This article first appeared in Irish Tax Review, Vol. 28 No. 1.and is reproduced with their kind permission.
Most countries tend to be associated with certain key things. In the Netherlands, it’s windmills and tulips; in Switzerland, it’s cuckoo clocks, chocolate and penknives; and in France, it’s red wine and cheese. One could argue that Ireland’s list would contain shamrocks, Guinness and a favourable rate of corporation tax!
The rate of corporation tax in Ireland has been 12.5% for just over a decade; however, given its huge significance in the world of foreign direct investment, it seems as if this rate has been in place for much longer than that. Indeed, to many who live outside Ireland, the 12.5% corporation tax rate is synonymous with the economic prosperity that arose in the period leading up to 2008 and that, after the hiatus of the last seven years, is now starting to reappear. This is borne out by the absolute support given to the 12.5% rate by successive Governments in Ireland and most notably by the current Executive.
Ireland is a bi-jurisdictional island, however; and for those living in “the North”, a low rate of corporation tax was not feasible. Northern Ireland, as part of the United Kingdom, is subject to the UK corporation tax rates. Until recently, these rates were 28% for large companies and 21% for small and medium-sized enterprises (SMEs), and although the rates for all companies will shortly fall to 20%, there is still a significant premium to the corporation tax rates for companies based in Northern Ireland.
Since the outbreak of the Troubles in the late 1960s, the Northern Ireland economy has struggled. The fall in private sector investment was taken up by public sector expenditure. This was financed not only by the British Government but also by the European Union and North America. Although this assistance was very necessary and greatly welcomed, it has led to a hugely imbalanced economy that is far too reliant on the public sector. Successive attempts at trying to attract the private sector have focused on the provision of grant assistance, which at best has provided respite but has tended to attract cost-sensitive, low-wage industries, which have often moved to pastures new when grant assistance has run out. It was clear that a new tactic was needed.
For over two decades, the author, together with other individuals and organisations, attempted to persuade the UK Government, Northern Ireland politicians and local business leaders that the power to vary corporation tax rates in Northern Ireland was an essential tool to facilitate the rebalancing of the economy. These calls were consistently met with denials and a long list of reasons why this could not be achieved. The UK Government was not supportive of tax devolution; the UK Treasury did not wish to delegate any of its tax-raising powers; Northern Ireland politicians were more focused on the peace process; and local businesses wished to maintain the grant-based status quo. On top of this, there was the ever-lingering concern that the European Union may block the devolution of tax-varying powers to Northern Ireland.
The decision nearly a decade ago by the ECJ in the Azores case1 sparked some hope in the campaign for corporation tax devolution. The ECJ indicated that devolution was permissible if the devolved region had its own legislative body, that body had the power to set a differing rate of corporation tax and the region bore the financial consequences of varying the rate of tax. The existence of the Northern Ireland Assembly meant that the first of these three requirements was met. It was therefore imperative to try to fulfil the second and third requirements.
After several false starts, the arrival of the UK coalition Government in May 2010, together with the appointment of Owen Paterson MP as the new Northern Ireland Secretary of State, injected impetus into the campaign. The Northern Ireland Economic Reform Group (of which the author was a member) produced a detailed and comprehensive economic review2 outlining not only the impact of a lower rate of corporation tax but also how it could be achieved. This report led to a UK Treasury consultation on the matter, which took place in 2011 and resulted in a very positive response from politicians and the Northern Ireland business community.
The outcome of the consultation was that both the Treasury and the UK Government indicated that corporation tax-varying powers could be devolved to the Northern Ireland Assembly as long as the cost of reducing the corporation tax rate was paid for by the Assembly out of a reduction in the financial assistance given to the Assembly by the Treasury in the form of the “block grant”. There was then a period of further consultation and debate.
The whole issue was put on hold during the lead up to the Scottish Independence vote, and a final decision was delayed until after the outcome of that vote. There was then a further delay to facilitate the Northern Ireland political parties reaching agreement on various economic matters germane to Northern Ireland. Then, after a long delay, on 8 January 2015 the UK Government published legislation that will eventually enable the Northern Ireland Assembly to set its own corporation tax rate.
