Corporate Taxation in the EC:
The Process of Corporate Tax Harmonisation in the EC
2001 Dr Jean-Philippe Chetcuti. All Rights Reserved.
Table of Contents
Taxes claim between a half and a third of national income in the MSs of the EC[xl] and carry a weight which cannot be overlooked. In the context of the minimisation of the overall tax burden of the EC[xli], the several fiscal divergences between MSs give rise to several important legal and economic implications for MSs and have made a case for a drive for the approximation of taxation systems. A joint statement was issued on 1 December 1998 by France and Germany, calling for rapid progress towards tax harmonisation in Europe. It was followed by press conferences at which it was suggested that the national veto over tax reforms should be abolished.[xlii] This proved a catalyst for public disagreement. With the setting up of a Single European Currency, coupled with other pressures for greater integration, tax harmonisation merits careful consideration. The views on the meaning of tax harmonisation and what form it should take are numerous and dissimilar. The purpose of this heading, therefore, is to explore the meaning, causes and implications of tax harmonisation and its role as a medium for the achievement of the internal market.
2.1. The Internal Market concept
The concept of a common market involves the elimination of all obstacles to intra community trade in order to merge the national markets into a single market bringing about conditions as close as possible to those of a genuine internal market.[xliii]
There arose the possibility that abolished customs barriers to trade could be replaced by internal taxes which would continue to discriminate against imports from other MSs. If different taxes were levied on a different basis or at different rates across the market, this would produce obstacles to the free movement of goods and services, thus frustrating the ultimate goal of achieving a genuine internal market. Clearly, an economic union and an internal market required a harmonised tax system. The EEC Treaty of 1957 began carefully[xliv] with provisions for the harmonisation of legislation concerning turnover taxes, excise duties and other forms of indirect taxation to the extent that such harmonisation is necessary to ensure the establishment and the functioning of the internal market.[xlv] Articles 90 to 93 of the Treaty are the principal provisions dealing with taxation and they are almost entirely concerned with indirect taxation. The European Court of Justice (ECJ) has commented on the relevance of these Articles to the internal market[xlvi] and has proved very supportive of the development of an integrated system of taxation. The ECJ has based the relevant decisions particularly on Article 95 and has included direct taxation in such decisions.
The Treaty establishing the European Community (EC Treaty) stated that its task was the creation of a common market, to which was later added an economic and monetary union.[xlvii] The activities of the EC were to include, among other things, a common commercial policy.[xlviii] The internal market was to be characterised by the abolition, as between MSs, of obstacles to the free movement of goods, persons, services and capital[xlix], and there was to be a system ensuring that competition in the internal market is not distorted.[l] This transcended the early steps towards indirect tax harmonisation. Undoubtedly, to sustain a single market, it is necessary to prohibit discrimination between imports and domestically produced goods and services. It has equally been argued that labour and capital should not be encouraged to migrate within the internal market for purely fiscal reasons and therefore corporate and personal taxation should be harmonised as well[li]:
it should be possible for corporations to run their business within the European Union without having their decisions regarding location, form of investment or financing influenced by taxation regulations. Consequently, in the long term a securing of the competition and ta neutrality though a joint policy of all Member States is desirable to satisfy the requirements of the internal market.[lii]
Ultimately, tax harmonisation will not only lead to the promotion of free trade and the single market, but it will also have the economic and political effect of creating an ever closer union among the peoples of Europe.[liii]
The main thrust of the argument for tax harmonisation has been cast in terms of free trade and a single market. There are also some related arguments, including:[liv]
2.2.1. Distortion of competition
Differences in the overall tax burden of similar investors in the various MSs result in different after-tax rates of return and different pay-back periods.[lv] This clearly gives rise to a distortion of the conditions of competition and thus the frustration of the principles underpinning the internal market.[lvi] The creation of benefits emanating from nationality or residence preserves interstate frontiers and keeps national markets segregated.[lvii]
2.2.2. Obstruction to the free movement of capital
One of the principles underlying the concept of the internal market is the principle of capital export neutrality.[lviii] Discriminatory treatment of international investment activities as compared with purely domestic investment activities acts to frustrate the ideal of capital export neutrality by hindering the free movement of capital.[lix] Thus the creation of preferences for investment in some MSs rather than others prevents capital export neutrality, whilst the diversity of tax burdens affecting businesses wishing to invest in the same MS means that neutrality of capital imports[lx] is not achieved.
