JOINT COMMITTEE ON FINANCE AND THE PUBLIC SERVICE debate -
Wednesday, 30 Apr 2003

Vol. 1 No. 7

Scrutiny of EU Proposals.

Chairman

I propose to take item No. 4 on the agenda, scrutiny of EU legislative proposals regarding the Green Paper on Entrepreneurship in Europe. This has been already referred to the Joint Committee on Enterprise and Small Business and only one aspect of the document has been referred to this committee for its consideration, namely, the matter of taxation.

I welcome the officials from the Department of Finance - Ms Brigid McManus, Mr. Liam Murphy, Mr. Pat Leahy and Mr. Jim Kelly from the Revenue Commissioners. I remind them that, while the comments of members are protected by parliamentary privilege, those of witnesses are not. Members are reminded of the long-standing parliamentary practice to the effect that members should not comment on, criticise or make charges against a person outside the House or an official by name or in such a way as to make him or her identifiable. I invite Ms McManus to brief the committee on this issue.

Ms Brigid McManus

Members will know many of us from the discussions on the Finance Bill and from other occasions. Mr. Liam Murphy deals with corporation and capital tax in the Department of Finance, Mr. Pat Leahy deals with VAT and Mr. Jim Kelly from the Revenue Commissioners deals with corporation tax issues in Revenue.

My remit today is to speak on the tax issues in the Green Paper on Entrepreneurship produced by the Commission. The Commission published its Green Paper last January. The intention is to have a consultation process by the end of June and to see how to go forward from there. The paper is broad and addresses two key issues. First, it considers why so few people start a business and, second, why so few European enterprises grow and why those that do grow do so at such a modest rate, particularly in comparison with other countries. The paper suggests a co-ordinated approach to entrepreneurship policy, involving all policy-makers at European, national and regional level, to provide a coherent response to the needs of entrepreneurs.

The paper identifies a range of issues that influence entrepreneurship, of which taxation is just one element. It basically amounts to one page and a couple of other references in the paper. It makes the following main points on how appropriate tax measures can contribute to the development, growth and survival of firms. The structure of the tax system, including income and corporate tax, labour tax and VAT, influences the ability of firms to expand. The complexity of tax systems is an administrative burden for entrepreneurs. The paper refers to the fact that the Commission has recently identified a number of tax obstacles to cross-border activities and highlighted possible remedies, which are being further examined. It refers to the taxation of labour, including marginal income tax rates, being an important determinant in regard to investment and employment and it raises the issue of the tax treatment of business transfers, particularly in regard to family businesses largely in a capital taxation area.

The references on page 17 are couched in fairly general terms rather than in specific proposals. In its concluding section, the paper poses a number of questions. Taxation is raised in question 2, with tax measures suggested as one of the possible ways of improving the availability of finance; in question 3 with national tax provisions listed as one of the factors which most hinder growth; in question 6 where the reduction of the tax burden in terms of rates or administration is raised as one of the possible ways that member states could make the balance between risk and reward more favourable to promoting entrepreneurship; and in question 8 as one of the ways spin-offs can be made more attractive.

I propose to say a few words about the factual position in Ireland on these taxation issues, in particular, current rates of tax and specific tax provisions as they affect business. I will then outline some of the issues regarding tax obstacles to cross-border activities in the Commission's 2001 communication cited in this Green Paper.

Ireland already has relatively low direct tax rates with the objective of encouraging enterprise, entrepreneurship and employment. A low corporation tax rate has been a key policy instrument since 1956. From 1 January this year, the rate on trading income is 12.5% - the lowest currently in the EU - and the rate on investment and rental income for companies is 25%.

On income tax, Ireland's rates have been reduced to 20% and 42%. In terms of taxes on labour and the tax wedge, one of the issues to which the paper refers, if one includes PRSI the most recent data available from the OECD relating to the year 2000 indicates that for a single person on the average production wage, APW, Ireland has the lowest tax wedge in the EU. The EU average tax wedge is 42.4% while the figure for Ireland is 29%.

Provisional data from the EU relating to the year 2000 shows that the EU average tax wedge for 2000 on a single low paid person on 50% of the APW is 35% while Ireland's tax wedge on that income is 14.8%. For a married couple with 50% of the APW, the tax wedge in Ireland is 3.8% while the EU average is 32.3%. The average tax rate, ATR, for a single person at average earnings has fallen in Ireland from 29.6% in 1996 to an estimated 17.16% in 2001. It can be seen from that, given that the paper is generally directed at most EU countries, that we are at the lower end of the spectrum. In most of the cross-comparisons carried out on matters such as the broad economic guidelines, we would be cited among the countries that have reduced their tax wedge over the past number of years. The trend has gone in the opposite direction in a few countries but we are not alone in reducing it.

