Introduction

I am glad to have the opportunity to address this Seminar on the Strategy for the Development of International Financial Services in Ireland. The Strategy document itself is the product of a unique partnership between the public and private sectors that has been fostered throughout the years from the inception of the IFSC. The report is an impressive blueprint for action and a testament to the importance which both the public and private sectors attach to meeting the challenges facing the international financial services industry in Ireland.

The fiscal and taxation environment in which the IFSC operates, along with the other sectors of the economy, is dramatically different today from what it was when the IFSC was created twelve years ago. This changing environment has come about, in part, as a result of the tremendous growth experienced in the entire economy as well as the in the international financial services area.

IFSC: Historical Context

In the first half of the 1980s, the unemployment rate reached a record high of 17% during a period of heavy emigration. Output was stagnant. Budget deficits exceeded 12 % of GNP. It was against this backdrop that the establishment of the IFSC was conceived as one of the means to remedy the situation.

The IFSC was established in 1987 with the objectives of creating sustainable employment while also contributing to the renewal of Dublin's Dockland. The Irish Government successfully obtained European Union approval for a time-limited preferential corporation tax rate of 10% on the trading income accruing to institutions conducting international financial services activities from the IFSC. Despite facing many difficulties along the way, the IFSC has spectacularly achieved the objectives which were set for it.

Changed Economic Environment

Ireland is entering the fifth straight year of what a recent OECD report describes as "stunning economic performance." Our economic performance is unmatched by any other OECD country. Output growth has averaged over 9 per cent per year on a GDP basis between 1994 and 1998. The unemployment rate has declined by nearly 9 percentage points to a current level of 6.4%. The net migration flow out of Ireland has been reversed. Last year alone 72,000 new jobs were created. Government finances have improved dramatically.

The growth of the IFSC mirrors that experienced by the general economy.

The IFSC is now established as a successful and reputable financial centre, providing substantial, high-quality employment over a broad range of activities. More than 6,500 people are employed directly in the Centre and in associated back-office projects. The Custom House Docks area has been transformed in a fine example of successful urban renewal, providing a vibrant and attractive working and living environment.

The IFSC now ranks well along with other global locations of choice for international banking, investment fund management and administration, corporate treasury management, non-life insurance and life assurance activities. Some 400 institutions have established standalone IFSC operations, including most of the top global financial companies

Consequences of Changing Environment

When approving the 10% tax regime for the IFSC in July 1987, the European Commission put a three-year time-limit on it. The Irish Government later sought and achieved a number of extensions of the deadline, with the last one in December 1994 extending the 10% tax regime to end-2005 for projects established by end-2000.

One result of the changing economic environment in Ireland has been a change in the attitude of the Commission to the timescale for the preferential tax regime. In 1998, following protracted negotiations, agreement was reached between the Irish authorities and the European Commission on the phasing out of the 10% corporation tax rate for manufacturing and for certified activities in the IFSC and the Shannon Zone.

The agreement brings forward the deadline for new projects by one year to end-1999. The number of new projects which may be approved in 1999 is limited to 67 - the same number of projects as approved under the agreement for 1998. Once the 1999 quota has been allocated, the preferential IFSC regime will not be available to any further projects in the international financial services area. The final tranche of new project approvals will be allocated in late July. Existing IFSC companies, will, of course, continue to be eligible for the 10% rate of corporation until their tax certificates expire at end-2005 for projects approved before 31 July 1998 and end-2002 for those approved since then.

Successor to 10% Tax Rate

It was always clear that the 10% tax regime in the IFSC was time-limited and would come to an end, though the extensions negotiated by the Government may have led some to hope that it could be continued indefinitely! What was not so clear was what would follow it. There was never any doubt however but that the Irish Government would do its utmost to introduce a regime which would ensure that the IFSC would still be an attractive place to do business and so build on the initial success. This indeed is what has happened.

The decision announced in May 1997 to move to a single rate of 12 ½ % for trading profits in all sectors of the economy and a higher rate of 25% on income arising from non-trading activity showed the way forward. The single rate for trading activities will apply from 1 January 2003.

The 1999 Budget speech and the 1999 Finance Act set out the timetable for the gradual introduction of the 12½% rate. The standard corporation tax has been reduced from 32% to 28% from the beginning of this year and there will be further reductions in the standard rate of 4% per annum in each of the years 2000, 2001 and 2002 and a 3½% reduction in 2003.

