Following the devolution of corporation tax in Northern Ireland, there is talk that other UK regions could follow suit, but will the complexities outweigh the advantages?
Studying this technical article and answering the related questions can count towards your verifiable CPD if you are following the unit route to CPD and the content is relevant to your learning and development needs. One hour of learning equates to one unit of CPD. We'd suggest that you use this as a guide when allocating yourself CPD units.
This article was first published in the July/August 2017 UK edition of Accounting and Business magazine.
On paper, the idea of devolving corporation tax rate-setting to the UK’s regions looks attractive. This is particularly so in the context of the previous government’s industrial strategy green paper, published earlier this year, which has as one of its aims a desire to rebalance the UK’s economy geographically as well as by sector.
The UK’s imminent departure from the European Union (EU) could also give such a move more impetus. As KPMG tax partner Tim Sarson said recently: ‘Addressing regional imbalances is vital to improving the UK’s prospects outside the EU.’ Sarson’s argument is that devolving corporate tax to the regions would better spread investment around the UK. ‘Tax devolution can be one of the pillars of an industrial strategy that takes account of places as well as sectors,’ he argued. ‘It’s an opportunity the government should grasp with both hands.’
There is of course a precedent for this with Northern Ireland and, says Sarson, there is also evidence of tax devolution making a real impact on the spread of investment in many countries including Switzerland, Germany and the US.
However, if the government were to grasp the opportunity, it might well find that the devil lies in the detail.
‘As a headline issue, it is terribly easy, but as soon as you go behind this headline it becomes phenomenally complicated,’ says RSM’s senior tax partner George Bull. ‘It is not as simple as it looks, and short-term political responses can have longer term unforeseen consequences.’
Looking specifically at the Northern Ireland position, where the province is primed to take over corporation tax rate setting powers in 2018, Bull observes that there were clear economic reasons for introducing the change, as there was strong competition from south of the border; the tax rate in the Republic of Ireland is currently 12.5%. However, Bull also notes that the direction of travel for the main corporation tax rate in the UK has been downwards and wonders whether this might dilute the impact of the devolved move.
The Northern Irish devolved tax is due to be introduced in April 2018. However, it is possible that this date could be pushed back due to the political impasse in Stormont. Negotiations to build a new executive were put on hold until after June’s general election.
But political difficulties are not the only concerns over the efficacy of a more widely devolved corporation tax regime. Transfer-pricing rules can be difficult at the best of times, but could prove even more so under a national, rather than international, devolved taxation regime.
Were, for instance, corporation tax to be devolved to the UK regions, might it not be possible to base a loss-making part of a business group in a high-tax area, while any profitable business is located in a low-tax region, with the ensuing temptation to divert other profits to this region as well? Of course, some might argue that if it is possible to operate a transfer-pricing system across national borders, it shouldn’t be beyond the wit of HMRC to operate something similar between regions in the UK.
But others counter this with the additional layer of complexity that would be introduced.
‘My view is that the added complexity would not be cost-effective,’ says David Brookes, tax partner at BDO. ‘You can see this in the US, where if a business touches a number of states, you can end up with a whole stack of tax filings. As well as having different rates, they also have different ways of computing the profit, and therefore the tax.’
Brookes acknowledges there can be competition between states to attract businesses, ‘but the big risk is you end up with a race to the bottom,’ he says.
But it is the question about how to allocate profits and losses that could be the big stumbling block. ‘If companies can group relief losses at one company in a group against profits in another, would they start manipulating profits to the lowest rate?’ Brookes asks. ‘There would be all the anti-avoidance legislation to prevent it, but particularly for small and medium-sized businesses, this would create more burdens. And more burdens for HMRC.’
As alternatives, Brookes suggests that property taxes might be an easier target for devolution as the properties, by their very nature, have a specific location.
Even income tax, which of course has already been devolved in Scotland, could be easier, as it is possible to establish where someone lives, but even here there are issues of residency that create added complexity.
Perhaps an alternative could be found in the German system, which has a corporation tax rate of 15% together with a trade tax, the rate of which can vary from around 14% to 16% and depends on which city the business is based in.
The trade tax works by splitting profit based on the salaries of those located in each city. Brookes’ German colleagues in BDO say it tends to be the more attractive cities that have the higher rates, while those with lower rates are seeking to attract more trade.
‘Using the German model could therefore work quite well because it would mean job creation would be encouraged in cities with lower trade tax rates, provided you could get the more attractive cities to keep their tax rates higher and not have a race to the bottom,’ Brookes says.
Devolving corporation tax is, of course, just one aspect of the devolution debate in the UK. At a time when central government is focused on securing the best deal for the UK to leave the EU, many involved in the already existing devolved institutions believe that greater fiscal powers should be passed down to them. If the Northern Ireland move proves successful, corporation tax could be added to the list.
Philip Smith, journalist
CPD technical article
"In Northern Ireland, there were clear economic reasons for introducing the change as there was strong competition from the south"