With regards to the allocation of resources, another consequence of the above effects of fiscal disharmony is that an optimum allocation of resources within the Community cannot be achieved. This is because corporate location or capital investment strategies are not based on purely economic efficiency such as relative labour and production costs but are ultimately influenced by tax considerations. The principle of fiscal neutrality which includes that of locational neutrality[lxi] and which harmonisation seeks to uphold, prevents buyers and sellers in otherwise efficient markets to take different courses of action for tax reasons alone. It also ensures that differences in tax systems do not interfere with efficiency in production and consumer choice in the EC.
2.2.4. World market competitiveness of community industries
It may be validly argued that an optimal allocation of resources together with a reorganisation of industry along Community rather than national lines would reduce production costs. As a result, community industries would enjoy economies of scale similar to those enjoyed by their Japanese and American counterparts who already enjoy the benefits of a large home market for their products. In their sizeable national market, Japanese businessmen do not have to face phenomena like capital gains tax liability in cross-border mergers and international juridical double taxation.[lxii] And American entrepreneurs are only confronted with such obstacles to a much lesser extent. Thus, fiscal disharmony deprives such industries of these advantages so that they stand a lesser chance of proving competitive in the world market.[lxiii]
It has been estimated that ten to thirty per cent of the expenditure of the corporate departments of both private and public concerns consists in the administrative cost of catering for the different fiscal systems of the various MSs.[lxiv] Thus companies, particularly small- and medium-sized enterprises, have to suffer the initial costs of tax planning and accounting advice and this only increases the burden of such enterprises seeking expansion in the European Market. It is held that at least partial harmonisation of corporate income tax would greatly reduce the financial and practical price presently paid by companies attempting to adhere to various evolutionary and dynamic fiscal systems.[lxv]
Increased opportunities for tax planning, avoidance and evasion arise where differences exist in the national tax systems of the various MSs. These activities tend to lead to considerable losses of revenue so that revenue authorities have to make good the lost revenue by digging their hands deeper in the pockets of other taxpayers. Arguably, the harmonisation of corporate income tax could diminish the incidence of such activities as the application of non-arms length transfer prices within European groups of companies. This might contribute to the recent tendency to lower the tax burden with the aim of enhancing the position of European businesses in the world market and promote commercial activity and economic growth.[lxvi]
2.3.1. Corporate tax unification
Corporate tax unification eliminates distortive disparities between national corporate tax laws by imposing uniform rules under the form of a regulation. In its most advanced stage, unification effectively transforms the ensemble of the MSs national fiscal systems into a centralised corporate tax model. This single European corporate tax law effectively implies that every aspect of corporate taxation is regulated at Community level and that MSs have been dispossessed of their fiscal sovereignty.[lxvii]
This mode of fiscal integration falls victim of the following objections:
1. Legal factor: Under the EC Treaty, the harmonisation of corporate tax laws is permitted through Article 94[lxviii] and in the form of directives, and only exceptionally[lxix] in the form of regulations. Thus unification measures in the field of corporate taxation are presently the exception not the rule.[lxx]
2. Economic factor: corporate tax unification presupposes a centralised economic structure according to which major economic policy decisions are taken at a central level and there is no room for diversities and variations.[lxxi] At this stage, however, the EC has not reached , and might ultimately not reach, such level of economic integration. Arguably, the EC requires tax unification measures; however, any such approach in corporate taxation is over-ambitious and highly speculative considering the current state of affairs.
3. Political factor: The latter economic incompatibility of unification is mirrored by its political incompatibility with the current political structure of the EC. Theoretically, corporate tax unification requires decisions on corporate taxation to be taken by the Council of Ministers which, unlike the European Parliament, is not directly accountable to Europeans. In the light of the democratic deficit[lxxii]existing in the ECs decision-making institutions, uniformity and centralisation the elements of tax unification lack political acceptability in the MSs where decisions, especially in the field of direct taxation, are taken by the democratically elected national parliament.[lxxiii]
4. Subsidiarity: The transfer of fiscal competence from the national to the supranational level should only occur where fiscal goals cannot adequately be reached on the national plane. Therefore, if even corporate tax harmonisation measures are many a time considered an unjustified surrender of national sovereignty in the light of the principle of subsidiarity[lxxiv], imagine the controversy which proposals for corporate tax unification would bring.[lxxv]
2.3.2. Tax coordination
Coordination aims at securing the concerted coexistence of corporate tax laws of different states in cases where there is ground for conflict[lxxvi]or there is a need for combined legal action[lxxvii].[lxxviii] If corporate tax unification fails on account of its far-reaching centralisation ideology, tax coordination falls short of the needs of the EC on three counts:
1. it lacks the binding forceof its competitors, unification and harmonisation;[lxxix]
2. it is suitable for a state of affairs which is politically and economically looser than those which characterises the EC of today.
