The Corporation Tax (Northern Ireland) Bill (‘Bill’) proposes to devolve powers enabling the Northern Ireland Assembly (‘Assembly’) to set its own rate of corporation tax rate in respect of trading profits (with some exceptions). At the time of writing, the Bill is expected to become law before the end of March.

After it is enacted the legislation will still need to be ‘switched on’ by the incoming UK Government after the 7 May 2015 election, in accordance with the provisions in the Stormont House Agreement. The Assembly will also need to set the rate of tax and the date from which it becomes effective. At the time of writing, neither of these had been finally determined, although the earliest date from which the Assembly will be able to vary the tax rate is 1 April 2017. The rate will then apply to financial years i.e. 1 April to 31 March and most commentators anticipate that the rate will be set at 12.5%, though 10% has also been mentioned. Whether the 12.5% (or 10%) rate will be achieved either in a single step on the designated date, or in stages; this too, is yet to be determined.

In briefings provided after the 8th January announcement, HMRC stated that the principles underlying the Bill have been agreed in outline with the EU Commission. Now that detailed provisions are available the overall effect and those of any individual features will likely be the basis of discussions between the UK government and the EU Commission to ensure they are compatible with EU law.

Which businesses, and activities, are affected?

The NI corporation tax rate (‘NIr’) will apply to all companies (regardless of where they are incorporated) which qualify as a ‘Northern Ireland company’.

A Northern Ireland company is one which carries on a ‘qualifying’ trading activity, and meets either the ‘SME test’ or the ‘Large company’ test. These tests are discussed in more detail below, however it is these tests which introduce the geographical aspect to the NIr. Crucially, there are important practical differences in the mechanics of the NIr regime for SMEs and Large companies.

It should also be noted that corporate partnerships with a NI trade are also within the regime – though with specific modifications to the legislation to accommodate them.

The NIr will not apply to non-trading profits or capital gains. These will remain subject to the main UK rate of corporation tax.

Furthermore, not all trading profits will be ‘qualifying trading’ profits. Certain activities are specifically excluded – these are lending and most banking activities, investment management, long term insurance, re-insurance and oil & gas. Again, the profits of these trades will remain taxed at the main UK rate of corporation tax.

Back office activities of excluded trades

Even though certain trades are excluded from the NIr regime, the Bill allows a relaxation for ‘back office’ activities of lending and investment (i.e. most banking), investment management and re-insurance trades. Companies carrying on these excluded trades can elect to bring into the NIr regime profits arising from back office activities wholly undertaken in Northern Ireland. The NIr taxable profit will be determined by a statutory 5% mark-up on back office costs.

Where the company’s entire activity is a back office activity, then normal transfer pricing rules will apply in determining the profit subject to the NIr.

The definition of ‘excluded trade’ and ‘back office activity’ will both be determined by the UK Government, and may be subject to future amendment.

The SME Test

To pass this test a company must:

• Be an SME under the normal EU size definition, and
• Meet the ‘NI Employer’ rule.

This test is applied annually, although a company will pass the test if it can meet both the size and NI employer criteria in either the current or previous accounting period.

If the SME Test is passed, then all the company’s qualifying trading profits – wherever made in the UK – are taxed at the NIr. However, if the test is not met, then the NIr will not apply to any of the company’s profits.

SMEs that are close to either threshold and/or are part of wider business activities with related entities may have difficulty in assessing their status in individual years and may fall in and out of the SME regime.

EU definition of SME

A company is regarded as SME under the EU definition, if, when taken together with all group companies and partner/linked enterprises, it has:

Less than 250 employees, and has either

• turnover of less than €50m, or
• balance sheet gross assets of less than €43m.

Companies that fail these size criteria are large companies for the purposes of the Bill.

NI Employer rule

This rules demands that at least 75%, by both time and cost, of the company’s workforce relates to activity carried on in NI. However, there is a further subtlety, as it is only the UK time and cost that is looked at in determining the 75% – so the test really requires a company to split its workforce’s time and cost into three; that relating to GB, NI and the rest of the world. From this it follows that a number of NI headquartered SMEs, with significant GB-based operations could fall outside the NIr regime.

The other subtlety in this rule is that a company’s workforce is defined more broadly than just the staff on its payroll. The workforce taken into account also includes externally provided workers i.e. temporary and agency staff. Again this could be an important point for some industries.

The Large company Test

A large company is one which is not an SME as defined by the EU criteria.

Large companies will be subject to the NIr on qualifying trading profits which are attributable to a Northern Ireland Regional Establishment (NIRE). This is essentially defined as a fixed place of business in NI.