The rate of capital gains tax has been reduced from 40% to 20%. Ireland has a standard rate of 21% VAT and a reduced rate of 13.5%. A significant amount of goods in Ireland are covered by zero rating. Ireland and the UK are unusual in this respect. As we have such a large body of goods that are zero rated we inevitably end up with some of the other goods at higher rates, giving us an average rate of about 15% across all the taxes.

On the tax treatment of business transfers the document refers to a reduction in inheritance and gift taxes in the case of business transfers. It is quite focused on family businesses in this context. This has already been done in Ireland in the case of CAT and CGT. In the case of transfers on death there is no stamp duty, no CGT and 90% business relief for CAT. The CAT Class 1 threshold for transfers to children is just over €441,000. That means that €4.4 million worth of business property can be transferred tax free to each child and, if tax arises, the rate is only 20% as compared to a top rate of 40% in 1999.

In the case of transfers in a lifetime there is retirement relief under CGT, which means a tax free transfer to children if conditions are met. The condition largely relates to length of ownership of the business. If CGT applies, the rate is only 20% as compared to a top rate of 40% in 1997. The CAT regime is the same in lifetime transfers as for transfer on death. Stamp duty can be up to 9% on real property, but the rate is halved for transfers to certain close relatives. If a shareholding is involved, as in many business cases, it would only be liable at 1%.

The paper also touches on tax measures to help provide finance. The measures Ireland has that are particularly worth mentioning are the business expansion scheme and the seed capital scheme. These have been an important source of finance for start-up businesses in Ireland that would otherwise be dependent on loan finance. The business expansion scheme has been in existence since 1984 and the seed capital scheme since 1993. They are due to run until 31 December 2003. As the Minister indicated in the discussion on the Finance Bill, a review will be carried out this year on whether it should continue and regarding issues raised in terms of the kind of limits that apply and the type of business covered.

General reference is also made in the paper to employee financial participation, although tax measures for this are not mentioned. In Ireland, a number of measures encourage such schemes. The share option is probably the scheme with which most people are familiar but we also have, among others, the SAYE scheme, a savings based share option scheme and ESOPs, which are in a number of companies.

Moving on to the European aspect of the cross-border obstacles referred to, the Green Paper mentions that the Commission has identified a number of tax obstacles to cross-border activities in the internal market. It has highlighted remedies, which are being further examined. The communication referred to is one presented to the Council of Finance Ministers on 6 November 2001. It was a follow-up on a study carried out on company taxation in the European Union by the Commission.

The communication presents a two-pronged strategy. The first part states there are particular obstacles in the short to medium term which should be tackled issue by issue by either amending existing directives, introducing new ones or agreeing a common approach. The second prong, which probably received a certain amount of debate at the time the communication was produced, proposes a comprehensive, common consolidated corporate tax base for companies throughout the EU. It gave four different options for how this tax base would be calculated. Under any of the options, the major issue would be how, having calculated the tax base, we would allocate the tax revenue to different member states.

Some of the obstacles discussed concerned the restrictive scope of the existing parent-subsidiary directive and the merger directive; the problems regarding the difference in fiscal treatment in different member states of transfer-pricing; double taxation conventions in the EU - as they are all done in different countries specific issues arise in their interaction; the limits allowed on cross-border loss relief; the 15 different sets of rules - a company operating in several member states must deal with different rules in each; the view that certain tax systems have a bias towards domestic investment which prejudices cross-border operations; and the problems which may arise from the manner in which European Court of Justice rulings on certain matters are implemented in different member states. They have either had some discussions in this area or will introduce revised directives, for example, in the case of the parent-subsidiary directive and the merger directive, where we are expecting Commission proposals in June.