3. it cannot ensure fiscal neutrality[lxxx] (the theoretical factor) in that coordination does not contribute to the assimilation of the corporate tax laws of the MSs and the elimination of the differences existing between these laws.
Corporate tax coordination and corporate tax unification being the two unacceptable extremes, is follows that the ideal solution remains corporate tax harmonisation.
From its conception, various authors on the subject have sought to crystallise the notion of tax harmonisation into a definition which comprises all its facets.
For instance, it has been suggested that harmonisation refers to any situation where differences in taxation between the states (or provinces) are reduced either by co-operation among the states or by a federal government policy. It is however acknowledged that a completely uniform tax system may not be optimal or practical.[lxxxi]Co-ordination has been regarded by some as a kind of consultation process about organising tax systems in a similar manner. In essence, such an interpretation presents co-ordination as a low-level form of harmonisation.[lxxxii]
Others have sought to define tax harmonisation in terms of its ends rather than on precise institutional arrangements and have proposed a more open definition:
Fiscal harmonisation may be viewed as the process of adjusting national fiscal systems to conform with a set of common economic aims.[lxxxiii]
Taking a wider view of tax harmonisation, one can adopt two approaches to the concept. The first, the equalisation approach, causes each country to converge with the others until it ends up with the same fiscal system The second, the differentials or fiscal diversity approach, allows each country to use its tax system as a policy tool in achieving major economic aims.[lxxxiv]
Harmonisation of tax has also been held to refer to the process of removing fiscal barriers and discrepancies between the tax systems of the various countries comprising the EU.[lxxxv] Admittedly, efforts in the direction of tax harmonisation need not be confined to the boundaries of the EC and may be extended to the rest of the globe. Removing fiscal barriers refers to the principle focussed upon in the first main moves towards European tax harmonisation, whereby imported goods and services within a free-trade area were not to be subject to any fiscal discrimination in comparison to domestically produced goods and services. In addition, the above definition refers to removingdiscrepancies between tax systems, implying, rather than standardisation, the bringing of tax systems into harmony or agreement[lxxxvi] making up a consistent and orderly whole, without each part being identical and hence a more flexible approach.[lxxxvii]
Ultimately, the EC tax harmonisation exercise can be generally defined as the process of planning how to approximate the tax systems of the fifteen MSs in order to better achieve the objectives of the Community.[lxxxviii] The emphasis, rather than on standardization, is more on operating in harmony.[lxxxix]
2.5.1. Horizontal harmonisation
The EC Treaty does not specifically provide for corporate tax harmonisation and there is definitely no case for vertical corporate tax harmonisation. The process of harmonisation should therefore be a process which aligns national corporate tax laws, adapting them to the needs of the common market.
2.5.2. Positive harmonisation
Negative harmonisation assumes the form of standstill clauses in the Treaty with which national laws comply. In the absence of specific provision in the EC Treaty for corporate taxation or for direct taxation, corporate tax harmonisation must be positive and must take the form of measures, in accordance with the EC Treaty, which harmonise national corporate tax laws.
2.5.3. Gradual harmonisation
The Ruding Committee[xc] recommended the adaptation of the corporate tax harmonisation process to the three stages of economic and monetary union and therefore, favours a gradual rather than single-phased approach.
2.5.4. Partial harmonisation
The principle of subsidiarity[xci] precludes the idea of a total harmonisation of corporate taxation and requires the proposed harmonisation to be partial and addressed to those issues of corporate taxation which pose problems to the establishment or functioning of the common market.
