Tax transfer: the final steps

PEYE 100311KB2 0019 The goal of devolving corporation tax is in sight, Michael Smyth writes.

It is highly likely that soon after the results of the Scottish referendum are known, the UK Government will begin a process to devolve corporation tax-varying powers from London to Belfast. This process involves the amendment of the 1998 Northern Ireland Act and it is therefore likely that from 1 April 2015 Northern Ireland will be able to set its own rate of corporation tax.

At present, on the island of Ireland, there are two fiscal jurisdictions and in the Republic of Ireland standard rate of corporation tax is 12.5 per cent whereas in Northern Ireland the standard rate of corporation tax is 21 per cent. Once tax-varying powers have been devolved, the Northern Ireland Executive will set the Northern Ireland rate to match the Republic’s rate.

The power to do this is provided by a European Court of Justice (ECJ) judgement in respect of the Azores. The ECJ in September 2006 dismissed the appeal lodged by Portugal against the Commission’s decision. In its decision, the ECJ rejected the Commission’s interpretation of selectivity when measures apply to an established region within a member state and thus allowing the possibility that the “reference framework” might not be only the territory of the member state.

The ECJ decision clarified the issue of whether a reduction in tax rates for a region of a member state constitutes state aid and it also set out three criteria for establishing whether a “tax-autonomous” regional institution is sufficiently independent politically and fiscally from the central government for state aid purposes.

The ECJ stated that a decision by a regional government to reduce tax rates must fulfil the following requirements. It must be taken by a regional authority that has a political and administrative status separate from the central government (i.e. autonomy in the constitutional sense). It must be taken without the central government being able to directly intervene regarding its substance (i.e. procedural autonomy). And the fiscal consequences of a reduction of the national corporate tax rate in the region must not be offset by aid or subsidies from other regions or central government (i.e. economic autonomy).

At present Northern Ireland satisfies the first condition. London must devolve the tax-varying power in order to satisfy the second condition. The third condition, namely the cost, will be the subject of a negotiation between the First and deputy First Ministers, the Prime Minister and the Chancellor of the Exchequer at the meeting to be held in late September 2014.

It is expected to cost Northern Ireland around £180 million per annum to cut its rate of corporation tax from 21 per cent to 12.5 per cent. This will not be easy when the Northern Ireland block is under intense pressure from both the spending squeeze and rising demand for services such as health.

For existing corporation tax-payers, the policy change will be a significant financial windfall and discussions are ongoing with representatives of the business community to ensure that a significant proportion of this windfall is re-invested.

The real strategic significance of the tax devolution is that it will almost certainly lead to an increase in both the quantity and quality of foreign investment in Northern Ireland at a time when the peace process has lost some momentum. The ability to generate hundreds or thousands of additional high value-added jobs should be seen as a necessary condition for changing Northern Ireland for the better.

The European Commission normally objects to such regional tax variation on the basis of state aid. However, in Northern Ireland’s case, the Commission is broadly sympathetic as it views the harmonisation of corporation tax on the island of Ireland as ending a single market distortion. While the Commission must be consulted on the application, it seems unlikely that it will stand in the way.

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