Under the longer-term comprehensive proposal, the Commission wants to have a common base while allowing member states to have a discretion over the rate of tax. It argues that this is not harmonisation because each member can have its own tax rate. In practice, it will be very difficult to make that kind of distinction once this route is taken. Our view is that the obstacles to cross-border activity which have been identified are capable of being satisfactorily dealt with by tackling them in a targeted way. In so far as there is a problem in how member states treat issues like losses, for example, these will be just as difficult to solve in a consolidated way as they would be to solve individually through a directive. We do not think this will contribute to the simplification of the system. The Commission's proposal was not to replace the existing systems but that each company could opt for either the Community or the national base. In our view, this means that companies, accountants and tax advisers would calculate in each case whether it would be preferable to opt for the domestic route, with the result that the 15 systems will be turned into 16 rather than replaced with one.

We also have concerns about the mechanism by which profits would be allocated from different countries on a fair basis. Where this has been done previously, turnover or employment in particular areas have been used as measures and these are not bases we would like to see being used from an Irish point of view. Our view on the consolidated base aspect is that we would be very strongly in favour of the removal of obstacles because this is in the interest of a country like Ireland that has a lot of multi-national cross-border activities, but we feel the targeted way of dealing with problems as they arise is the way to tackle it.

This is an outline of the position in a number of the areas touched on in the Green Paper. We will be happy to provide any further information or answer any queries.

Deputy R. Bruton

I thank the Assistant Secretary for her presentation. It seems a pretty inoffensive paper but the issues it throws up are twofold and we must consider whether some of this consolidation may damage Ireland in the longer term. I notice a specific reference is made to the issue of the fiscal treatment of transfer pricing. There has been quite a bit of discussion about the rules that apply in Ireland and whether they are robust in terms of their capacity to be changed by other tax authorities. I would be interested to hear Ms McManus's views on where Ireland will stand on this issue if there is a move towards some form of consolidation.

On the wider issue of enterprise and the encouragement of enterprise, I would like to know whether this Green Paper has thrown up any assessment of seed capital schemes in other countries that have been perhaps more successful than ourselves. It is certainly my impression that the seed capital scheme which is aimed at the individual entrepreneur has not had a huge take-up. A number of restrictive conditions still govern it. I understand from people in the IT industry that with the present shake-out, quite a number of people are considering setting up in business and if the Irish seed capital scheme were more generous, this could be an opportunity to get small firms off the ground in the IT sector. They would then have longer-term prospects of being rooted in the Irish economy than some of the parent companies from which people have been let go. I am interested to hear whether we have something to learn from EU practice elsewhere on the issue of seed capital and getting individual entrepreneurs into the field.

My other questions concern the normal bugbears one hears about small business such as the thresholds for audit requirements. I do not know to what extent the Revenue Commissioners have a role in dictating what these thresholds should be but I understand that we require an audit that costs €3,000 or €4,000 to conduct on relatively small businesses compared to other EU countries. Perhaps very small companies should not be required to engage an auditor. Similar comments have been made on the threshold for VAT.

One of the keys to entrepreneurship in the longer term is investment in research and development. One of the products of our success is a low corporation tax rate and therefore the tax-based incentives for research and development are relatively small. I am aware that some years ago Revenue introduced a scheme of multiple rebates or something like a 200% write-off on research and development. Can the research and development element of our system learn from what the other 15 member states are doing to promote such activity in small and emerging companies?

Ms McManus

On transfer pricing, some of the publicity such as appeared in a particular article a few weeks ago was somewhat confusing. The EU Commission communication is very much focused on existing rules for transfer pricing. The way it works and the documentation requirements on companies can vary. A transaction can occur between two member states and broadly the same kind of records will be kept but it can end up with people having to keep two sets of records because the rules are interpreted or dealt with a bit differently. In terms of the Commission communication, it is not trying to introduce any kind of consolidated transfer pricing rules in the Community as such. If there is eventually a consolidated tax base in the second leg of their proposal, general rules would apply to everything. In its targeted proposals, the Commission is anxious to try to tidy up the administration - matters like the arbitration convention for example, to deal with disputes among member states as to how transfer pricing rules could apply. There is a joint transfer pricing forum at European Union level on which business and revenue authorities are represented. Jim Kelly is a member of that forum and I will ask him to speak about its work.

In terms of the Commission proposal, certain issues arise for Ireland. Correspondence with the Institute of Taxation was publicised. We have certain transfer pricing rules in our 10% rate in existing law. The question of whether our existing law is exactly in compliance with OECD guidelines and where we go from here has been discussed both in Ireland and in other countries. By and large, we have not had difficulties with other countries such as the United States which have transfer pricing rules in terms of the kind of audits they require of companies that are based here.