Although there are still several requirements to be fulfilled before the Assembly can set its own rate (see below), the publication of the legislation is an enormous step toward Northern Ireland having a lower rate of corporation tax.
The Bill is both comprehensive and technical and, at 87 pages, not for the faint-hearted. However, by its very nature, corporation tax legislation is complex and involved, and the new legislation is intended to integrate fully a lower rate of corporation tax in Northern Ireland into the existing UK corporation tax regime. For that reason alone, it is clear that HM Treasury fully expects the rate-setting powers to be devolved to the Assembly in the foreseeable future.
The legislation will grant the power to the Northern Ireland Assembly to set a rate of corporation tax for companies based in Northern Ireland that is different from the rest of the United Kingdom. Indeed, the Bill facilitates the rate being reduced to as low as nil!
Although the Bill does not specifically quote a starting date, the press releases issued at the time indicate that the legislation will become effective only from 1 April 2017.
The new rate of corporation tax will apply only to the trading profits of companies that carry on a trade in Northern Ireland and is clearly aimed at companies that will create employment in the North. It will exclude companies that have only rental or 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, those profits will remain subject to the main rate of UK corporation tax (which will be 20% from 1 April 2015). Non-trading profits and capital gains will remain subject to the UK main rate of corporation tax.
The profits of certain trades are excluded from the regime, including trades involved in oil activities and the trades of lending and investment. The excluded lending activities include lending of money, finance leasing, issuing and administering means of payment, provision of guarantees, money transmission services, provision of alternative finance arrangements and other activities carried out in connection with such activities.
The investment exclusions are relevant to regulated activities within the Financial Services and Markets Act 2000 and include accepting deposits, dealing in investments (as principal or agent), arranging deals in investments, safeguarding and administering investments, and entering into regulated mortgage contracts. Back-office activities of these trades are carved out of the exclusion, but the attributable profits to such activities are restricted to a 5% mark-up on cost.
The legislation operates differently for SMEs and large companies (companies that are not SMEs). For large companies, the legislation will apply to the profits that are attributable to the activities that the companies carry out in Northern Ireland. This will require the use of transfer pricing legislation and concepts that are associated with permanent establishments in international taxation. Although this will require analysis and judgement, most large organisations will be well capable of carrying out the necessary breakdown of their trading activities.
For SMEs, the legislation is structured so that the company will either be fully within the Northern Ireland rate regime or fully excluded from it. The determining factor is that SMEs will qualify if more than 75% of their staff time and staff costs arising in the UK are incurred in Northern Ireland.
Therefore, Northern Ireland companies whose employees travel outside the United Kingdom 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 it is basically one with less than 250 employees and a turnover of less than €50m or a balance sheet of less than €43m. However, “linked” (connected) 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.
A considerable amount of the new legislation is devoted to how the existing loss relief rules and other tax reliefs available to UK companies will apply to Northern Ireland-based companies that qualify for the Northern Ireland rate. Such companies will continue to qualify for loss relief and the various other allowances and reliefs, but with the applicable rates of relief modified to reflect the difference between the Northern Ireland rate and the main UK rate.
In most cases the adjustment to the amount of relief has been set so as to give the same cash value of the relief that the company would have received if it did not qualify for the Northern Ireland rate. Therefore companies that qualify for research and development relief should not lose out if the Northern Ireland Assembly sets a rate that is lower than the main UK rate. Northern Ireland companies will still also qualify for the “patent box” regime and all of the film, TV, video game and theatrical reliefs that are currently available to UK companies.
As noted above, there are still some gateways to pass before a lower rate of corporation tax can apply in Northern Ireland. In summary these are:
Although it is possible that one or more of these stages may not happen, this would be unexpected.
It is therefore entirely possible that, by 1 April 2017, companies based in Northern Ireland carrying on trading activities will be able to avail of a corporation tax rate that is similar to the 12.5% rate currently enjoyed by companies based in the Republic of Ireland. The impact that this will have on local companies and on the prospect of attracting more foreign direct investment is enormous: 8 January 2015 should go down as a memorable date for the Northern Ireland economy.