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Future of the 12.5 p.c. CT rate Back  
The 12.5 p.c. CT rate will arrive in just under three months’ time. Will it survive attempts at killing it at birth?
Since 1980 Ireland had manufacturing relief, or the 10 p.c. rate of corporation tax as it was known, available to promote inward investment and domestic enterprise alike. Because this incentive was available to some elements of the economy only, it conflicted with EU State aid rules. Ireland’s response to the discovery of this fact by the EU Commission was to agree a programme for phasing out the 10 p.c. rate.
What was objectionable to the EU about the 10 p.c. rate was that it was available to some businesses but not to others. Accordingly Ireland embarked on a programme of reducing its standard corporation tax rate so as to provide all businesses (with some minor exceptions) with a 12.5 p.c. corporation tax rate on their trading income, and a 25 p.c. rate on other income. While the EU have not formally blessed the 12.5 p.c. corporation tax rate, neither have they objected to it and they are well aware of it.

New entrants
Ireland is not alone in encountering problems with the EU Commission regarding targeted tax incentives for industry. The forthcoming expansion of the EU into Eastern Europe and the Mediterranean has involved negotiations between the applicant countries and the EU regarding the wide range of targeted tax incentives which those countries presently have. Generally the EU has been demanding that tax incentives which are targeted on some industries, but not on others, should be removed as a precondition for entry.
Cyprus has been a well-known location for ‘offshore business’. It offered a 4.5 p.c. effective tax rate for businesses which located there while being owned from abroad. This low tax rate, combined with an extensive range of double tax agreements especially with the former Communist bloc, has made Cyprus a booming location for offshore holding companies and offshore investment and trading companies of all types. Because the 4.5 p.c. tax rate was available only to foreign controlled businesses largely operating on an offshore basis, Cyprus has had to phase it out as part of its price for admission to the EU. Cyprus has noted the Irish solution to the EU problem and has legislated for a universal corporation tax rate of 10 p.c. which will apply to all companies other than semi-State bodies. The 4.5 p.c. rate is being phased out for existing companies up to 2005.
Hungary is another country which has developed a niche business in offshore companies. Generally these were offered a 3 p.c. rate on financing and on intellectual property income in particular. Hungary also has been in negotiations with the EU. It has recently published draft proposals, which are expected to become law, which will begin the phasing out of this tax break in the period up to 2005. It is expected that a nation wide corporation tax of 12 p.c. will be introduced.

Can you beat zero?
Estonia has had what is perhaps the sweetest CT rate of them all – zero percent on undistributed profits! You don’t get much lower than zero percent. This was introduced in 2000 and the Estonian government has managed to negotiate its retention in the accession negotiations with the EU. Estonia levies taxes on distributions of corporate profits, but not on retained profits. Some aspects of its taxation of distributed profits conflict with the parent subsidiary directive and the resolution of this problem has been long fingered until the end of 2008.
The ‘Irish solution’ has also attracted attention in European centres which will not be joining the EU, such as the Channel Islands and the Isle of Man. Those territories are being obliged to conform to the EU code of practice on harmful tax competition. The code requires that special low tax rates for offshore companies should be ended. These territories are now looking at a zero percent for all companies, both onshore and offshore as a solution to this difficulty.
The reaction
The spread of the ‘Irish solution’ has to be borne in mind as part of the background to the recent UK attack. The UK removed Ireland from the ‘excepted countries list’ in its controlled foreign company legislation. That legislation effectively taxes in the UK the overseas profits of UK controlled companies subject to various exceptions. Generally speaking companies in Ireland were subject to that legislation only if they availed of the 10 p.c. corporation tax rate. Other companies were automatically excluded by reason of being Irish. The automatic exclusion has now ended and UK controlled companies in Ireland must now look to other defences (such as proving that they are not here for tax reasons primarily) to avoid UK taxation on their UK parents.
Several EU countries have similar CFC legislation. Hitherto none of them have applied it to the profits of Irish resident companies controlled by their local residents. The British move is bound to refocus their attention on the possibility of doing so.
In some respects the present situation is rather like the last days of July 1914. A set of events have been put in train and there may be no stopping them. It seems inevitable that Ireland will react to the UK move by taking a case before the European Court of Justice, on the grounds that the UK move is a breach of EU law. That it is a breach of EU law is fairly clear. It is directly intended to inhibit UK companies from setting up businesses outside the UK, and in particular in Ireland, a fellow EU member state. That after all is the essential function of controlled foreign company legislation.
If the EU rules against the UK, it will likewise be striking down similar legislation in all the other member states of the EU, in so far as it is applied to companies setting up businesses in other EU member states. It is likely that those other EU member states will shortly include the zero tax rate Estonia, the 10 p.c. tax rate Hungary, and the 12 p.c. tax rate Cyprus. The matter is no longer a localised dispute between the UK and Ireland. It is also going to impact right across the EU.

Ripple effect
In some respects the row is not likely to be confined to the UK’s controlled foreign company legislation. Most European states have a plethora of other legislation which is likely to prove illegal under EU law, should the controlled foreign company legislation fall foul in that respect. These include ‘thin capitalisation rules’ which disallow interest deduction for subsidiaries controlled from abroad where those subsidiaries are not capitalised to a specified extent. The Advocate General of the European Curt of Justice has already recommended to the court that they declare such rules incompatible with EU law.
It also includes transfer-pricing rules which impute arm’s length prices to transactions between connected parties but which are applied only to transactions with non residents. Also in trouble may be the exit charges to capital gains and in respect of capital allowances, when a company leaves residence in one country and moves to another.
The four aspects of legislation mentioned above, controlled foreign company legislation, thin capitalisation rules, transfer pricing on cross border transactions, and exit charges are fundamental parts of the tax regime of most EU member states. Revenue authorities in many of these states probably could not conceive of life without them.
Ireland may shrug its shoulders at a zero tax rate in Estonia, but if you are collecting taxes in Finland, a zero tax rate in your next-door neighbour looks very different than it does from Ireland. A 10 p.c. tax rate in Hungary may not excite us greatly (have you ever tried to speak Hungarian?) but it begins to look quite uncomfortable if you are charged with collecting taxes in Germany or in Italy.
‘The Irish solution’ to the crisis over manufacturing relief may have lit a long slow fuse that could yet lead to a spectacular explosion in the tax systems of Europe.

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