Monday 26 September 2016

Northern Ireland's 12.5pc corporate tax rate will pose threat to foreign direct investment in the South

The North will have its own 12.5pc corporate tax rate from 2018. This means that it will compete harder against the Republic for FDI projects, writes Dan White

Published 22/11/2015 | 02:30

Martin McGuinness and Peter Robinson at last week’s announcement of their ‘Fresh Start’ agreement, which will change northern tax rates. Photo: Colm Lenaghan
Martin McGuinness and Peter Robinson at last week’s announcement of their ‘Fresh Start’ agreement, which will change northern tax rates. Photo: Colm Lenaghan

The 12.5pc company tax rate will no longer be confined to the southern part of the island. Last week's 'Fresh Start' agreement between the DUP and Sinn Fein means that, subject to certain conditions, Northern Ireland will also have its own low company tax rate from April 2018 - less than two-and-a-half years from now.

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The success of the IDA in attracting foreign direct investment to the Republic has long drawn covetous glances from north of the Border. The figures are incontestable: some 174,000 people are employed directly by IDA-supported companies, with a further 122,000 jobs being indirectly dependent.

For many years, there has been a strong body of opinion arguing that Northern Ireland should follow the Republic's example and cut its corporate tax rate in order to attract FDI.

This was strongly opposed by Gordon Brown, who was UK Chancellor of the Exchequer between 1997 and 2007 and then Prime Minister until 2010. Mr Brown's implacable opposition represented an insurmountable barrier to a separate corporate tax rate for Northern Ireland.

Westminster's opposition to a separate Northern Ireland corporate tax rate thawed following the Conservative victory in the May 2010 UK general election. Both David Cameron and his Chancellor George Osborne made it clear that the North could have its own corporate tax rate if it was prepared to accept a reduction in the annual block grant (stg£11.4bn, or €16.25bn, for the year to April 2016), which is paid by the UK Treasury to the Northern Ireland Executive.

The reduction in the block grant resulting from a separate Northern Ireland corporate tax rate has been estimated at stg£300m.

So what will a lower corporate tax rate do for the Northern Ireland economy - and what will be the implications for us in the Republic?

Will a low-tax Northern Ireland see the IDA lose out as FDI projects head north of the Border instead?

One day, perhaps - but not just yet.

For a start, the Northern Ireland Executive will have to clear a number of hurdles before Westminster devolves corporate tax-raising powers to Stormont.

Not alone will it have to meet the full cost of the devolution of corporation tax, the Executive has also committed itself to demonstrating that its finances are on a sustainable footing through implementing the terms of the 2014 Stormont House Agreement, plus the terms of last week's deal, as well as any future reform measures.

"It's still conditional. The key thing is what happens to the budget over the next three years," says Dr Esmond Birnie, chief economist with PwC in Northern Ireland.

Even allowing for this necessary caveat, supporters of the devolution of corporate tax are optimistic about its impact on the Northern Ireland economy.

Professor Neil Gibson, director of the Ulster University Economic Policy Centre and senior economic adviser to EY Ireland, reckons that a 12.5pc Northern Ireland corporate tax rate has the potential to create an additional 30,000-35,000 jobs by 2033.

But will those be jobs that would otherwise have gone to the Republic?

Will Northern Ireland's gain be our loss?

Sometimes, but not always would seem to be the answer.

"Anything that provides a boost anywhere on the island is positive. There will be the potential for overseas investors to straddle the euro/sterling divide. A lower corporate tax rate allows Northern Ireland to compete for investment that it could not have done previously," says Professor Gibson.

The economic recovery in the Republic has had some potentially negative side-effects.

"Dublin is getting very expensive again," says Professor Gibson, who feels this will certainly give Northern Ireland the edge when competing for some FDI projects.

"We already have certain advantages - lower wages, lower personal taxes, lower costs. This adds another advantage," he says.

One of the reasons that George Osborne was prepared to concede a lower tax rate to Northern Ireland is that he has been busy cutting corporate taxes in the rest of the UK.

