Devolution of corporation tax
By Donald Drysdale for ICAS
9 January 2020
Donald Drysdale studies a recommendation that corporation tax be devolved to Scotland, but finds it unattractive. The views expressed are his own and not necessarily those of ICAS.
Northern Ireland
The Republic of Ireland has long had an aggressively low corporation tax rate, successfully attracting inward investment – in spite of attempts by the European Commission to counter use of the Republic for tax avoidance activities by multinationals.
North of the Irish border, Westminster’s Corporation Tax (Northern Ireland) Act 2015 allows for devolution of power to the Northern Ireland Assembly to set a Northern Ireland rate of corporation tax, allowing fairer tax competition between Northern Ireland and the Republic.
The Westminster government will bring the Act into effect, devolving the rate-setting power, once the Northern Ireland Executive demonstrates that its finances are on a sustainable footing. This has been delayed by the power-sharing crisis at Stormont since 2017.
Originally the Executive had committed that from April 2018 it would set a tax rate of 12.5%. Significantly, this equated with the rate in the Republic and might therefore have prevented businesses from being drawn away from the UK by a temptingly lower rate in the south.
Once implemented, the Northern Ireland rate will apply to certain Northern Ireland trading income, creating fresh tax competition within the UK. The Northern Ireland block grant will be adjusted to reflect the fiscal costs of a reduction in the rate of corporation tax.
Northern Ireland corporation tax will remain part of the UK corporation tax regime, administered by HMRC under a Memorandum of Understanding with the Northern Ireland Department of Finance and Personnel.
HMRC’s draft guidance, last updated in January 2018, explains the key concepts and the main rules and procedures that will apply for the purposes of Northern Ireland corporation tax.
Scotland
In December 2019, independent think tank Reform Scotland published a new report entitled ‘Growing Up: A Corporation Tax For Scotland’, calling for the devolution of corporation tax to Scotland to enable the creation of a more attractive business environment.
It recommends that the Scottish Government should design a corporation tax policy that attracts more entrepreneurs to Scotland, incentivises the creation and development of new businesses and, ultimately, produces more top-rate taxpayers – all commendable aspirations.
The report even suggests offering a zero-rate of corporation tax for new businesses setting up in Scotland, including for a set period after they begin to earn profits – noting that they would contribute in other ways to public revenue, particularly through employment.
It claims (naively, in my view) that such a zero-rate policy would have no cost because it would apply only to newly-created enterprises. This ignores predictable, manipulative behaviour by the re-structuring of pre-existing businesses, phoenix companies etc.
The impact of devolution
In 2019 another independent think tank, the Institute for Government (IfG), updated its summary of tax devolution measures announced from 2012 to 2017.
If and when all these are implemented, the devolved administrations and local government will control (or have a direct interest in) 43% of tax revenues collected in Scotland (including assigned VAT), 21% in Wales, 14% in Northern Ireland and 9% in England (including council tax and business rates).
IfG concluded that devolving corporation tax could create unwelcome tax competition between different parts of the UK – noting that Northern Ireland was a reasonable exception, specifically to allow more effective competition with the Republic of Ireland.
Figures quoted by Reform Scotland are prepared on a different basis to those from IfG, and according to them Holyrood’s current fiscal powers allow it to control only 37% of what it spends. They say that devolving on-shore corporation tax would increase this to 46%.
Complications of devolution
For companies and their tax advisers, the Corporation Tax (Northern Ireland) Act 2015 provides an indication of the sort of complexities we can expect – multiplied if further devolution of corporation tax follows, e.g. to Scotland and Wales.
The Northern Ireland Assembly will have the power to set the Northern Ireland rate. This rate, in general, will apply to all the trading profits of a company that is a micro, small or medium-sized enterprise (SME) if its employee time and costs fall largely in Northern Ireland.
The rate will apply to a corporate partner’s share of the profits of a partnership trade if that company and partnership are both SMEs and the partnership’s employee time and costs fall largely in Northern Ireland.
The rate will also apply to the profits of a large company, and (in the case of corporate partners not covered by the SME rules) to a corporate partner’s share of the profits of a partnership. In these cases it will apply to profits attributable to a Northern Ireland trading presence – termed a ‘Northern Ireland regional establishment’ (NIRE). The trading profits attributable to the NIRE will be computed using internationally recognised principles with some modifications and adaptations.
In an accounting period in which a large company or partnership is within the regime – and therefore referred to as a ‘Northern Ireland company’ or ‘Northern Ireland firm’ – its trading profit or loss will be split between ‘Northern Ireland profits or losses’ (taxed or relieved at the Northern Ireland rate) and ‘mainstream profits or losses’ (taxed or relieved at the main UK rate).
Special rules will apply where a company or partnership making profits overall (or, alternatively, making losses overall) makes a Northern Ireland loss (in conjunction with a mainstream profit) or a mainstream loss (in conjunction with a Northern Ireland profit). HMRC’s draft guidance also explains concepts necessary to understand how the legislation works – in particular ‘qualifying trades’, ‘excluded trades’, ‘excluded activities’ and ‘back-office activities’.
The guidance describes how rules governing intangible fixed assets will apply to protect against tax avoidance arising from the shifting of income streams and/or manipulation of disposals of assets.
The guidance also explains how rules governing capital allowances and balancing charges will be adapted in calculating Northern Ireland profits and losses. It also sets out the application of research and development (R&D) relief and expenditure credits to expenditure incurred for the ‘Northern Ireland trade’ of a Northern Ireland company.
Separate sections in the guidance relate to remediation of contaminated or derelict land, the application of the various ‘creative reliefs’, and the patent box rules – all in relation to a Northern Ireland company. A final section explains how the rules will be adapted to deal with partnerships at least one of whose members is a company.
Conclusion
As Scotland has discovered, fiscal devolution can bring confusion and conflict and comes at an administrative cost. Businesses operating across different parts of the UK will need to take this into account.
Uncertainties caused by Brexit have been of particular concern to businesses, and many of those uncertainties will remain throughout 2020 and perhaps beyond. The possibility of another independence referendum creates further uncertainty for businesses operating in Scotland.
While the political and economic landscape remains so unclear, it is hard to see how devolving corporation tax powers to Holyrood would help to provide greater stability and certainty.
Article supplied by Taxing Words Ltd
