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UK Sceptical About Scottish Corporate Tax Cut

by Robert Lee,, London

21 July 2011

The UK government's negative attitude toward the possibility of a reduced rate of Scottish corporation tax has been demonstrated by a Treasury paper which estimates the potential economic damage likely to arise as a result of such a policy.

Scotland's corporate tax rate is currently aligned with that in the UK as a whole, and sits at 26%. This rate is to be reduced over the next three years, following an initial 2% reduction in April, and will fall to 23% by 2014. The UK government recently concluded a consultation on the plausibility of devolving corporate tax responsibility to Northern Ireland, where the provincial government would then have the option to reduce its own rate. The Scottish National Party, which runs the devolved Scottish administration, wishes to see similar treatment for Scotland, but the Westminster government is largely opposed to the option.

The Treasury paper estimates that were the rate reduced to that levied in Ireland (12.5%), as is proposed in Northern Ireland, it could reduce overall Scottish government spending power by a total of around GBP10bn (USD16bn) to GBP12bn over a five-year period. In particular, the losses incurred from dropping the headline rate alone, not taking into account any other figures, show that revenues could drop by over GBP850m within the next two to three years. The total losses, taking into account the effect on business behaviour among other factors, could hit nearly GBP2.6bn per annum by the 2012-13 financial year. By the end of the five year period, such costs could rise to GBP2.7bn for 2015-16.

In addition, the paper predicts that the introduction of a separate regime and a lower rate applicable solely in Scotland would increase business administrative costs as companies would have to account for their profits separately. There is also a significant presence of life assurance and general insurance companies in Scotland. The paper argues that it is extremely likely that the profits of such companies domiciled in Scotland would be allocated there, and so taxed at a lower rate. This would cost the Exchequer GBP105m in 2011/12 and GBP135m per year thereafter.

Moreover, a Scottish rate cut would offer a strong behavioural incentive to English and Welsh companies to relocate their technical funds to Scotland, increasing the cost to the Exchequer. Several large banking, financial and industrial companies maintain their headquarters in Scotland, and pay corporate tax through their Scottish parent company. Were a regime change brought in, the paper stresses that such companies would find it easier to claim that their corporation tax arises in Scotland. This would hit government revenues to the tune of GBP440m by the end of the five year period, it is claimed.

The government's position on the matter was confirmed by Scottish Secretary Michael Moore, who told the Scottish Affairs Committee that this type of analysis must inform the devolution debate. He said: "This paper makes clear the very real risks for Scotland in making changes to corporation tax without first looking at the details. Cutting corporation tax to Irish levels would leave the Scottish government with a gaping hole in its budget. To risk losing more than GBP2bn in spending power in a single year raises some serious questions that Scottish Ministers need to address in their proposals to devolve corporation tax. What cuts would be made? What other taxes would be increased?"

Moore added: "Analysts have examined a whole range of factors here. They have looked at the direct impact of a cut in corporation tax as well as the behaviour effects of 'profit shifting' and 'tax motivated incorporation'. It highlights not only the revenue involved but also the complexity involved in one tax change. This doesn't even take into account the administrative costs for government and business. The UK government is already cutting corporation tax to one of the lowest levels in the G20, helping Scottish businesses to grow and generate new jobs. There are advantages to being able to share risks across a much wider tax base so that different parts of the UK support each other. Making changes to that system have to be carefully thought through and set out in real detail for everyone to analyse."

"We await the substantial detailed case from the Scottish Government on Corporation Tax but we will not agree to anything that will damage Scotland's best interests", Moore concluded.

TAGS: tax | economics | business | fiscal policy | insurance | corporation tax | United Kingdom | tax rates | tax reform

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