 94% of Northern Ireland's VAT registered
enterprises have fewer than 10 employees, while fewer than 45
companies, from a universe of just under 57,000 VAT-registered
undertakings, have more than 500 employees. A mere 10 companies
account for 50% of all local exports, while the region has the
second-lowest level of business formation and business growth
amongst the 12 UK regions.
(vi) Northern Ireland's GVA per capita is over
19% below the UK average and, despite some recent modest improvement,
is broadly where it was in the mid-1970s. This relatively disappointing
GVA per capita performance is largely a factor of lower productivity
and we note the comments of the Economic and Social Research Council,
that:"…firms in Northern Ireland are significantly
less orientated towards producing new goods and services and in
some important sectors they are less internationally orientated
than might be expected. Both factors contribute to such firms
having lower productivity and competitiveness."
(vii) The Northern Ireland Executive's Programme
for Government, set out five priorities, including; Growing
a Dynamic, Innovative Economy; with Public Service Agreement
(PSA),1, entitled; Productivity Growth having the Aim:
Improve Northern Ireland's manufacturing and private services
productivity.
(viii) However, the productivity gap between
Northern Ireland and Great Britain has existed for three decades
and PwC's analysis of key performance indicators suggest that
over a period of more than half a century, Northern Ireland has
not materially closed the gap with GB. Over that period some 15
economic development strategies have set out to close this gap
and all have failed.
(ix) We therefore conclude that, since the reduction
in the corporation tax rate in the June 2010 Budget is UK-wide
and is largely offset by reduced capital allowances and increasing
NIC, it does not advantage Northern Ireland relative to the Republic
of Ireland and will therefore not have a sufficiently market effect
on competitiveness to narrow the prosperity gap between Northern
Ireland and Great Britain.
2. What would be the benefits of equalizing
the corporation tax rate in Northern Ireland with that of the
RoI?
(i) There is no certainty, considerable disagreement
and occasional contradiction as to the likely quantifiable benefits
of corporation tax harmonisation between Northern Ireland and
the Republic of Ireland (RoI).
(ii) Our examination of the various arguments
in favour of harmonising the rate of corporation tax between Northern
Ireland and RoI, have failed to define the quantitative benefit
over a specific period of time. In reaching this conclusion, we
have examined a number of published papers and also note that
the review commissioned by the last government and led by Sir
David Varney also failed quantify the likely benefit, concluding
that, "…any reduction in the rate would have a short-term
impact on revenue which would not be outweighed by long-term benefits."
(iii) Nevertheless, were a reduction in the level
of sub-regional corporation tax to be offered to Northern Ireland
such that it would equalise the rate between Northern Ireland
and RoI, we believe that would increase in the attractiveness
of the region for foreign direct investment.
(iv) However, while we believe that corporation
tax harmonisation would be of benefit and we would welcome it
in the absence of other options, we believe that there are other,
perhaps more targeted options which have not received as much
publicity and we elaborate on these in later chapters.
(v) In 2000, the former Irish Finance Minister
Ray MacSharry[3]
was quoted as saying "…no financial weapon was more
important than tax in attracting FDI;" and, indeed, this
may have been the case at a time before globalisation became a
driver of low-GVA production towards regions with low labour costs
and even lower tax rates.
(vi) In terms of attracting and retaining foreign
direct investment (FDI), there is little doubt that Ireland's
tax regime has been advantageous, but it is important not to oversimplify
this situation: "…during the 1980s, the period of
the boom in US FDI, there were no changes in the Irish tax system,
indeed the corporation tax rate actually increased in the 1980s,
so it is not possible to invoke it as an explanation for the timing
of the boom."[4]
(vii) Since 2000, over 80 countries have cut
their corporation tax rates to lure a declining volume of increasingly
sophisticated global FDI, with Puerto Rico's effective corporation
tax rate for manufacturing companies as low as 2% - in fiscal
terms, a race to attract FDI, can also be a race to the bottom.
(viii) In 2006, a report by the Northern Ireland
Economic Research Institute (ERINI)[5]
with assistance from Oxford Economics concluded that corporation
tax harmonisation with RoI would allow NI to capture part of the
RoI FDI inflow and could:
- create 180,000 new jobs by 2030;
- double the growth rate of the NI economy and
eliminate the productivity gap with the UK in a decade;
- recover of the initial loss of £300 million
in reduced corporation tax within six years with substantial benefits
to the exchequer thereafter;
- increase private sector exports and employment;
and
- result in a substantial reduction of the level
Westminster subvention.
