Having written my first Article on the benefits of reducing corporation tax in Northern Ireland in 1997, I can in no way be accused of being the world's most effective campaigner! However, if something is worth doing, then it's worth taking the time to do it properly and I truly believe that a lower rate of corporation tax has the potential to make a significant difference to the long term future of the economy in Northern Ireland.

The first real opportunity to reduce corporation tax in Northern Ireland arose in 2007 when the then Labour government set up the Varney Review to look into the benefits of reducing the rate of corporation tax. Unfortunately, there was no political will in Westminster to introduce the necessary legislation and the Varney review concluded that tax varying powers should not be conferred on the Northern Ireland Assembly. Whilst many campaigners, including myself, were very disappointed, there was a silver lining to the Varney report. In effect, the Treasury paper indicated that it was feasible for Northern Ireland to have tax varying powers if the appropriate criteria were fulfilled. What was missing at the time, as mentioned previously, was the political will to do so.

Roll forward to June 2010 and the political will to reopen the debate arrived in the form of the Coalition government and more specifically with the enthusiastic support of Owen Patterson, the current Secretary of State. It then became a Government commitment to seriously reconsider the corporation tax debate in Northern Ireland and it is this commitment that has lead to the consultation document which was published on 22 March 2011.

The document entitled “Rebalancing the Northern Ireland economy” runs to 52 pages and contains six chapters. Whilst the opening chapters provide some background to the current state of the Northern Ireland economy and the UK Government's strategy for rebalancing the UK economy as a whole, the meat of the consultation document is contained in chapter 4 entitled “Corporation Tax in Northern Ireland”.

The chapter looks at the benefits and costs of the Northern Ireland Assembly reducing the corporation tax rate in Northern Ireland to 12.5% and then considers various ways of introducing such a reduction.

However, before looking at each of these issues, one needs to understand the mechanics by which a reduction in the corporation tax rate can take place in Northern Ireland.

Under the provisions of the current Northern Ireland Act, the statute under which the Northern Ireland Government operates, taxation is an excluded matter. Therefore, as the power to vary tax is not devolved to the Northern Ireland Assembly, it will be necessary for the Northern Ireland Act to be amended so as to grant the power to vary corporation tax to the Northern Ireland Assembly. This is a key requirement and must be achieved prior to the Northern Ireland Assembly making any decisions on how and when to vary the corporation tax rate.

Once the Northern Ireland Act has been amended, then to be in compliance with EU State Aid rules, as articulated in the well trailed Azores case, it will be necessary for the Northern Ireland Assembly to take the decision to vary corporation tax and also to bear the cost of any such tax variation.

Returning to the consultation document, the following are the key highlights.

Benefits of Reducing Corporation Tax in Northern Ireland

The document outlines the main benefits of a reduced rate of corporation tax as being additional investment into Northern Ireland by foreign owned firms (Foreign Direct Investment) and by existing Northern Ireland firms. The document estimates that FDI will grow by over £300m per annum within ten years of reducing the rate of tax to 12.5%. This will in turn lead to increased economic growth and a stronger private sector which would help contribute to the rebalancing of the Northern Ireland economy. Ultimately the main benefit will be the creation of long term employment and a stronger private sector which would provide a significant boost to all businesses in Northern Ireland.

The consultation document does not quantify the potential number of new jobs, however a report from the Northern Ireland Economic Reform Group last year estimated that a reduction in the rate of corporation tax to 12.5% could lead to the creation of 90,000 new jobs over a 20 year period. Whilst the number of new jobs cannot be guaranteed and is based on certain assumptions, the clear overall principle is that a reduction in the rate of corporation tax to 12.5% would result in a very significant number of jobs being created over the longer term.

What are the Potential Costs?

In order to comply with EU rules on state aid, any reduction in tax collected as a result of a reducing the rate of corporation tax would have to be borne by the Northern Ireland Executive. However, when assessing what the overall cost would be, there is a strong case to argue that the reduction in corporation tax should be offset by any increase in other taxes such as payroll taxes, National Insurance contributions and even the reduction in Social Security Benefits.

There are also potential costs to the Northern Ireland Assembly arising from a loss of tax in GB from the artificial shifting of profits by GB companies seeking to solely benefit from a lower corporation tax rate in Northern Ireland by either setting up brass plate companies or by manipulating transfer pricing rules. In addition there may be additional administrative and collection costs to be borne both by the Northern Ireland Executive and also by businesses wishing to avail of the reduced corporation tax rate.

The consultation document attempts to quantify the costs associated with a reduction in corporation tax via an immediate drop from 28% (falling over the next four years to 23%) down to 12.5%. Based on Treasury's estimates, the net cost of an immediate drop in the rate of corporation tax would fall in the range of between £225m and £285m per annum. However, it should be noted that the costs are best estimates by the Treasury and do not constitute accurate figures.

Alternate Means of Reducing the Corporation Tax Rate

The consultation document considers various alternative methods of reducing corporation tax other than an immediate reduction to 12.5%. These alternatives include deferring the reduction for a period of time, phasing in the reduction over a period of time and excluding non-trading profits.

The document indicates that a significant reduction in the upfront cost of reducing the rate of corporation tax can be achieved by phasing in the reduction over a five year period (so that the rate reduces by 2.5% per annum until it reaches 12.5%). The document also indicates that by applying the reduced rate of corporation tax only to trading profits then there would be a significant saving each year.

Based on the figures in the consultation document, the cost of phasing in a reduction to the rate and solely applying the reduced rate to trading profits would reduce the average annual cost of the first five years to less than £60m per annum. This would reduce the initial costs to about 25% of an immediate reduction in the rate of corporation tax to 12.5% and, in the context of the Northern Ireland block grant, which amounts to £12 billion per annum, the average cost for the first 5 years would amount to only 0.5% of the block grant. The costs are thus very small in the overall context of the Northern Ireland economy and the potential benefits to be achieved.

The chapter also considers but quickly dismisses other alternative tax measures which could be introduced including additional R&D credits, enhanced capital allowances, trading credits and an extension of the National Insurance holiday.

Conclusions

For low corporation tax to be achieved in Northern Ireland the Government at Westminster must grant the power to vary the tax rate to the Northern Ireland Assembly and in turn the Northern Ireland Assembly must take the decision to vary the tax rate.

In summary, the consultation document focuses on whether the Government should grant tax varying powers to the Northern Ireland Assembly and tries to determine whether the potential benefits from a reduction in the rate of corporation tax will exceed any potential costs.

Business and all other interested stakeholders, both in Northern Ireland and abroad, have now had the opportunity to respond to the consultation document and to tell HM Treasury whether the Northern Ireland Executive should get the necessary tax varying powers in addition to commenting on when the rate reduction should be introduced, how the rate reduction should take place and what the final reduced rate should be.

A low rate of corporation tax could be a game changer for the NI Economy and help transform it from a public sector dependant underperformer to a private sector led achiever. Yes this might now actually happen!! I await the Government's response with bated breath....

Eamonn Donaghy is head of Tax KPMG Belfast.