Mr. Jim Kelly

To add to what Ms McManus said, the paper from the Commission suggested that the Commission would set up a joint transfer pricing forum. That was set up by the Council and has representatives from business and tax authorities. The instruction to the joint transfer pricing forum was to look at the problems of compliance with transfer pricing rules which companies experienced and consider whether there were different documentation requirements in different countries. It would not be sufficient for an indigenous or multinational company, which was transacting business involving two different countries, to have one set of documentation. It might have to have different documentation for each country. The forum was asked to review those practical problems. Documentation is one of the matters on its agenda.

The second issue to be examined is the functioning of the arbitration convention. The arbitration convention provides for dispute resolutions where there are transfer pricing problems. This involves two steps. The first is where the two countries concerned are obliged to get their heads together and try to come up with a solution to relieve any double taxation. Where they cannot achieve a solution, they are obliged, under the second step, to set up an advisory commission of experts to look at the issue and come up with a binding solution. The arbitration convention has been used very little and the arbitration commission, which is designed to decide on particular cases, has only been used once very recently involving France and Italy. All kinds of problems arose in trying to get that up and running and working properly.

Ms McManus

We do not generally have issues in terms of US companies or people like that who have transfer pricing with the IRS.

Mr. Kelly

Yes, that is correct. There would not be problems on the US side. The US and any other country would have transfer pricing legislation designed to protect its own tax base. If its tax base is understated, the legislation kicks in to protect against that. That is the standard transfer pricing legislation that exists in all jurisdictions. We have not had problems with the US. One would expect that some problems would always arise regarding any particular provision and these would have to be resolved. However, there has not been any significant problem.

Ms McManus

I will move on to the seed capital scheme. Some of the issues here arise perhaps from the nature of the seed capital scheme, which was intended to be for people who were made unemployed and set up a very small business. Certain rules govern this which, in terms of the IT sector, are those being referred to. These include ownership of other companies, for example, or the fact that the scheme was geared very much to the PAYE employee sector. With the changing nature of the economy and the nature of work, particularly in the IT sector, people who have multiple ownership interests and a mixture of employee and self-employed income are now debarred from the scheme because of the conditions. We have undertaken to look at those kinds of issues in the context of the review we are carrying out.

The BES scheme is very much the one that is targeted. One could call it the normal investor-owner type situation with the seed capital more geared towards the employee who starts up a small business than somebody who has many directorships and investments. In terms of the Green Paper, nothing much has emerged from the experience of other countries, but we are working in conjunction with the Department of Enterprise, Trade and Employment. The Department has already done some work with the agencies, reviewing their experience in terms of needs, and will draw on other countries' experience of some of these schemes.

The most recent review was carried out about a year before the scheme was extended in the Finance Act 2000. At that stage, while they were seen as useful, it was not considered that there was a great case for increasing the limits significantly in terms of a niche need for finance. However, some increases were made in the limits. People tend to seek limit increases in both the BES and seed capital schemes. Obviously, there is a balance here somewhere between filling a niche and getting back to the position we were in a number of years ago before the scheme was reviewed where we ended up having a lot of tax-driven schemes and a large amount of dead weight in the system. It is a question of trying to achieve that kind of balance. In so far as we or the Department of Enterprise, Trade and Employment can get information on the experience of other countries gathered by the Commission or others, we will use it.

I will deal with research and development and then ask Mr. Kelly to say something about the audit issue and small businesses. The Minister indicated on Second Stage of the Finance Bill that the whole issue of how we might use tax on research and development was under examination. It is obviously a very important aspect of our industrial policy that we try to embed companies in Ireland in terms of their research and development capacity and involvement. It is true that when there is an expenditure driven activity, there is more of an attraction to write it off in a high tax jurisdiction as a cost.

The experience of other countries in terms of research and development credits has been that it can be difficult to introduce a tax measure that targets additional expenditure as opposed to giving a tax credit for research and development generally. The UK originally announced that it would have a research and development tax credit targeted only at additional expenditure on research and development. It found it so difficult to devise a scheme that it ended up with a scheme that gives a tax credit for all research and development expenditure.

Obviously, both from an industrial policy and cost effectiveness point of view, if one were looking at such a scheme one would want to maximise its effectiveness. One would not want to fund something that would be done regardless of whether it was funded. There is considerable public expenditure in the research and development area, both under Structural Funds, which are business driven and research and development in the educational area. Obviously, there has to be an integrated approach there and we will certainly look at that.