(ix) However, four years later in 2010, a report
by the Northern Ireland Economic Reform Group[6]
(whose members included Dr Victor Hewitt Director of ERINI and
Neil Gibson of Oxford Economics Ltd, co-authors of the 2006 ERINI
Report) concluded that corporation tax harmonisation between Northern
Ireland and the Republic of Ireland would:
- Create 90,000 new jobs by 2030;
- Cut unemployment, "…much further
than would otherwise be the case…"; and
- reduce the level of Westminster subvention by
£1 billion by 2030.
(x) While the key authors of both reports were
common, the intervening period served to significantly modify
their long-term forecasts as to the likely impact of low corporation
tax on the Northern Ireland economy.
(xi) In addition, there is some evidence that
low corporation tax is of limited value in stimulating an indigenous,
small-firms economy (such as Northern Ireland's): "…low
corporation tax rates are relevant where businesses are already
profitable, but not… relevant to the growth of emerging companies…"[7]
(xii) There is also an argument that low levels
of corporation tax in regions of relatively high labour and operational
costs (such as the UK and RoI today) have stimulated investment
from foreign direct investment sectors that are most suited to
transfer pricing: "…the industrial sectors that have
boomed in Ireland are …particularly well able to avail of
transfer pricing in minimising their global tax liabilities…
they are 'patent intensive' rather than capital or technology
intensive… [and] … four sectors exhibit characteristics
that can only be explained as a response to the global tax planning
incentives provided by the low Irish CT rate: cola concentrates,
software reproduction, organic base chemicals and computers."[8]
(xiii) Consequently, without the ability to accurately
profile the size, sector, global-outreach and investment level
of likely new FDI attracted by reduced corporation tax, it is
impossible to predict the benefits of equalizing the corporation
tax rate in Northern Ireland with that of RoI. That impossibility
and the consequent lack of certainty as to the benefits suggests
that corporation tax may be sufficiently unwieldy to form a single
central focus around which sub-regional economic development strategy
can be hung.
(xiv) Nevertheless, whilst we cannot endorse
the enthusiasm of some commentators for a rate reduction to RoI
levels, such a reduction would certainly be of some benefit, albeit
one that is difficult to quantify. So the option was to choose
between the status-quo or rate parity with RoI, plainly the latter
would be preferable.
3. What alternative measures could be introduced
by the UK Government to make the NI economy more competitive
(i) In addressing this question, we accept as
underlying principles the notions that, "measures …
to make the NI economy more competitive", must individually
or collectively, stimulate significant increases in key measures
including, GVA-per capita, exports, pre-tax profits (declared
in Northern Ireland) and employment.
(ii) We are also conscious of the relationship
between corporation tax and PAYE, in that they contribute around
8% and 18% respectively of total UK tax revenues[9].
Consequently reducing the level of corporation tax in Northern
Ireland would impact on the overall UK corporation tax - assuming
the measure was extended to existing undertaking operating in
the region. However, as the primary reason for sub-regional corporation
tax reduction would be to attract new FDI, there would be a net
increase in new corporation tax take - albeit at a lower level.
Likewise with PAYE, the new employment afforded by new FDI investment
would similarly increase the PAYE tax take, which would, to some
degree, offset the reduction in corporation tax.
(iii) In that sense therefore, the measures referred
to above should serve to significantly stimulate both profits
and employment.
(iv) Returning to the example of RoI, the central
focus of Irish economic development strategy is flexibility; the
ability to tailor incentives to the needs of those mobile investors
that can make the greatest contribution to Irish wealth creation
and to modify those incentives to reflect new technologies and
global and national circumstances.
(v) While there are reasons not to make cutting
Northern Ireland's corporation tax rate the sole basis for economic
development strategy; there is a compelling argument for giving
the Executive the power to do it.
(vi) The new generation of mobile investor willing
to pay relatively high UK and Irish labour costs wants more than
low corporation tax. IDA Ireland today - as distinct from the
IDA in 1987-88 when MacSharry was Finance Minister - is no longer
pushing 12.5% corporation tax as the sole rationale to invest.
A basket of new incentives, including R&D Tax Credits, Patent
Income Exemptions and Intellectual Property (IP) Tax Relief, are
attracting high-value, high wage, wealth-creating clusters, where
R&D and innovation are key drivers.
(vii) Finally - with one exemption-the EU does
not permit sub-regional tax variation. To get the freedom to strike
a regional rate of Corporation Tax, Northern Ireland must fulfil
the conditions laid down in the Azores Judgement[10]
at the European Court.
(viii) But meeting the criteria of the Azores
Judgement lets the Executive do much, much more than just cut
Corporation Tax. They could create fiscal and tax incentives specifically
targeted at the high-value, wealth creating overseas investors
the region needs to deliver the productivity targets contained
in the Programme for Government and the recent Independent Review
of Economic Policy (IREP).