2.5.5. EC-imposed and market-led harmonisation
There are two possible approaches to harmonisation. It can either be imposed by the EC on the MSs (a top-down approach) or else it can be induced by the market (a market-led or bottom-up approach). Ideally, a mid-way solution (a hybrid solution) should be adopted. Minimal harmonisation would be imposed to tackle the dissimilarities between the corporate tax laws of the MSs and therefore:
1. address those tax obstacles which hinder cross-border operations. This includes working on an intra-Community tax treaty network as well as efforts to assimilate the content of the tax treaties in existence between MSs and third countries, thus preventing the creation of tax havens within the EC for third country companies.[xcii]
2. produce common rules for a minimum tax base, ideally elaborating the 1988 Preliminary Draft Proposal for a Directive on the Harmonisation of Rules Determining the Taxable Profits of Undertakings.
Market forces should then be left to steer the harmonisation of statutory corporate tax rates.[xciii]
(for figure II, email author at firstname.lastname@example.org)
In attempting a possible classification of the levels of harmonisation (Figure II), I shall first lay down the main components of the tax system. These are the taxes being levied, the tax bases[xcv], the rates of tax and the ways in which taxes are administered.[xcvi] Complete harmonisation or standardisation of taxes is the extreme shown at the right hand branch of Figure IIwhere each country has exactly the same tax system. In this scenario, each country imposes the same taxes (for example, value added tax), levied on the same tax bases (goods, services) and at the same rates.[xcvii]
The complete absence of harmonisation is the diametrically opposed arrangement seen in the left hand branch of Figure II. Here we have different taxes in different countries and the complete absence of any double taxation treaty and of any systematic administrative co-ordination between the tax authorities of the different countries over matters such as tax evasion.
Between the radical poles of absolute harmonisation and non-harmonisation, it is possible to identify varying levels of harmonisation. The first movement away from completely different fiscal systems might be the introduction of a degree of administrative cooperation between tax authorities regarding taxpayers with tax affairs falling within more than one tax jurisdiction. The next step might be the negotiation of formal double taxation treaties so that the same income is not taxed twice by two or more different tax jurisdictions. In Figure II, therefore, this situation is described as the mitigation of non-harmonisation.[xcviii]
A possible compromise would be partial harmonisation[xcix], which entails the harmonisation of some taxes and not others. In this way, the EC would establish some taxes to be applied uniformly in all the MSs, allowing the MSs to impose any other taxes they deem fit.
Nominal harmonisation is a slightly higher form of tax harmonisation in that, although countries have the same taxes as is the case in the EC for corporation tax, value added tax and income tax however, these taxes are not levied on the same tax base or by the same administrative methods in all the MSs. For this reason, the result produced by this step leaves much to be desired. For instance, the tax base might vary from country to country; although each MS levies an income tax, the scope of such tax differs in different countries. As regards indirect taxation, some goods and services which are subject to tax in some countries, are not so subject in other countries. Moreover, the method of administering a tax might be different; thus, each MS has a form of corporation tax, but they use different forms of interpretation between tax paid on corporate profits and that imposed on shareholders, e.g. the classical system and imputation systems.[c]
As the argument for fiscal federalism goes, it would be acceptable for tax decisions to be taken at Community level and others at a lower level, and this in the light of the different demands for public goods and services which feature in various countries having different national, political and cultural traditions. Thus, the suggested two-tier arrangement, known as the local government model contemplates levying the same taxes, on the same tax bases, in each country while allowing local tax jurisdictions within such countries to charge taxes at different rates and even to impose different taxes from other local tax jurisdictions. It is submitted that such divergent local taxes are most suited to finance the peculiar demands of different MSs on their public purses.
A factor which challenges the foundations of the arguments for fiscal federalism remains that it is a fundamental principle for MSs to retain for themselves their exclusive power to tax. Fiscal sovereignty means that MSs are free to decide themselves how the domestic fiscal system should cater for domestic needs, without interference from the EC. What can be tolerated are Community acts which minimally encroach on domestic fiscal sovereignty only in the field of cross border operations.
In practice, nonetheless, in the sphere of European tax harmonisation, the question remains: to what extent are fiscal differences between countries consistent with the overall goal of tax harmonisation and what degree of harmonisation is desirable to attain? Thus, the concept of fiscal federalism raises the question of the appropriate levels of government at which particular fiscal responsibilities might best be lodged.