Another issue of which we must be conscious is that where we have a low general tax rate, whatever we put in place must not seen as overly aggressive in an international or EU tax context. State aid rules also govern the UK and other EU member states. In other words, it is not possible to discriminate in the rules or at least this can only be done with good reason. For example, it might be possible to target SMEs, but it is not possible to decide to give a research and development tax credit or grant to a certain sector or a certain type of company without running into state aid rules. As far as I am aware, the biggest problem in an international context where they have been trying to do this is to get something that is sufficiently targeted to address the additional research and development being sought - the dead weight cost.

Mr. Murphy might like to say something about the scheme in existence a couple of years ago.

Mr. Murphy

The scheme was introduced in 1996 when Deputy Richard Bruton was Minister for Enterprise and Employment. It only lasted a couple of years and effectively trebled for tax purposes the amount of expenditure. As Ms McManus rightly said, having a low tax rate of 10% or 12.5% for write-off purposes is not great for research and development, which is largely expenditure driven with the high labour costs of skilled people. I do not think it was very successful. That is the reason it was allowed to lapse. The difficulty with research and development, as Ms McManus said, is that in order to target it properly, for example in terms of IDA approval, one runs into immediate trouble regarding State aid. If one approaches it on too wide a basis, as the British have done, there are huge dead-weight costs - they are giving everything. One has to try for additionality across a wide sector. However, while additionality is very good, it will inevitably give a tax benefit to something which would have happened anyway. When everyone wishes to do it properly, there are many problems involved. OECD studies have been carried out on it, including one last year, from which mixed views emanated. Some countries said that tax-based schemes worked while others said they did not.

Science Foundation Ireland has had a huge budget, comparatively speaking, for the past couple of years. Perhaps the grant approach is the better way but, as Members will be aware, many companies in Ireland are strongly tax-driven. That is the current position.

Ms McManus

Of course, any of these proposals must always be looked at in a general budgetary and public finance context.

Chairman

That timely reminder is appropriate.

Ms McManus

We would not want anybody to think the Department of Finance was becoming too liberal.

Deputy R. Bruton

They all went to Punchestown together.

Ms McManus

On the threshold for VAT, there is always a question of balance, as has been discussed earlier, between a threshold which leaves out the rather small companies that do not really matter and the competitive issue if there is a very high threshold, apart from the tax cost issue of those who are below the threshold competing with those who are just above it. We have, I believe, the second highest threshold in the EU, the UK being the highest. The existing levels are €51,000 for goods and €25,000 for services. If those were increased to €64,000 and €32,000, which is as much as we could do under current EU law, that would represent €12 million for services and €29 million for goods. That would remove over 7,000 businesses from the VAT net. The UK registration in both cases is £54,000 sterling, which is the highest in the EU. Some member states do not have thresholds at all - they oblige everybody to register. There would be a cost issue if the level were raised significantly, but there is also a competition issue. Mr. Kelly will comment on the audit aspect. Obviously, the more general audit requirements are a matter for the Department of Enterprise, Trade and Employment, as distinct from the tax aspect.

Mr. Kelly

It is primarily a question for the Department of Enterprise, Trade and Employment as to what the appropriate thresholds should be, in terms of determining whether a company needs to be audited. Clearly, that Department will have to balance all views, as between the business community which, perhaps, would like to have the thresholds raised and others who might have a view to the contrary. The Revenue point of view would, I expect, be based on the fact that we deal with all accounts, company and non-company. In so far as we deal with companies, most of them are now subject to an audit requirement. The starting point for calculation of taxable profits is the profit as per the accounts. If accounts have been subject to audit by an independent auditor, that provides some comfort and is of some assistance to Revenue when we are looking at the relevant accounts and determining what the appropriate Revenue audit programme should be. That being said, our inclination would be against increasing the threshold. Others may argue that it should be increased but, from a Revenue point of view, we would prefer to have as much comfort as possible by submitting accounts to audit.

Senator O’Toole

I appreciate the very clear overview which has been given on the issues. While people may speak of a common European approach, the reality is all our decisions are based on current practice in Ireland. Currently, the Irish position is very competitive in terms of, say, corporation tax. Accordingly, nobody in Ireland wants a common European approach. While I appreciate that it may not constitute a Government view, I would welcome a response from the Department officials as to the direction in which we are heading. It is my understanding that a number of the applicant countries will lift us off the bottom of the league very quickly. For instance, I believe Estonia has no corporation tax.