(ix) We would therefore begin with the assumption
that Westminster would, through invoking the Azores Judgement
give the Executive the power to strike a sub-regional rate of
Corporation Tax. This would, as in the case of Gibraltar, give
the Executive total sub-regional fiscal flexibility to encourage
high value-added FDI to locate in Northern Ireland, to establish
centres for R&D, training and marketing, with all the spin-off
benefits for local educational institutions in terms of linkages
and new revenue streams.
(x) The clear advantage of such flexibility -
as the Irish have discovered - is that fiscal policy can be tweaked,
or even radically altered, to suit likely future trends in investment
and global policies. There is therefore no requirement - as is
the case with corporation tax - to create speculative 20-year
models based upon historic trends.
(xi) We would also draw the Committee's attention
to the report from the Milford Group, developed in 2000-01. Investing
for the Future - the proposals from the business-led think-tank,
recommended tax incentives to stimulate and reward investment
in R&D, training and marketing. The Milford Group's original
proposals were supported by the then Ministers in the Northern
Ireland departments of Finance and Personnel (DFP) and Enterprise
Trade and Investment (DETI) and were subject to independent evaluation
and endorsement by the Ulster Society of Chartered Accountants
in November 2002.
(xii) In essence, they anticipated the Azores
Judgement and proposed a series of tax incentives that would be
fiscally neutral and which would have the following characteristics.
- be readily understandable;
- have a significant impact on post tax profits;
- be attractive to viable and highly profitable
projects rather than "cash hungry" low return projects;
and
- encourage investment and innovation
(xiii) The proposals used a series of worked
examples to illustrate how tax incentives in Northern Ireland
- as per their recommendations - could deliver significantly greater
retained profits that a simple 12.5% corporation tax alternative
as then prevailed in RoI. The Milford Group recommendations -
first proposed in 2001 - were largely adopted by the Irish government
in their incentives to stimulate IP, R&D and innovation, but
were overtaken in Northern Ireland by the return of Direct Rule
4. Is a reduction in corporation tax the simplest
and quickest way to make the NI economy more competitive and how
long would it be before NI realised the benefits?
(i) Cutting corporation tax may not be the simplest
and quickest way to make the NI economy more competitive; however,
the inability to accurately quantify the likely benefits, render
certainty impossible. Nevertheless, we have outlined in previous
sections some alternatives to a simple reduction in the headline
rate of corporation tax.
5. What are the legal barriers to the introduction
of different corporation tax rates on a regional basis within
the UK?
(i) See section 4 and our references to the European
Court of Justice and the Azores Judgement.
(ii) In a second case, in July 2002 Gibraltar
announced a new corporate taxation policy setting a zero rate
of corporation tax for all companies but introducing new taxes
on company personnel and property occupation which were capped
at 15% of profits. The existing corporate forms which allowed
zero taxation, the Exempt and Qualifying companies, would be abolished.
(iii) However, the European Commission subsequently
ruled that the tax reforms proposed in 2002-03 were in breach
of state aid rules.
(iv) In December 2008, the European Court of
First Instance ruled in favour of Gibraltar, stating that the
European Commission was wrong to argue that the tax reforms proposed
were in breach of state aid rules, and effectively giving the
jurisdiction licence to set its own tax rules.
(v) The Court dismissed the EU Commission's case,
and stated that although the UK is representative of Gibraltar,
Gibraltar does, however, have fiscal autonomy from the UK, and
therefore can introduce its own individual tax system (a corporation
tax rate of 10-12%).
(vi) Given the foregoing, and the successive
rulings of the ECJ that, subject to the appropriate implementation
of the Azores Judgement, we believe that there would be no legal
barrier to the use of the Azores Judgement to facilitate the Northern
Ireland Executive to reduce the headline rate of corporation tax.
6. What would be the effect of reduced tax
revenue in NI?
(i) As separate sub-regional statistics for corporation
tax raised from undertakings operating in Northern Ireland, it
is impossible to be precise, but various estimates suggest that
the impact of reducing corporation tax to 12.5% would be between
£150-£200 million per annum.
(ii) However, as previously stated, the successful
attraction of new FDI as a result of reducing corporation tax
to 12.5% would be offset by additional taxation - PAYE, VAT and
Income Taxes - remitted to Treasury.
7. What evidence is there from other countries
that having different corporation tax rates on a regional basis
is effective?
(i) As has been explained, referencing to other
regions and seeking to transfer that experience to Northern Ireland
for the purpose of extrapolation, is unhelpful and may tend to
mislead.
(ii) We must accept that, for over half a century,
Northern Ireland has failed to close the prosperity gap with GB
and has, over that period, become increasingly dependent on increasing
levels of public expenditure, while the private sector has remained
largely grant-dependent and has failed to become internationally
competitive.
(iii) A series of economic development strategies
undertaken under direct rule has failed to have any material impact
on this situation and only a radical departure from historic and
failed policies can have an impact.
