Why lowering the Corporation Tax rate might be the biggest mistake Stormont ever makes…

Before reading this post please note I am not some raging lefty. I have worked for myself my whole life. I personally would benefit from a reduction in Corporation Tax, but as a citizen I think it is completely the wrong strategy.

On the Nolan Show this morning it disclosed a DUP proposal to slash public sector jobs and use the savings to fund a cut in Corporation Tax. The idea is that this will boost private sector jobs and rebalance the economy. It is a nice idea in theory but will it work?

Multinational companies pay little or no tax already

If Microsoft decide to set up an office in Belfast tomorrow, our rate of Corporation Tax is of no interest to them at all. Why you might ask? Well Microsoft, along with most multinational companies, funnel all the profits from their European operations through their Dublin office. It is irrelevant what tax rate operates in each country.

Let’s take for example everyone’s favourite search engine Google. From the Guardian:

The internet giant doesn’t pay 12.5% corporate tax in Ireland, it pays 20%. But that figure is not the interesting one. The interesting figure is the gargantuan “administrative expense” that reduces its gross profit from €5.5bn to just €45m.

Grant Thornton tax accountant Peter Vale, who works with multinationals in Dublin says the corporate tax rate of 12.5% may not be a critical factor for companies like Google.

The search engine is using Ireland as a conduit for revenues that end up being costed to another country where its intellectual property (the brand and technology such as Google’s algorithms) is registered. In Google’s case this country is Bermuda, according to an investigation by Bloomberg last year.

The 2009 Google Ireland Limited accounts show the company turned over a phenomenal €7.9bn in Europe for the year ending 2009 – up from €6.7bn the previous year.

The internet giant made a gross profit of €5.5bn, with an operating profit of €45m after “administrative expenses” of €5.467bn were stripped out.

Administrative expenses largely refer to royalties (or a licence fee) Google pays it Bermuda HQ for the right to operate.

Notes on page 16 of the accounts also show that the Irish corporate tax paid is €9.6m – an effective tax of around 20%.

A highly efficient tax structure across six territories that meant Google paid just 2.4% tax on operations outside the US.

Put simply multinational companies are running rings around governments and paying the bare minimum of tax already.

The race to the bottom?

Even if the Corporation Tax rate was a factor, then how could we possibly compete with the likes of Estonia where Corporation Tax is zero?

The UK government is funding businesses that put the high street out of business

Say for example you fancy reading the new John Cleese autobiography. Instead of trekking down to Waterstones and getting wet you decide to order it on your Kindle. You pop on over to Amazon UK, but note when you buy the ebook you are actually buying it  from ‘Amazon Media EU S.à r.l.’ This Amazon company is actually located in Luxemburg not the UK. From the Wall St Journal:

Amazon EU generated €15.5 billion, or about $19.8 billion, in revenue in 2013, local company filings show. But it had just €28.8 million in net profit.

Now this is where it gets really crazy. From The Telegraph:

Amazon’s UK operation generated £4.2bn of sales last year, but it used a subsidiary in Luxembourg to help it reduce its corporation tax bill in the country to just £2.4m in 2012. According to documents filed at Companies House, the company received £2.5m in government handouts over the same period.

If you are a UK company trying to trade on the high street imagine your annoyance at finding out not only are your competitors using complex tax arrangements that make it impossible for you to compete but the government is actually giving them subsidies.

How will a cut in Corporation Tax affect NI businesses?

NI is a small business economy. Government figures show that:

• Over three quarters of VAT and/or PAYE registered businesses with a main (or registered) address in Northern Ireland had total employment of less than five.
• At March 2013, businesses with total employment of less than 50 accounted for approximately 98% of all VAT and/or PAYE registered businesses in Northern Ireland.
• Businesses with 50-249 employees accounted for 1.5% of the total.
• Businesses with 250+ total employment accounted for 0.3%.
• Businesses with total employment of less than 10 accounted for 89.0% of the Northern Ireland total.

The level of Corporation Tax has very little day to day effect on these businesses. If I run an off license in Limavady, if Corporation Tax goes up I am very unlikely to shut up shop and move to Poland. Business people are not fools. Of course we would be happy to pay less tax, who would not? Most small companies take their salary in the form of drawings (you take your money out of the profits). This means they have an effective tax rate of 20%, far less than all of you reading this. Furthermore they do not tend to pay National Insurance either (all this is perfectly legal I might add). And Stormont wants to make them pay even less tax?

The flaw in the plan is the assumption that reducing the tax level will lead to more jobs and growth. This is not the case. Businesses only employ the staff they need: no more, no less. Give them more money and yes, some will be reinvested. But more likely that money is going on a holiday, new car or being put into an ISA or pension (if you have a personal pension the Government gives you an extra 20%-40% on top of everything you put in).

Who benefits from a reduction in Corporation Tax?

As we seen from the figures above most companies in NI are small. Very few companies are large enough to really benefit from a cut in Corporation Tax. This push for lowering the Corporation Tax is being driven primarily by the big tax and accountancy companies. It will not shock you to learn that people who make their money minimising their client’s tax bills are pushing to lower tax levels.

The nightmare scenario

The proposal by the Treasury is that any reduction in Corporation Tax will come out of our block grant. Put simply money that could be spent on nurses and teachers will instead go to big businesses.

This can lead to a situation where a large company can locate its head office from London to Belfast. They could be employing as little as one person to answer the phone, yet we would ALL be subsidising their tax cuts.

We have seen already how companies run rings round tax laws. Stormont is no match for the armies of solicitors and accountants that these businesses have.

Cutting civil servants does not mean a boost to the private sector

In the Nolan Show coverage they linked the two issues, but I believe they are completely separate. I would take the view that our public sector is far too large and we need to do more to rebalance the economy. But linking this with job cuts is completely the wrong approach.

What do you think? I would be more than happy to be proved wrong. Maybe a cut in Corporation Tax will bring a swarm of companies to our shores. But don’t hold your breath.

In part 2, I will look at the alternatives ways to boosting the private sector. Part 3 will look at how the Republic succeeded in attracting international companies. 

For further reading on this topic, this post is a good read…