Much of the discussion in this regard is taking place in a type of freeze frame, in the sense that many decision makers are unaware of the fact that the ground is changing under our feet at this stage. If I may simplify matters, without suggesting this as a basis for drawing a conclusion, we are now opposed to a common European approach because Ireland has the lowest corporation tax and is, therefore, the most attractive location. Conversely, we should have a different view next year, when new member states have come in, with a lower and more attractive regime than ours. I appreciate that that is an utter simplification but, nonetheless, it is worth drawing attention to it. I am actually attracted, to some extent, to the idea of a common European approach, although I do not quite understand it. Perhaps the officials will spell out more fully the consistency between having a common, consolidated tax base and, at the same time, allowing discretion over the rate of tax. I would like to have a more detailed explanation.

What we have seen in the past few years has shown us that words mean what people say they mean, as in Alice in Wonderland. All of us believed we knew what profits were until, in recent years, we discovered they could be described as royalties, franchises or various other descriptions under which people could repatriate them. I would be concerned, even if there were an approach towards a generality of consolidation within Europe, that the system will never work in the same way as the ideal presented. Is there a need to approach the matter from a different viewpoint, by co-ordinating approaches rather than conclusions? Much of the problem is created by bureaucracy - and I am conscious that I am speaking to four excellent bureaucrats. It would be useful if we even had mutual recognition of bureaucracies among European countries. For example, if a form is numbered E45 in this country, there should be a similar form, of the same number, in every other country. Perhaps other countries might need additional forms, such as E45 a, b, c and so on, but if each country had a form with the appropriate information, there would be a basic level of recognition - somewhat like the recognition of the E111 form in the health area in each EU country.

There are two issues in terms of different jurisdictions. One of those, which has been dealt with by the officials, concerns a situation outside of Europe, say in the USA, whereby US legislation would require Irish-based US companies to maintain two sets of books. Sometimes, that can work well. For example, it saved Elan from becoming an Enron last year. By having an Irish set of books, to prove compliance with Irish requirements, the company was saved. If it is possible to have documentation which is recognised as appropriate at a particular level in different countries, then countries which have additional requirements can arrange accordingly. At least, in that situation, one would not have to prepare a completely new set of books in order to move from one country to another. That would be useful. Companies operating in Germany sometimes have to comply with seven different sets of regulations. In a European context, that involves not just 15 systems but even more than that in many cases.

Whether we can get bureaucracy working in a co-ordinated fashion is one issue. Another issue which is never fed into this discussion is that while everybody talks about the companies in terms of the various problems of moving from one to the other, it is not a level playing field. Different regulations, ranging from employment legislation to health and safety legislation to a variety of other regulations, which will affect the same type of companies in different jurisdictions.

Other issues also arise. The classic one at present is insurance and Ireland's insurance regime is not matched in any other jurisdiction. This means that people are not starting off from the same point. I cannot find any similarity with Ireland when I consider what is happening in different European countries. Is it possible to move forward in that way?

Senator Leyden

My comments are similar to those of Senator O'Toole. Harmonisation suits us at the moment but I am wary of debates between members of the European Union. It is a matter perhaps of bringing in increased tax harmonisation between Ireland and the rest of the Union. The current position is to our benefit although I accept that it may not be so in one year's time.

Is the end of this year the deadline for the business expansion scheme? The scheme has been tremendously helpful in the creation of employment. Has the Department assessed the benefits accruing to the economy under the scheme? For example, in Kiltoom, south Roscommon, the Hudson Bay Hotel would not have been built without the BES. Certain people have benefited from that but the local economy has also benefited. I understand there are certain restrictions with regard to hotels but would appreciate a response to my query.

I was a Minister of State at the Department of Enterprise, Trade and Employment, as was Deputy Richard Bruton, and at that time the Department had a scheme known as "training houses". It applied to companies which were not manufacturers but were exporters, for example, mushroom producers. The scheme was much sought after at the time and was very helpful to some of the big companies which availed of it, such as those in Monaghan, which are now very successful. No mention is made of this in the excellent presentation made to the committee today but I would like to know if the scheme is still operating. The scheme introduced full corporate tax for those sectors.

Ms McManus

We are here to outline and explain policy but not to comment on it.

Senator O’Toole

The members of the delegation are among friends.

