AN early decision is required on the future of the 10 per cent tax rate for manufacturing after 2010, when it is due to expire. This is a critical issue for many overseas projects, where there is a long lead time involved in planning and construction and then several further years to achieve profitability.
These companies will only take a decision to invest in Ireland if their tax position after 2010 is clear.
The tax rate after 2010 has to be low because competing countries have gradually reduced their rates over the last decade. States such as the Netherlands, Switzerland and Singapore can offer effective tax rates of less than 10 per cent.
A low tax rate is also required to help offset competitive disadvantages, particularly with the UK, in areas such as employment taxes, transport and energy costs.
The 10 per cent rate applies to manufacturing, software, data processing and a limited range of other activities. There is a need to ensure that a lower rate of Corporation Tax is also available to service enterprises.
Service jobs have been growing twice as fast in the European Union as in Ireland. As a result, there is unexploited potential in services which can be more fully realised with a lower rate of tax.
Forfas proposed the following three options for Corporation Tax after 2010 in "Shaping Our Future: A Strategy for Enterprise in Ireland in the 21st Century", which was published last May:
. Single low rate
A single low rate for trading income, as close as possible to the 10 per cent rate with perhaps a higher rate for non trading income, would have significant benefits.
It would retain our competitiveness for overseas investment and would give a major stimulus to Irish and overseas owned service companies.
This is a desirable option. The apparent costs could be offset by revenues from increased activity in the same way as the 10 per cent rate for manufacturing has generated increased exchequer revenue over the years.
The revenue generated was above what it would otherwise have been, despite initial reservations that the 10 per cent rate would result in reduced exchequer revenue.
. Extension of the 10 per cent rate
The 10 per cent rate has been the most powerful investment incentive for Ireland since its introduction in 1980. A decision to extend it would have clear advantages. Any such decision should also be accompanied by a gradual reduction in the standard rate, to benefit services companies.
. Ruling System
A number of EU countries have introduced a "ruling" system to provide low effective tax rates for preferred sectors of economic activity, on a general or a case by case basis. In some cases, the effective tax rates negotiated for new investment projects under the system have been less than 10 per cent, although less certainty attaches to such "rulings" compared with the 10 per cent rate of tax for manufacturing that applies in Ireland.
There is a growing interest in "ruling" systems in a number of countries. However, such a system could have considerable constitutional and administrative difficulties in Ireland.
. Tax incentives
Investment in Irish owned enterprises could also be expanded through other means. The present taxation system favours investment in low risk areas where the pre tax returns are high. These include residential property, property in urban renewal areas, pensions, special savings accounts and Post Office accounts.
This position makes it difficult for manufacturing and services companies to attract investment, particularly because their projects are inherently more risky. The risk reward balance should be changed in favour of these investments. This would involve removing tax incentives for non productive investment and ensuring that equal tax treatment is given to all forms of long term savings.
. Capital Taxes
Investment would also be encouraged if all capital gains from manufacturing and services were taxed at the lower rate of income tax, which is 27 per cent at present. The present rate of capital tax is 40 per cent with a reduced rate for smaller companies.
Entrepreneurs risk losing their investment if the projects in which they invest are not successful. A high rate of capital tax can reduce the incentive for promoters to build a business to a size and scale necessary to compete successfully in the international market place. In order to encourage investment it is, therefore, important to ensure that the capital appreciation on successful projects is not unduly diluted by tax.
High capital taxes also act as a deterrent to management moving from employment, where the reward is mainly by way of salary, into an entrepreneurial position where the rewards would be mainly by way of capital gain. These entrepreneurs cannot take profits out of the business because the funds are needed to finance growth. They are, therefore, motivated by the likely appreciation of their shareholding.
Capital taxes account for around one per cent of tax revenue. A reduction to the lower rate of income tax would favour investment and is unlikely to result in any significant loss of tax revenue.