How are the profits attributable to a NIRE computed?

The broad objective of the Bill is to tax trading profits earned in NI at the NIr

Hence a large company must appropriately split its profit between that arising in NI and that in GB (and elsewhere in the world). In doing this the company should adopt internationally recognised transfer pricing/branch allocation principles and treat the NI activity as if it was dealing with the other parts of the company on an arm’s length basis (the ‘separate enterprise’ principle). It goes without saying that businesses will be expected to be able to justify the profit attribution adopted, and retain the documentation necessary to support it.

Large companies and capital allowances

On entry to the NIr regime, companies will be expected to apportion, on a just and reasonable basis, the tax written down value of their capital allowance pools between assets used in NI and GB operations. In future years companies will be required to split capital allowance additions in a similar way.

Where there is an asset used in both NI and GB activities, that asset is to be de-pooled and kept in a single asset pool and allowances apportioned on a just and reasonable basis.

Other Matters

Relief and credits

Where an SME is entitled to relief by way of an additional deduction for R&D expenditure the approach is to provide relief of the same value as that for SMEs subject to the UK tax rate. This is done by way of a formula. The post 1 April 2015 R&D additional deduction for SMEs is 130% of the qualifying expenditure. So, for example, if the NIR were 12.5%, the additional deduction becomes 208% (130% × 20/12.5), meaning that for each £100 of qualifying R&D expenditure, there is a tax benefit of £26.

Where there are NI losses which are surrendered by an SME for a repayable tax credit, there are similar adjustments to maintain the value of the credit and compute the losses surrendered.

It is worth noting that similar provisions apply for a number of other tax reliefs such as Contaminated Land relief, Film Tax relief, Television Production, Video Games Development and Theatrical Production; the broad intention is that the value of the relief or any cash credit is not reduced for NI companies as a result of a reduction in the corporation tax rate.

The approach with the large company Research and Development Expenditure Credit (RDEC) is to preserve the value of the credit by including any RDEC as part of UK main rate profits. There is no adjustment to the rates of tax or credit and the monetary value of the relief remains the same for NI or GB businesses.

The Patent Box regime, which broadly taxes income arising from the exploitation of patents and related income at a reduced rate, is modified for NI companies so that the effective 10% Patent Box tax rate applied in the existing UK regime is maintained.

Intangibles

The treatment of intangibles is one of the most complex areas in the Bill. A key aspect is that the Bill distinguishes between pre and post commencement intangibles.

Pre commencement intangibles are assets created by any person that are in existence at the commencement day (which as mentioned above, is anticipated to be 1 April 2017). Intangibles debits and credits arising in relation to such assets will remain relievable or taxable as main rate profits.

Intangibles debits and credits arising in relation to assets created post commencement will be relieved or taxed at the NIr.

It is also worth noting that in the case of a ‘Northern Ireland company’ that is a Large company, it will be necessary to identify the intangibles debts and credits that are attributable to the company’s NIRE; only those debits and credits will be subject to NIr.

Losses

The overall approach to qualifying trading losses under the NIr regime is to permit the same types of offset – i.e. carry forwards, sideways relief, carry back or group relief – as under current UK tax law. However there is a ‘preferential’ approach adopted. NI losses (i.e. losses incurred on trades subject to the NIr) are to be offset in preference against NI profits, and main rate losses preferentially against main rate profits.

After that preferential offset, a remaining NI loss can be used against a main rate profits, however the loss is revalued to reflect a difference in tax rates. For example, an NI loss of £100 would only shelter a main rate profit of £50 if the tax rates were 10% and 20% respectively. No similar revaluation is required where a main rate loss is used against an NI profit.

On the commencement of the lower NI rate, there is no requirement to revalue losses brought forward. Such losses cannot be NI losses as these are defined expressly as losses arising in the NIRE post commencement.

Conclusion

As the analysis above has illustrated, for businesses with existing operations in NI there is considerable complexity to the Bill, particularly as the new regime is introduced It is therefore important that businesses start to assess the potential implications on their business, so that they are best positioned in advance of potential commencement on 1 April 2017.

However, for Foreign Direct Investment (FDI) companies, whilst the Bill has some nuances, and subtleties, it is grounded in familiar international tax principles.

Martin Fleetwood is a Partner and Michael Heinicke is a Senior Manager in PwC’s tax team in Belfast.

Email: martin.fleetwood@uk.pwc.comTele: +44 (0)2890 415486Email: michael.heinicke@uk.pwc.comTele: +44 (0) 28 9041 5052