Madoc Batcup explores the prospects for lowering corporation tax in West Wales and the Valleys
As pointed out in the final Holtham Report on the Assembly’s finance, the Westminster government is committed to “producing a government paper examining potential mechanisms for changing the corporation tax rate in Northern Ireland.” This raises the question whether similar powers should be given to Wales.
Although the UK government claims to have complete freedom to set its own tax policy, it has been increasing circumscribed by the powers of the European Union as interpreted by the European Court of Justice. As a result any devolution of corporation tax powers must be compliant with European law.
There have been a series of cases before the European Court of Justice which have clarified the legal tests which must be satisfied for tax powers exercised at below Member State level to be compatible with European law.
A conference to discuss this subject was recently organised by the Centre Maurits Coppieters, a Brussels think tank which specialises in researching the position of European nations and communities which are not member states of the European Union. The conference was hosted by Åland, an autonomous Swedish speaking part of Finland, comprising some 6,500 islands in the middle of the southern part of the Gulf of Bothnia, between Sweden and Finland. It has a population of just under 30,000, but still has its own bank, and insurance and shipping companies. It has its own parliament, the Lagtinget, which makes laws in areas such as health and education. It is also responsible for broadcasting and has its own radio station as well as two newspapers. It receives a block grant from Finland allocated in a similar way to the Barnett formula in Wales. In short, it is a testament as to how resourceful even a small community can be when given the right opportunities.
The speakers at the conference included an economist from the OECD as well as experts from a number of the non Member State nations of the EU such as the Basque country, Flanders, and Scotland. I provided an overview of the situation in Wales.
Although there is still a pending case in respect of Gibraltar there are two key cases which currently define the European legal position. These are known for simplicity as the ‘Azores’ case and the ‘Rioja’ case, dealing with the position of the Azores and the Basque country respectively. These cases have ruled that differential tax rates which apply to only part of a Member State will only be compatible with EU law in the following circumstances:
1. If they are instituted by an independent entity which has the necessary authority and bears the consequences of its actions, or that
2. If they apply to a severely disadvantaged area of the EU and are therefore permissible as an operating aid.
It is the second possibility which is of most interest to Wales. The European Court of Justice spelled out very clearly in the Rioja case the criteria for an entity to have sufficient authority to apply within its jurisdiction different taxation rates from the rest of the Member State. Paragraph 51 of its judgement states:
“In order that a decision taken by a regional or local authority can be regarded as having been adopted in the exercise of sufficiently autonomous powers, that authority must first have, from a constitutional point of view, a political and administrative status which is distinct from that of the central government. Next, the decision must have been adopted without the central government being able to intervene directly as regards its content. Finally, the financial consequences of a reduction of the national tax rate for undertakings in the region must not be offset by aid or subsidies from other regions or central government. Those three conditions are commonly considered to be the criteria of institutional, procedural, and economic and financial autonomy.”
It is clear that at the current time the Welsh Government and its legislative procedure do not satisfy the criteria laid down by the European Court of Justice. If they were to do so tax varying powers could only be permitted if any changes were not offset by aid or subsidies from central government.
However, this brief extract from the European Court’s judgement is not the whole story. The Basque country is one of the wealthiest parts of Spain. In the Azores case the Court was looking at (among other things) the lowering of corporation tax in one of the poorest parts of Portugal. The basis of EU jurisdiction in these cases is that, under Article 87 of the EU Treaties, aid granted by a Member State can distort competition in trade between Member States and that changes in tax would constitute aid. However, that article also provides that such aid is compatible where it is to promote the economic development of areas where the standard of living is ‘abnormally low’. The European Court of Justice considered whether changes in tax could be permissible under the regional aid guidelines, and in paragraph 101 of its judgement said:
“… such aid must be justified in terms of its contribution to regional development… its level is to be proportional to the additional costs it is intended to offset.”
The EU regional aid guidelines provides that aid is compatible if an Objective 1 area, such as West Wales and the Valleys, has a per capita GDP of less than 75 per cent of the EU average. West Wales and the Valleys is such an area – indeed, the only area of the UK under the most recent Eurostat figures – which is why it is eligible for convergence funding.
The Advocate General (who delivers a preliminary opinion to the European Court of Justice) pointed out in his opinion that the European Commission:
“… concluded that a reduction in corporation tax should allow these firms [non financial firms in the Azores] to improve their financial situation and thus contribute to regional development. As a result….the aid was compatible with the common market.”
Without going into the wider issues of both cases, it seems clear that there is a strong argument that since West Wales and the Valleys are entitled to receive aid under the EU regional aid guidelines, it would also be permissible to lower corporation tax, as long as the reduction in the tax was compatible with the degree of disadvantage suffered. A link with GDP might be one way to achieve this. This would not require a transfer of tax varying powers to the Welsh Government since it could be done by the Westminster government directly.
It should be noted that the ambit of the judgement of the EU is potentially very wide. Although the European Commission denied in the Azores case that their position might “hinder the exercise by Scotland or Northern Ireland of the powers conferred on them in tax matters”, the European Court of Justice did not rule on this. As a result in the future a lowering of income tax resulting in lower employment costs could well be considered as distorting competition. In terms of the complex inter-relationship between devolved governments and Westminster where the financial consequences of any decision may lie is likely to be very uncertain, and much will depend on the burden of proof.
In the Azores case the European Court of Justice claimed that it had jurisdiction since the reduction of taxes in the Azores affected all economic sectors. Moreover, since at least some of the companies affected carried on economic activities between Member States, trade between Member States was “likely to be affected”.
This logic could also be applied to local business tax (non domestic rates). UK local authorities receive on average about 80 pr cent of their income from central government. The proceeds of these local business taxes are collected by local authorities, but are then, in the case of Wales, sent to the Welsh Government where they are mixed with the block grant received from the UK government and the money is then re-apportioned to the local authorities.
Any change in these local taxes could also be regarded as affecting intra-Community trade since in any given local authority there may be companies exporting to the EU. In addition, there are rate relief systems operating in Wales (and indeed in England and Scotland) which reduce the cost of these taxes for smaller companies. It is open to question whether local authorities could satisfy the criteria of having “a political and administrative status separate from that of the central government” or that the measure was adopted “without the central government being able to directly intervene as regards its content”. In the case of Wales it would certainly be very difficult to disentangle whether variations in tax were in fact “offset by aid or subsidies from other regions or central government.”
It is likely that the influence of the European Union will be increasingly felt in the field of tax in the years ahead. But whatever the complications of meeting the criteria set down by the European Court of Justice in respect of devolved tax powers, the Welsh government should argue a strong case with Westminster that: (i) a lower rate of corporation tax in West Wales and the Valleys would be permissible under European law; and (ii) this would be an effective way to stimulate business formation and growth in one of the poorest parts of the UK in the difficult times ahead.