Reducing Corporation Tax - A Price Worth Paying
Reducing the rate of Corporation Tax in Northern Ireland will attract Foreign Investment. The EU rules require that the initial cost of reducing Corporation Tax must be paid by the NI Assembly. However this is not a sunk cost it is an investment in our economic future.
The Treasury consultation process on rebalancing the Northern Ireland economy finally closed on 8 July 2011. It is very impressive that over 700 responses were received by HM Treasury to the consultation paper. It is clear that this issue has created a very significant amount of interest within the Northern Ireland business community and indeed the wider community. The level of response was in no small part due to the efforts of the Grow NI group.
Recent economic studies by the Northern Ireland Economic Reform Group and the Economic Advisory Group have clearly stated that the long term benefit of reducing corporation tax will be the creation of tens of thousands of jobs over the next two decades. This is obviously a benefit worth trying to obtain. However, as it is much easier to quantify the potential costs to the block in monetary terms, there has been a significant amount of focus on what this cost may be.
Should the Northern Ireland Executive receive the power to vary the rate of corporation tax, and then exercise that power to reduce the corporation tax rate to say 12.5%, there is a requirement under EU legislation for the Northern Ireland Executive to effectively pay for this by means of a reduction in the block .
When the Treasury produced their consultation document, they attempted to estimate what the costs to the Northern Ireland block may be. However, it is worth emphasising that the numbers prepared by Treasury were only estimates and in fact in certain cases might be better described as guestimates. Nevertheless, it is worth outlining what these costs might be.
The headline cost is, in simple terms, the amount of corporation tax that companies based in Northern Ireland would save if the corporate tax rate was reduced to 12.5%.
However, this is not the only figure which should be considered. There are also additional costs that may arise as a result of businesses being transferred out of personal ownership into company ownership and converting income tax payments for lower corporation tax payments. This is called tax motivated incorporation. There is also the impact of companies artificially pushing profits into Northern Ireland as a result of the lower corporation rate. If these profits come from the rest of the United Kingdom, then there would be an overall tax loss but if these profits come from countries outside the United Kingdom, then there is an overall tax gain.
On the upside however, as lower corporation tax will result in increased economic activity, there will be more people in employment and these individuals will pay more PAYE and national insurance. This additional tax revenue should be capable of being set against the corporation tax losses. The same can be said about any additional VAT that will arise as a result of enhanced spending due to there being more people in employment. Also a very significant saving can be made if the reduced rate of tax only applies to trading profits, thus leaving investment profits subject to the full rate of corporation tax.
When all of the figures contained in the Treasury consultation document are taken together, the picture can become a little clearer. Table A shows that the net impact could be as low as £145m.
There has been speculation that the Treasury may have understated the costs of reducing corporation tax by £100m, due to the tax saving that Northern Ireland branches of companies based in Great Britain would obtain as a result of operating in a lower corporation tax area. However, no figures have been provided to support this.
SO WHERE DOES THIS LEAVE US?
Firstly, as already stated, all of the figures provided by Treasury are estimates and therefore before a final decision on costs is taken, it will be necessary for the actual corporation tax costs to be obtained by the Treasury and this will require additional more detailed analysis from them.
Secondly, whilst a net cost of £145m (or indeed £245m) is a very significant figure, it needs to be considered in the context of the Northern Ireland public expenditure budget. The current amount of the public expenditure budget over which the NI Executive has discretion, (excluding capital expenditure and social security costs) amounts to approximately £10.5 Billion per annum. If the net cost of corporation tax reduction was £145million, then this would account for 1.4% of the annual public expenditure budget that the NI Executive can control. In big picture terms, this is not a material amount as can be seen in Diagram 1.
Whilst a reduction in the block is not something to be welcomed, as it could lead to a reduction in public expenditure, it should be understood that it does not necessarily mean a reduction in front line public services. Indeed, the Confederation of British Industry last year indicated that Northern Ireland could reduce its public sector expenditure by up to £2bn without the need for front line services to be affected.
The possibility of getting something for nothing would be very attractive, but a reduction in the rate of corporation tax in Northern Ireland cannot be one of them. It is a requirement of EU legislation that Northern Ireland must effectively pay for its reduction in corporation tax. However, the upfront cost of reducing corporation tax is anticipated to pay for itself many times over during the next couple of decades. In effect the upfront initial costs should be seen as an investment into Northern Ireland’s future rather than as an irrecoverable cost. Indeed, even the upfront costs should be seen as a small proportion of the overall subvention that Northern Ireland receives from the UK Treasury, and funding these costs should not cause material hardship to the running of Northern Ireland.
If you want to get something worthwhile, then it is worth paying for. The prize of introducing reduced corporation tax is very significant, and the comparatively modest cost of (or should I say investment in) achieving this is a price well worth paying.
Head of Tax, KPMG Belfast