How will a lower corporation tax rate benefit the Northern Irish economy? Eamonn Donaghy, head of tax at KPMG Belfast, explains that Northern Ireland, due to its disproportionately small private sector and shared border, is well-suited to reap the full advantages of a lower corporation tax rate.
What is the legal and political background to this Act?
The Northern Irish economy has struggled since the outbreak of the ‘Troubles’ in the late 1960s. Private sector investment became scarce and was gradually replace by increased public sector expenditure. While this assistance was necessary, it led to a hugely imbalanced economy that is heavily reliant on the public sector. Successive attempts to attract the private sector were based on the provision of grant assistance that appealed to cost-sensitive, low wage industries that tended to move on when grant assistance had run out. For many years, other business leaders and I attempted to persuade the UK government, Northern Ireland’s politicians and local business organisations that the power to vary corporation tax rates was an essential tool to facilitate the rebalancing of the economy. Neither the UK government nor the UK Treasury were supportive of tax devolution and, on top of this, there was the concern that the European Union could block the devolution of tax varying powers to Northern Ireland.
Portuguese Republic (supported by Kingdom of Spain and UK) v EC Commission (C-88/03) [2006] All ER (D) 21 (Sep) stated that devolution of tax varying powers to regions of member states was permissible if the region had its own legislative body. That body would have the power to set a differing rate of corporation tax and the region bore the financial consequences of varying the rate of tax.
In early 2010, an organisation of which I was a member, the Northern Ireland Economic Reform Group, produced a detailed and comprehensive economic review outlining not only the impact of a lower rate of corporation tax on the Northern Ireland economy but how it could be achieved. The UK coalition government of May 2010 together with Owen Paterson MP as the new Northern Ireland Secretary of State set up a UK Treasury consultation on the matter that resulted in a very positive response from Northern Ireland politicians and the business community. The outcome of the consultation was that both the UK Treasury and the UK government indicated that devolving the power to vary corporation tax could be given to the Northern Ireland Assembly (NIA).
After long delays to facilitate a referendum on Scottish independence in September 2014 and the signing of the Stormont House Agreement by the Northern Irish political parties in December 2014, the UK government published draft legislation that will eventually enable the NIA to set its own corporation tax rate.
What powers have been devolved to the NIA, and what is the likely timescale for the implementation of any resulting changes?
The Corporation Tax (Northern Ireland) Act became law on 26 March 2015. In essence, the legislation will devolve the power to the NIA to set the rate of corporation tax for companies that have trading operations in Northern Ireland. The Act is comprehensive, technical and, at 89 pages, not for the faint-hearted. The legislation will grant the NIA the power to set a rate of corporation tax for companies based in Northern Ireland that differs from the rest of the United Kingdom. Indeed the Act facilitates the rate being reduced to as low as 0%. However, by its very nature, corporation tax legislation is complex and the new legislation is intended to fully integrate a lower rate of corporation tax in Northern Ireland into the existing UK corporation tax regime.
While the legislation does not specifically quote a starting date, the government press release issued at the time indicates that the earliest date on which the NIA will be able to set a rate will be 1 April 2017. The legislation also contains a clause that requires a Treasury regulation to set the first financial year in which the NIA will have the ability to set a corporation tax rate. However, there are still some gateways to pass before the Treasury regulation can be implemented so that a lower rate of corporation tax can apply in Northern Ireland.
The Northern Ireland political parties must do what they agreed to do in the Stormont House Agreement, which includes passing the Welfare Reform Bill and agreeing the NIA budget. While it is possible that these stages may not happen, this would be an unexpected outcome. It is therefore likely that by 1 April 2017, companies carrying on trading activities in Northern Ireland will be able to benefit from a corporation tax rate likely to be similar to the 12.5% rate for companies based in the Republic of Ireland.
Which companies will qualify for the Northern Ireland rate?
The new rate of corporation tax will only apply companies that trade in Northern Ireland and it is particularly aimed at companies that will create employment in the north. It will exclude companies that only have rental and investment income and thus are unlikely to employ many, if any, people. If a company trading in Northern Ireland has profits or income that do not derive from the Northern Ireland trade then those profits will also remain subject to the main rate of UK corporation tax—which since 1 April 2015 is 20%. Non-trading profits and capital gains will also remain subject to the UK main rate of corporation tax. Certain trades are excluded from the regime, the main ones being the trades of lending and investment, which will deny the Northern Ireland rate to many companies in the financial services sector.
The legislation operates differently for small and medium-sized enterprises (SME), and large companies. For large companies, the legislation will apply to the profits that are attributable to the trading activities carried out in Northern Ireland. This will require the use of transfer pricing legislation and concepts that are associated with permanent establishments in international taxation.