The move to a single 12½% corporation tax rate on all trading income is a major development which required a review of other elements of the business taxation system. This review was needed both to protect the domestic revenue yield and to ensure that a low general rate does not attract undesirable activities here with consequences for our international standing. The 12½% rate will provide a very favourable environment for enterprise, including financial services, in Ireland. However, the necessary safeguards have to be built into the system to ensure that it operates in a manner which is satisfactory in all respects.

The introduction of the general 12½% corporation tax regime and the ending of the IFSC licensing system will mean that, eventually, there will be no distinction between the treatment of IFSC companies and other financial service operations. The ring-fence surrounding the Centre, in terms of the IFSC-specific application of certain other tax treatments, will lapse.

The Government is committed to maintain and build on the level of success so far achieved by the IFSC. The 12½% rate is the key policy action for this. It must be recognised, however, that there are domestic and EU State Aid constraints on implementing any additional potential legislative initiatives.

The fundamental domestic constraint on any action is, of course, the cost to the Exchequer of any changes, since they will have to apply generally rather than be limited to the IFSC. It will be necessary to evaluate these costs in the light of the benefits to be gained.

A number of changes have already been made to support the 12½% regime. Others are still under consideration.

Tax Credits

One of the changes which has already been introduced is the abolition of the tax credit on dividends, which leaves us now with the so-called "classical" system.

Dividend Withholding Tax

The 1999 Finance Act also introduced a withholding tax at the standard rate of income tax on dividend payments to Irish resident individuals and certain non-residents. This is seen as a necessary accompaniment to the single low rate of tax for both domestic and international reasons.

It provides an efficient collection mechanism and reduces the risk that dividend income would not be included in shareholders' tax returns - the additional tax payable by top rate shareholders on dividend income is higher under the classical system than under the partial imputation system. If the withholding tax were confined to dividends paid to residents, this would create avoidance and evasion opportunities for Irish shareholders, particularly shareholders in closely-held companies, through the use of certain foreign holding company structures. In such circumstances, the 12½% corporation tax could well be the sole tax imposed on distributed company profits. Within the context of the reduced corporation tax rate, no advance corporation tax and the increased domestic income tax payable on distributed profits, this situation could not be sustained. A blanket exemption for dividends paid to all non-resident entities could result in tax leakage and in problems for the perceived equity of the new corporation tax regime.

Also, the imposition of a withholding tax which made a distinction between residents and non-residents could run into problems under the EU Code of Conduct on business taxation. Two factors to be taken into account in determining whether a measure might be considered potentially harmful under the Code are the according of advantages to non-residents (or in respect of transactions with non-residents) and whether advantages are ring-fenced from the domestic market.

In light of the fact that the absence of a withholding tax on dividends in Ireland has been important over the years in attracting foreign direct investment, the introduction of this measure was a difficult policy decision and it has been drawn up in a way which seeks to get an appropriate balance between the various interests. The Government decided that the withholding tax should apply not only to resident individuals, but also to individuals, companies and other entities resident or controlled outside of the EU or tax treaty countries. The exemption for tax treaty countries was structured in a way that intermediate holding structures using non-treaty countries would not trigger withholding. Most IFSC companies will not be adversely affected by the withholding tax regime because of the way that it is structured.

Exempting our tax treaty partners from withholding is, of course, entirely justifiable as we are simply eliminating double taxation on the dividends, and giving the primary taxing right to the country of residence. Indeed, the same general approach has been adopted by a number of other EU countries. While the vast majority of foreign investment into Ireland comes from countries with which we have a tax treaty, the dividend withholding tax clearly will provide a strong impetus for extending our treaty network, particularly to include emerging countries being targeted by the IDA. We hope to conclude a number of such treaties with new partners in the coming year.

Securitisation

The Government introduced measures in this year's Finance Act which will broaden the scope for the conduct of asset-securitisation activities in the wider domestic economy. The encouragement of securitisation activities has been identified as a priority objective in the Strategy document.

The measures introduced increase the range of assets which may be securitised under our domestic legislation and is wider that that available in an IFSC-context. While such non-IFSC securitisation vehicles are not afforded "deemed trading" status, the 1999 Finance Act provided for a deduction from profits in respect of interest and certain other expenses of such securitisation vehicles.