In his first term as Chancellor, he slashed the UK's corporate tax rate from 28pc to 20pc. And after the Conservatives' general election victory last May, he announced plans to cut it even further to just 18pc - within spitting distance of our and Northern Ireland's 12.5pc rate. The only compensation of lower UK-wide corporation tax rates is that Northern Ireland will see less of a reduction in the block grant.

The narrowing gap between corporate tax rates on both sides of the Border and those in the rest of the UK means that a lower tax rate is less of an advantage when seeking to attract FDI than it once was. And the advantage conferred by lower corporate tax is almost certainly going to be further eroded.

Last month's BEPS (Base Erosion and Profit Shifting) proposals from the OECD will force multinationals to report their profits on a country-by-country basis. This will make it much easier for national tax authorities to see which companies are gaming the system.

At the same time, public and political opinion is moving strongly against tax avoidance by multinationals. In May 2013, Apple's tax affairs in Ireland were probed by the US Senate while Mr Osborne introduced a special punitive 'Google Tax' in his March 2015 budget, aiming at transnational companies adjudged to have been diverting taxable profits from the UK.

Further cramping Northern Ireland's style is the fact that, unlike Scotland (which plans to establish its own tax-collecting agency), Her Majesty's Revenue & Customs will continue to collect Northern Ireland's taxes - including the 12.5pc rate corporate tax. And HMRC will watch the new arrangements like a hawk in order to prevent, or at least minimise, the incidence of companies and individuals from the rest of the UK relocating to Northern Ireland for tax purposes.

"Brassplating is a very real concern on the part of HMRC. They do not want to create a nominal tax presence in Northern Ireland", says Dr Birnie.

It is with this danger in mind that last week's agreement includes provision for the monitoring of the new system after 2018 by HMRC for "behavioural changes" - in other words, tax-motivated relocations by companies or individuals.

If HMRC doesn't like the way things are going, it can recommend a reduction in the block grant - which the Stormont Executive relies upon to fund over 90pc of Northern Ireland's public spending. This means that HMRC retains a very powerful stick with which to beat the Executive.

This combination - of lower corporate tax rates worldwide, increased scrutiny of the tax affairs of transnational companies and the likelihood that HMRC will be keeping a close eye on the new system after 2018 - means that Northern Ireland's new 12.5pc corporate tax rate is unlikely to be the cure for all of Northern Ireland's economic woes, at least not in the short term.

"Is it a game-changer by itself? Almost certainly not. Northern Ireland will have to put in place other measures. The Republic has a long lead, going back to the 1950s. We are not going to jump to Republic of Ireland levels of performance in three or four years. It is not just the nominal tax rate but the effective rate that counts," says Dr Birnie.

Over the past half-century, the Republic has used its low corporate tax system not just to attract FDI but also to develop an "ecosystem" of skilled staff, development bodies, air routes, tax treaties, links to higher education and so on. While Northern Ireland can imitate the Republic's 12.5pc rate immediately, putting these other elements in place takes much, much longer.

Professor Gibson believes Northern Ireland may end up using its 12.5pc tax rate to develop expertise in other sectors, rather than competing head-on with the Republic.

He hopes that the 12.5pc tax rate can help Belfast address what he reckons is its biggest economic disadvantage - the weakness of the private sector versus the public.

With Chancellor Osborne continuing to impose austerity in the UK, Northern Ireland's public sector is shedding jobs - with up to 8,000 posts expected to go over the next four years. Professor Gibson expects these losses to be more than offset by the creation of up to 21,000 private sector jobs in the same period.

A separate corporate tax rate and the country-by-country reporting being demanded by the OECD will almost certainly lead to greater tax transparency for Northern Ireland,

This could prove to be something of a double-edged sword. If Northern Ireland were a stand-alone entity, it would have a fiscal deficit of close to 30pc of GDP. That didn't matter while the rest of the UK was prepared to pick up the tab. But it will now.

With Mr Osborne determined to reduce the UK-wide deficit, Northern Ireland's continuing reliance on the block grant to balance its books is certain to come under scrutiny.

The probability that most tax-raising powers will be devolved to Scotland during this parliament will pile further pressure on the Executive to pay more of its own way.

All of which means that we in the Republic could find ourselves competing hard with our northern neighbours for FDI projects, and sooner rather than later.

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