State must be clever to take advantage of EU tax laws

Comment: The European Court of Justice is playing an increasingly significant role in shaping the Republic's tax laws.

In the negotiations for the new European Union Constitution, the Republic, and other similarly minded states, secured a major victory by ensuring that a unanimous vote of all EU member states would be required in order to harmonise EU tax regimes. With 25 member states now in the EU, many of them hostile to EU tax harmonisation, the chances of any such unanimous agreement is virtually nil.

Countries such as France and Germany, which were pushing for tax harmonisation, have irretrievably lost this debate.

This means, for example, that the Republic retains the sovereign right to keep its corporation tax at the relatively low rate of 12.5 per cent and can continue to use this as an incentive to attract foreign industry.

However, the EU can still affect domestic tax laws - sometimes in ways that horrify the political rulers of member states.

Firstly, the EU is empowered to ensure fair competition throughout the EU. We have seen recently that this can prevent the Republic from giving cash grants to multinationals that it wants to encourage to invest here.

The same principle applies to tax breaks - a specific tax break granted to one company or even to one sector of an economy may be contrary to EU law.

It was for this reason that the special tax breaks applying to manufacturing and IFSC companies had to be phased out. However, there was nothing in EU law to prevent the Republic from introducing a general low rate of corporation tax for all companies and this was the policy response chosen by the State.

Another area where the EU plays a significant role is in enforcing the principle of "freedom of establishment". This freedom is guaranteed by EU law and it means that a company cannot be discriminated against because it is based in one country rather than another.

An example of such unlawful discrimination was the treatment of deposit interest under Irish law. The treatment used to be that a deposit with an Irish bank suffered 20 per cent DIRT and no further tax, even if the recipient was a 42 per cent taxpayer. However, a deposit in a bank account elsewhere in the EU was liable to tax at the taxpayer's top marginal rate. The 2005 Finance Bill has removed this discrimination. Anyone who has suffered from this in the past may have a case to claim a refund of tax from the Irish Revenue.

There are currently a number of significant tax cases before the European Court of Justice.

In one case, the UK has been taken to court because it sought, under the terms of the UK's Controlled Foreign Corporation rules, to tax the profits of certain Irish subsidiaries of the Cadbury Schweppes group.

Many EU member states have Controlled Foreign Corporation rules and they are generally designed to remove any tax advantage from financial-type profits being earned in a lower tax country (the Republic in Cadbury's case). Such rules have, therefore, been somewhat of an obstacle to attracting investment to the State. If the taxpayer wins this case, it will be a welcome boost to the Republic's attractiveness to overseas investors.

Another case which the European Court of Justice will decide shortly is whether to allow Marks & Spencer to shelter its UK profits with losses generated by subsidiaries in other EU member states. If the taxpayer wins this case, many companies in the UK and the Republic may see dramatic reductions in their corporation tax liabilities.

The Irish authorities have been relatively sensible in trying to ensure that Irish law complies with European law, although a number of provisions in Irish law remain vulnerable to an EU law challenge.

The State has also, at times, been clever in trying to position the Republic to take advantage of evolving international law. An example of this is the legislation which the Republic introduced to facilitate Common Contractual Funds.

A Common Contractual Fund is a vehicle designed to allow pension funds in many different countries to be pooled. By being one of the first states to introduce legislation to allow Common Contractual Funds, the Republic has positioned itself to corner a lot of this business.

Fast and clever policy responses from the State can ensure that the Republic and it's economy take advantage of the opportunities offered by international law whilst avoiding the worst pitfalls.

Conor O'Brien is a tax partner with KPMG