8. What are the implications for other regions
if there were different levels of corporation tax within the UK?
(i) A national fiscal regime which permitted
a derogated sub-regional differential tax rate would create the
potential for what is sometimes called 'brass-plating' and the
temptation to attribute, to a lower tax sub-region, a level of
profit which may not be commensurate with the value added, or
risk borne, by the activities carried out in that sub-region.
(ii) Of legitimate concern are the risks (fiscal,
commercial and structural) to other, non-derogated regions - and
ultimately to Treasury - that organisations which are already
UK-based migrate their businesses in whole or part to the sub-region.
However, that concern arguably does not give due weight to the
primary objective of a sub-regional tax rate, which is to address
the non-fiscal features which weigh against Northern Ireland when
it is competing in the global FDI market.
(iii) Many countries which operate sub-regional
tax regimes have had to address this concern - Germany, the US,
Canada and Switzerland among them. None of them have developed
a simple solution. Indeed, many appear to have relied significantly
upon other, non fiscal, factors to limit this risk.
(iv) The creation of a lower tax rate regime
for Northern Ireland is likely to raise the same concerns for
the UK Treasury. Solutions which seek to address this will, ideally,
be straightforward to understand and implement and provide a reasonable
degree of certainty to both taxpayer and Government. However,
the experience of other countries suggests there are likely to
be difficulties in achieving this, and hence compromises to be
made. Nevertheless, amongst the possible mechanisms to address
this concern are:
- reliance upon non-fiscal factors to limit the
risk;
- amending, where necessary, current UK Transfer
Pricing legislation so that it covers sub-region to sub-region
transactions; or
- "capping" the profit which enjoys the
preferential sub-regional tax rate.
(v) Each of these possible mechanisms could
be supported by a "claw-back" regime which ensured that
companies which sought to unfairly exploit the regime would be
subject to a retrospective removal of the tax incentive. This
could be further augmented by a tax penalty regime. The overall
intention being to ensure that only the profit fairly attributable
to the activities carried on in Northern Ireland enjoys the reduced
tax rate.
(vi) Considering the second point above, the
UK treasury already has in place powerful and extensive legislation
aimed at protecting the UK tax base against unfair erosion resulting
from the pricing of UK: non-UK product and service flows. It is
possible that this legislation could be amended to address sub-region
to sub-region transactions. To simplify the additional compliance
costs associated with this there could be exclusions for UK-owned
businesses, certain industry sectors and/or small/medium-sized
enterprises. Certain aspects of the UK tax legislation already
differentiate between small/medium-sized enterprises and "large"
enterprises.
(vii) Considering the third point above, the
regime could provide for a "cap" on the level of profits
which would benefit from the preferential tax rate. In the interests
of simplicity, certainty and reducing compliance costs, this cap
could be linked to the Gross-Value-Added, or a similar measure,
by the activity carried on in Northern Ireland.
(viii) For example, the amount of profit benefitting
from the preferential tax rate could be capped by being linked
to the level the Northern Ireland-based workforce or by being
linked to the aggregate Northern Ireland-based payroll/PAYE cost.
In the further interests of simplicity, certainty and reduced
compliance costs these measures could, perhaps, be benchmarked
to industry or sector averages, where appropriate. UK tax legislation
already incorporates a tax relief (Research & Development
Tax Relief) which, whilst complex, does incorporate (in connection
with the cash tax refund aspect of the relief, available to small/medium-sized
enterprises) a linkage between the relief and the claimant company's
PAYE cost.
21 September 2010
2 PricewaterhouseCoopers LLP: 2009 Total Tax Contribution
Survey Back
3
McSharry & White (2000) The Making of the Celtic Tiger;
Back
4
Walsh (2003). Taxation and Foreign Direct Investment in Ireland. Back
5
ERINI (2006) Assessing the Case for a Differential Rate of
CT in NI; Back
6
NI Economic Reform Group (2010):The case for a reduced rate of
Corporation Tax in NI Back
7
Clemson Centre for International Trade. (2005). The Transformation
of the Irish Economy - the Role of Public Policy: Back
8
Walsh (2003). Taxation and Foreign Direct Investment in Ireland: Back
9
Institute for Fiscal Studies. (2009) Sources of Government
Revenue Back
10
While routinely challenged by the European Commission, reduced
tax rates were declared legal under the Azores Judgment of the
European Court of Justice in 2006. Regions are permitted to have
lower rates than their national level if they meet three tests:
the region must have the political and administrative authority
to introduce its own tax regime; the national government cannot
have the power to influence such a decision; and the region
must bear the full fiscal consequences of introducing its own
tax regime and, must not be compensated by the national authority
for loss of tax revenue. Back
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