SMEs will be either fully within the Northern Ireland rate regime or fully excluded from it. SMEs will qualify for the Northern Ireland rate if more than 75% of their staff time and staff costs arising in the UK are incurred in Northern Ireland. Therefore, Northern Ireland SMEs whose employees travel outside the UK should not be penalised for their export activities and should meet the threshold as long as the amount of time spent in Great Britain is not significant.
The definition of SME is derived from the European Commission definition and is one with less than 250 employees, a turnover of less than €50m and a balance sheet of less than €43m. However, ‘linked’ companies must be taken into account, which means that the SME status of a company in a group will be determined by the consolidated size of the group.
In your view, is the Act likely to achieve its stated aim of encouraging jobs and growth in Northern Ireland?
There have been several significant economic studies carried out by both the public and private sector that conclude that a lower rate of corporation tax in Northern Ireland would result in increased economic investment and job creation. These studies are supported by the significant ongoing success of the Irish economy, where the 12.5% rate of corporation tax has been a linchpin to the successful attraction of foreign direct investment (FDI) for the last two decades. The current reduction in the public sector purse is also creating a need to grow the private sector and a low rate of corporation tax will almost certainly increase not only the amount of FDI but will also stimulate further investment from existing FDI investors and indigenous companies.
How is the Act likely to be viewed in Scotland, Wales, or elsewhere in the EU?
The benefits of a low rate of corporation tax would probably be positive in other countries of the UK and indeed other EU countries. However, the benefit does not come without a cost. Should other countries wish to have a separate and lower rate of corporation tax then, in order to comply with the EU rules, they will have to pay for any resultant reduced tax yield. In the case of a region of a country, this could be done by means of a reduction to the central government funding they receive. In the case of a country, this could be done by a reduction in the corporation tax receipts that they generate. While the cost to the NI central government funding of reducing the rate of corporation tax is not insignificant, it is deemed ‘manageable’. However, for other countries, the cost is likely to be prohibitive. Two of the main reasons that a low rate of corporation tax is worthwhile in Northern Ireland are the existence of a land border with another EU member, the Republic of Ireland, which operates a 12.5% corporation tax rate, and because the private sector is far too small a percentage of the Northern Irish economy. Both of these reasons are somewhat individual to Northern Ireland and thus are unlikely to have the same impact in other countries. Therefore, other countries may wish to have a low rate of corporation tax but may not be willing or capable of paying for the cost of doing so.
Interviewed by Ioan Marc Jones for LexisNexis UK legal news analysis and Lexis PSL.
How will a lower corporation tax rate benefit the Northern Irish economy? Eamonn Donaghy, head of tax at KPMG Belfast, explains that Northern Ireland, due to its disproportionately small private sector and shared border, is well-suited to reap the full advantages of a lower corporation tax rate.
What is the legal and political background to this Act?
The Northern Irish economy has struggled since the outbreak of the ‘Troubles’ in the late 1960s. Private sector investment became scarce and was gradually replace by increased public sector expenditure. While this assistance was necessary, it led to a hugely imbalanced economy that is heavily reliant on the public sector. Successive attempts to attract the private sector were based on the provision of grant assistance that appealed to cost-sensitive, low wage industries that tended to move on when grant assistance had run out. For many years, other business leaders and I attempted to persuade the UK government, Northern Ireland’s politicians and local business organisations that the power to vary corporation tax rates was an essential tool to facilitate the rebalancing of the economy. Neither the UK government nor the UK Treasury were supportive of tax devolution and, on top of this, there was the concern that the European Union could block the devolution of tax varying powers to Northern Ireland.
Portuguese Republic (supported by Kingdom of Spain and UK) v EC Commission (C-88/03) [2006] All ER (D) 21 (Sep) stated that devolution of tax varying powers to regions of member states was permissible if the region had its own legislative body. That body would have the power to set a differing rate of corporation tax and the region bore the financial consequences of varying the rate of tax.
In early 2010, an organisation of which I was a member, the Northern Ireland Economic Reform Group, produced a detailed and comprehensive economic review outlining not only the impact of a lower rate of corporation tax on the Northern Ireland economy but how it could be achieved. The UK coalition government of May 2010 together with Owen Paterson MP as the new Northern Ireland Secretary of State set up a UK Treasury consultation on the matter that resulted in a very positive response from Northern Ireland politicians and the business community. The outcome of the consultation was that both the UK Treasury and the UK government indicated that devolving the power to vary corporation tax could be given to the Northern Ireland Assembly (NIA).
After long delays to facilitate a referendum on Scottish independence in September 2014 and the signing of the Stormont House Agreement by the Northern Irish political parties in December 2014, the UK government published draft legislation that will eventually enable the NIA to set its own corporation tax rate.
What powers have been devolved to the NIA, and what is the likely timescale for the implementation of any resulting changes?