Ms McManus

Let me explain the policy from our perspective. If one looks at harmonisation, consolidated tax bases and unanimity, which is probably the other issue in terms of the European convention and the kind of tax issues arising at present, there are a number of inter-linked issues. The first concerns the role of tax in any country, which is very much at the core of sovereignty. Tax is a particular instrument which is used in different ways in different countries, and that can be as much to do with history and culture as economic interest. For example, with regard to excise duties on alcohol, northern European countries such as ours have a tradition of very high excise rates on alcohol whereas the southern European countries do not tax it at all. In a sense, that has as much to do with political or social choices or the particular stage of development a country is at; for example, with regard to a peripheral country's corporation tax rate.

We should not think of taxation as the only competitive issue because there are many other relevant issues such as education, infrastructure and so on. In highly integrated countries such as Canada and the United States, a wide variety of tax rates are found, depending on the particular circumstances of particular states. I am not sure that a case can be made that it is either necessary or desirable - in objective terms and leaving aside particular Irish interests due to our low rate - to take that flexibility away from individual member states.

From a policy point of view, there is a good case for saying that we will undertake the necessary harmonisation or co-operation - whatever word one chooses - to allow us to take advantage of the European market. There should not be barriers or too much bureaucracy, although tackling that might be more difficult than tackling cross-border losses. Even leaving aside the importance to Ireland of the corporation tax rate, there is a good case for saying that all of the arguments about subsidiarity should be applied to the taxation area within the European Union for many reasons, not least the democratic accountability of governments and parliaments to their individual member states.

For that reason, the unanimity issue is very important because when agreement is made at EU level to adopt a common approach, the agreement is in everybody's interests because the necessary compromises have been made to meet those interests. Without that kind of safeguard in the system, there is a risk that the Union would end up with a common approach just for the sake of it.

I was asked about the rates. It is true that Estonia has a zero rate and Cyprus is at 25%, although it has indicated it will go down to 12%.

Mr. Murphy

Cyprus had two rates up to now - 4% for international financial services, much like Ireland, and a normal rate of 25%. Our understanding is that Cyprus is merging the two rates, similar to our own, at about 12% or 13%. Similarly, Hungary, which is at 18%, is thinking of coming down to around the same level as Ireland.

Ms McManus

I think the Hungarians are talking about 14%. There is an issue with regard to the bigger countries in that even they are on a downward trend with regard to corporation tax rates, certainly in Germany, if not to the same degree in France. However, there is a wider issue about rates. If one argues with regard to entrepreneurship, which is pertinent to this paper, that lower rates generate more activity, then it would be expected that rates would come down and it would be of benefit, from a European perspective, for rates to come down.

The area of corporation tax, in particular, cannot be viewed in isolation from the international economy in which we work. If Europe decided, for some reason, that all corporation tax should be set at 80%, this will not mean that business will move from Ireland to France or Germany; it will go to Switzerland, Singapore, India or elsewhere. The European Union cannot operate as if in a vacuum.

For those reasons, there is a strong case for saying that, whatever their relative tax rates, member states should have the freedom, to the maximum extent possible, to take decisions at national level. That is not to say that there cannot be a large degree of co-operation and agreement where there is a benefit in terms of removing barriers to the advantages of the single market. While it may take a bit more time because it would have to be negotiated through the various systems, I think it is worth it.

There is a code of conduct group at EU level which was set up at the Council of Ministers to tackle harmful tax competition. That operates on a voluntary basis and there is no legal basis for it. However, it has been quite successful at moving forward and achieving a common approach on many issues. Bureaucracy is an issue for the European Union as a whole in many areas other than taxation. The joint transfer pricing forum is trying to tackle that and various EU-level programmes are in place. The fiscales programme brings EU officials together in an attempt to build a common approach on administrative issues.

Harmonisation does not always eliminate problems. There has been a harmonised base in terms of the VAT system since 1977, but there are as many interpretations of the detail of VAT laws as there are member states. I suspect many different forms exist, although the common base has meant there have been attempts to put in place common computer and invoicing systems. There is a willingness at EU level to harmonise, but we all come from very different systems which can be an issue.