I am aware that there are residual issues which the industry side has indicated are impediments to the development of securitisation business in Ireland notwithstanding the changes made in the Act. The Department is currently addressing these residual issues and I am confident that suitable solutions will be found.

Withholding tax on interest payments by companies

The Finance Act, 1999 also introduced significant changes to the withholding tax regime relating to the payment of interest by Irish companies. Prior to the Act, companies were obliged to withhold tax on the payment of annual interest, subject to a narrow range of exemptions which included IFSC-certified companies and collective funds. The facility for IFSC-certified companies to pay interest gross would, in general, lapse on the expiry of their relevant certificates.

Continuing the exemption for IFSC companies only after 2002 or 2005, as the case may be, was not considered feasible for a number of reasons, including the implications for our obligations under the EU Code of Conduct on business taxation. Instead, the approach adopted was to introduce a more broadly based withholding tax exemption for interest paid by any Irish resident company or collective fund to companies resident either in the EU or in a tax treaty country.

Other Tax Issues

There are other significant issues to be resolved in the tax area which are relevant to the continued success and future development of the international financial services industry in the post-IFSC period. The Department will continue to work closely with industry interests to resolve these issues. Within the constraints imposed both by our obligations to our EU partners and the competing demands being made on the Exchequer, I am confident that satisfactory solutions can be found to these difficulties.

EU Aspects

With regard to international tax considerations, Ireland supports a more co-ordinated approach to taxation policy at EU level which does not undermine the principle of subsidiarity and which takes account of the respective areas of competence of the Member States and the Community in determining taxation policy as reflected in the Treaty.

On 1 December, 1997, the ECOFIN Council agreed a package of measures to tackle harmful tax competition in order to reduce distortions in the single market. This package includes a Code of Conduct on business taxation and proposals for future Directives on the taxation of interest on savings and on abolition of withholding tax for cross border interest and royalty payments between companies.

The Code of Conduct is a political agreement which is without prejudice to the rights and obligations of the Member States under the Treaty. It is designed to curb harmful tax competition by targeting tax measures which have a significant effect on the location of business within the Community and which provide for a significantly lower effective rate of taxation than the rate generally applying in the Member State in question. Such measures are regarded as potentially harmful under the Code. A Code of Conduct Group, chaired by Dawn Primarolo, UK Paymaster General, has been established by the Council to examine potentially harmful measures in the Member States with a view to assisting the Council in determining what measures are actually harmful. Measures deemed to be harmful are to be rolled back in accordance with the provisions of the Code.

While Ireland's 10% rate of corporation tax for manufacturing and the IFSC have been listed as potentially harmful measures under the Code, these are being phased out under the agreement reached between the Irish authorities and the Commission. The phasing out arrangements agreed with the Commission are in line with the timetable for rollback set out in the Code. The 12½% rate on all trading income is fully in line with the Code.

The draft Savings Directive is designed to ensure a minimum of effective taxation of savings income in the form of interest payments in the Community. Member States would be required to either apply a withholding tax on the payment of interest to individuals or to provide the other Member States with information on savings income paid to their resident. The Directive would apply only to individuals and not to companies or businesses.

The Directive has been discussed in technical and high level groups since July 1998. Ireland is supportive of the Directive in general. The taxation of savings is a matter that can only be effectively addressed in an international context.

A proposed Directive on Interest and Royalty Payments provides for the elimination of taxation in the source country, whether by withholding or assessment, on interest and royalty payments between associated companies and permanent establishments located in different Member States. Such taxation is considered to represent an impediment to cross-border economic activity and to the smooth functioning of the single market. The purpose of the Directive is to remove this impediment by allocating taxing rights to the Member State where the beneficial owner of the interest and royalty income is resident. Although Ireland has some concerns about certain of the provisions, including coverage, we hope that these will be resolved and that the Directive can be agreed.

There was a lot of talk late last year about tax harmonisation at EU level. However, the Vienna European Council in December 1998 confirmed that harmonisation of corporation tax rates is not on the EU's agenda. The conclusions issued by the Heads of State and Government following that meeting provide a good conclusion to my address:

"Cooperation in the tax policy area is not aiming at uniform tax rates and is not inconsistent with fair tax competition but is called for to reduce the continuing distortions in the single market, to prevent excessive losses of tax revenue or to get tax structures to develop in a more employment-friendly way."