The Corporation Tax (Northern Ireland) Act became law on 26 March 2015. In essence, the legislation will devolve the power to the NIA to set the rate of corporation tax for companies that have trading operations in Northern Ireland. The Act is comprehensive, technical and, at 89 pages, not for the faint-hearted. The legislation will grant the NIA the power to set a rate of corporation tax for companies based in Northern Ireland that differs from the rest of the United Kingdom. Indeed the Act facilitates the rate being reduced to as low as 0%. However, by its very nature, corporation tax legislation is complex and the new legislation is intended to fully integrate a lower rate of corporation tax in Northern Ireland into the existing UK corporation tax regime.
While the legislation does not specifically quote a starting date, the government press release issued at the time indicates that the earliest date on which the NIA will be able to set a rate will be 1 April 2017. The legislation also contains a clause that requires a Treasury regulation to set the first financial year in which the NIA will have the ability to set a corporation tax rate. However, there are still some gateways to pass before the Treasury regulation can be implemented so that a lower rate of corporation tax can apply in Northern Ireland.
The Northern Ireland political parties must do what they agreed to do in the Stormont House Agreement, which includes passing the Welfare Reform Bill and agreeing the NIA budget. While it is possible that these stages may not happen, this would be an unexpected outcome. It is therefore likely that by 1 April 2017, companies carrying on trading activities in Northern Ireland will be able to benefit from a corporation tax rate likely to be similar to the 12.5% rate for companies based in the Republic of Ireland.
Which companies will qualify for the Northern Ireland rate?
The new rate of corporation tax will only apply companies that trade in Northern Ireland and it is particularly aimed at companies that will create employment in the north. It will exclude companies that only have rental and investment income and thus are unlikely to employ many, if any, people. If a company trading in Northern Ireland has profits or income that do not derive from the Northern Ireland trade then those profits will also remain subject to the main rate of UK corporation tax—which since 1 April 2015 is 20%. Non-trading profits and capital gains will also remain subject to the UK main rate of corporation tax. Certain trades are excluded from the regime, the main ones being the trades of lending and investment, which will deny the Northern Ireland rate to many companies in the financial services sector.
The legislation operates differently for small and medium-sized enterprises (SME), and large companies. For large companies, the legislation will apply to the profits that are attributable to the trading activities carried out in Northern Ireland. This will require the use of transfer pricing legislation and concepts that are associated with permanent establishments in international taxation.
SMEs will be either fully within the Northern Ireland rate regime or fully excluded from it. SMEs will qualify for the Northern Ireland rate if more than 75% of their staff time and staff costs arising in the UK are incurred in Northern Ireland. Therefore, Northern Ireland SMEs whose employees travel outside the UK should not be penalised for their export activities and should meet the threshold as long as the amount of time spent in Great Britain is not significant.
The definition of SME is derived from the European Commission definition and is one with less than 250 employees, a turnover of less than €50m and a balance sheet of less than €43m. However, ‘linked’ companies must be taken into account, which means that the SME status of a company in a group will be determined by the consolidated size of the group.
In your view, is the Act likely to achieve its stated aim of encouraging jobs and growth in Northern Ireland?
There have been several significant economic studies carried out by both the public and private sector that conclude that a lower rate of corporation tax in Northern Ireland would result in increased economic investment and job creation. These studies are supported by the significant ongoing success of the Irish economy, where the 12.5% rate of corporation tax has been a linchpin to the successful attraction of foreign direct investment (FDI) for the last two decades. The current reduction in the public sector purse is also creating a need to grow the private sector and a low rate of corporation tax will almost certainly increase not only the amount of FDI but will also stimulate further investment from existing FDI investors and indigenous companies.
How is the Act likely to be viewed in Scotland, Wales, or elsewhere in the EU?
The benefits of a low rate of corporation tax would probably be positive in other countries of the UK and indeed other EU countries. However, the benefit does not come without a cost. Should other countries wish to have a separate and lower rate of corporation tax then, in order to comply with the EU rules, they will have to pay for any resultant reduced tax yield. In the case of a region of a country, this could be done by means of a reduction to the central government funding they receive. In the case of a country, this could be done by a reduction in the corporation tax receipts that they generate. While the cost to the NI central government funding of reducing the rate of corporation tax is not insignificant, it is deemed ‘manageable’. However, for other countries, the cost is likely to be prohibitive. Two of the main reasons that a low rate of corporation tax is worthwhile in Northern Ireland are the existence of a land border with another EU member, the Republic of Ireland, which operates a 12.5% corporation tax rate, and because the private sector is far too small a percentage of the Northern Irish economy. Both of these reasons are somewhat individual to Northern Ireland and thus are unlikely to have the same impact in other countries. Therefore, other countries may wish to have a low rate of corporation tax but may not be willing or capable of paying for the cost of doing so.
Interviewed by Ioan Marc Jones for LexisNexis UK legal news analysis and Lexis PSL.
