All parts of the UK will be watching the progress of the Smith Commission on devolved powers to Scotland closely. Their report is due on 30 November 2014, and tax is high on the agenda. Both Northern Ireland and Scotland will be interested in how the United Kingdom proposes to deal with the devolution of corporation tax, an objective which is firmly on the agenda of the Scottish government. 

The question of reducing the corporation tax rate in parts of the UK is not new. Following a decade-long campaign in Northern Ireland to put rates on a par with the Republic of Ireland’s 12.5%, a proposal was made in 2011 but set aside from parliamentary debate from April 2013 for fear of influencing the outcome on the Scottish independence referendum. The question is now on the political radar again and the Northern Irish Parliament, amongst others (including the Confederation of British Industry), is pushing for a decision to be made imminently. It is expected that the United Kingdom government will make an announcement on the point in the Autumn Statement on 3 December 2014, with supporters optimistic that the new power could be in place by 2017. It is inconceivable that corporation tax powers could be devolved to Northern Ireland without Westminster being lobbied hard to extend the same powers to Scotland.

There are practical concerns surrounding the possible devolution of corporation tax, not least in the case of Northern Ireland the tight legislative deadline of the general election in May 2015, by which the United Kingdom government would have to produce a draft bill, leaving Stormont to then pass its own legislation. The Conservative Party have asserted that corporation tax is “the least suitable of all taxes for devolution” to Scotland, although it has considerable appeal to regional governments and their electorates because of its potential to influence the place of corporate activity.

In addition to the practical problems raised, there are important legal hurdles to be overcome. Article 87(1) of the 1997 consolidated version of the EC Treaty prohibits state aid which “distorts or threatens to distort competition”. The 1998 EC State Aid Guidelines clarified the definition of aid as a measure which, amongst others, “confers on recipients an advantage which relieves them of charges normally borne from their budgets eg. a corporation tax reduction.” Devolution of tax setting powers at a regional level would be subject to state aid rules, in common with devolution at a member state level.

The ECJ in the 2006 judgment concerning the Azores (Portugal v European Commission (C-88/03)) set out three criteria which must be satisfied when determining whether a rate of tax may be lowered in a region of a Member State: institutional, procedural and fiscal autonomy:  

  1. Institutional autonomy – the decision to lower tax rates must have been taken by a regional government which had “a political and administrative status separate from that of the central government”. As it stands under the Northern Ireland Act 1998 and subsequent amendments under the St. Andrews Agreements, Northern Ireland does not have the power to reduce corporation tax. It is arguable though that the Northern Ireland Executive has institutional autonomy as the Northern Ireland Assembly is elected separately to the United Kingdom government and already controls some policy decisions. However until the power to set corporation tax rates is fully devolved to Northern Ireland, it may fall at this hurdle.
  2. Procedural autonomy – the ECJ confirmed that the decision to reduce the rate “must have been adopted without the central government being able to directly intervene as regards its content”. Under the current proposal Northern Ireland would have full control over the rate setting of corporation tax in Northern Ireland without involvement of the United Kingdom government. This is of course subject to any declarations to the contrary which may be contained in the Autumn Statement.
  3. Fiscal autonomy – in order to be considered as having fiscal autonomy, the financial consequences of the rate reduction in the region “must not be offset by aid or subsidies from other regions or central government, the regional or local authority assuming the political and financial consequences of such a measure.” The Northern Ireland Executive currently receives funding through the Stormont Block Grant, provided by the United Kingdom Treasury out of a nation-wide tax pool, the size of the fund transfers being determined by the Barnett formula. However in order to fulfil this requirement ostensibly the amount of corporation tax revenues to be transferred to Northern Ireland under the formula would have to be reduced by the amount lost as a result of lowering corporation tax rates.  Commentators have estimated that this could set the Northern Ireland economy back by as much as £400m per year with some estimates that compensation would need to be in the region of an additional £2.4 billion in private sector profits. Although the reduced rates could result in increased business investment, it is unlikely that Northern Ireland would feel the benefit of increased revenues for some time.

To sum up, the power to reduce the corporation tax rate will need to be fully devolved to Northern Ireland and the Northern Ireland Executive may need to engage with the EU Commission and the UK government regarding the financial consequences of such devolution, in order to eliminate or reduce the risk of legal challenge. The same hurdles are likely to apply to Scotland, if the UK government can be persuaded. In each case, it seems there will have to be a change to the Barnett formula - which the current UK government has recently pledged to uphold.