The matter of the manner in which the consolidated base would work was raised. The Commission offered a number of options in this regard, one of which was the introduction of a system of home state taxation. An Irish company would use the Irish base to calculate its tax bill. The Commission has issued a discussion paper, or consultation document, to industry recently which outlines a proposal for a pilot project for SMEs in border areas. A couple of member states have done some work in border areas based on this type of idea. The other approach mooted was to introduce an EU method of calculating a tax base by which everybody would calculate according to common rules. In the context of home state taxation or a consolidated tax base, an Irish company would calculate its base rate at 12.5% while a company in Germany would calculate its base and pay the German tax rate. The tax would then be distributed on a group basis according to a state's particular activities or some other formal method. One of the major problems is calculation of the proportion. It can be argued that this happens in terms of VAT where there are similar systems but different VAT rates in various member states.

The difficulty is that in trying to decide common rules for a common tax base, one ends up with the same problems we face at the moment. Loss relief is a difficult issue for member states because if one gives credit for losses in another member state, one incurs a loss against one's tax base. That is proving quite a difficult issue to resolve even in the context of a narrow directive which tackles only losses. One would have just as much trouble trying to get member states to agree how to approach the matter on a consolidated basis as one would dealing with the issue in the same way. Member states treat a great many matters differently in their corporation tax base, whether it be capital allowances or another element. With consolidation, much of the flexibility of member states would be removed and if it were discovered that a loophole existed or a particular interpretation of a provision was made, problems would be caused in terms of unintended exploitation of legislation. The consolidated tax base would then have to be re-negotiated.

It is not clear that the same base calculation for all companies would apply, while much member state flexibility would be removed. Many rigidities would be introduced to the system. Different member states may wish to provide research and development tax credits or other incentives in different ways. If a common base exists, it will be very difficult to make the appropriate provisions. I find it very difficult to see how home state taxation would work because different activities would go to the most attractive home-state taxation base. While one can see a certain attraction in being able to calculate by only one set of rules for small companies that might not conduct much activity abroad, in practice the big multinationals will move if they think there is a tax saving to be made.

Mr. Kelly

Regarding the competitive issue, if the system were introduced on an optional basis, multinationals would be able to opt in if it were to their benefit and particular tax rules would apply. Another company competing with a multi-national in the domestic market without operating across borders would be subject to domestic tax rules. Two different sets of rules would then apply to two competing companies which would result in a competitive issue.

Ms McManus

The business expansion schemes have had different termination periods and it is the practice to initiate reviews of their benefits. It was not announced in the budget that the BES and seed capital schemes would terminate at their deadlines. That issue will be subject to review.

Mr. Murphy

Transitional relief was introduced with regard to hotels which has been welcomed generally. The 10% tax rate was applied to trading houses in the Finance Act 1987 to allow small firms without export expertise to sell to a specialised trading house. There were examples of this practice in Japan. The trading houses would buy the goods and centralise the expertise for exporting. Approval of the measure from Brussels was required as it was a clear aid to exporting which is against all the rules of the EU and the common market. The Irish economy was in such a bad state in 1987 - which is when the 10% tax rate for the IFSC was introduced - that Brussels kindly permitted the measure. When the economy began to improve in the 1990s, it became less acceptable to Brussels. The number of firms seeking certificates decreased and it was decided by the Departments concerned that there was no point seeking a derogation. Our 10% tax rate for manufacturing and the IFSC came under attack from the Commission in 1996, which is another reason the measure faded away.

For a long time, mushroom cultivation was regarded under the export sales regime as a separate activity to encourage exports. When we joined the Common Market in 1973 we were supposed to phase out the export sales regime nil rate for everything by 1980. We met this requirement which we transitioned to 1990 and we applied a 10% rate to mushroom cultivation. In the early 1990s, that measure was attacked as Monaghan Mushrooms was exporting great amounts of product to Northern Ireland and Great Britain which resulted in a complaint from British mushroom growers to Brussels. The Commission took us to task and told us to abolish the rate, leaving us with no choice but to comply. We told the mushroom growers to become manufacturers and a 12.5% rate now applies.

Senator Leyden

I presume the trading houses are still in place as there was no termination date on them.

Mr. Murphy

There was a termination date of the end of 1999 for that tax regime. Other 10% activities legislated for in the Finance Act 1990 will continue to 2010, but the trading house regime will not.

Chairman

If there are no further questions, I thank Ms McManus, Mr. Murphy, Mr. Leahy and Mr. Kelly for their informative briefing and, in particular, for their contributions to the question and answer session which we found very helpful. It will assist the committee in finalising our scrutiny of this EU document.

We will suspend for a moment to allow the witnesses to withdraw and will continue with our own business thereafter.

Sitting suspended at 4.10 p.m. and resumed at 4.11 p.m.