3. Progress in harmonisation of corporate taxation

Corporate Taxation in the EC:
The Process of Corporate Tax Harmonisation in the EC
2001 Dr Jean-Philippe Chetcuti. All Rights Reserved.

3. Progress in harmonisation of corporate taxation

Unlike VAT, direct taxation is at a purely embryonic stage of harmonisation.[ci]

This is Advocate-General Lgers description of the record of tax harmonisation through Community legislation in the domain of direct taxes.  In this part, I shall seek to demonstrate how the principles underpinning the concept of the internal market have concretely moulded the fiscal developments in the EC since 1962, in the light of the ideal of corporate tax harmonisation advocated by Euro-enthusiasts.

3.1. The Neumark Committee

The harmonisation of direct corporate taxation was first proposed in the 1962 report to the Commission of the Fiscal and Financial Committee (the Neumark Committee).[cii]  The Committee recommended more action at Community level to address the current state of affairs in the fields of company and dividend taxation:

the current situation is at such a point of confusion that an analysis in a systematic way is required.  It goes without saying that harmonisation will have to be achieved [ciii]

The Neumark Committee held that differences in total tax burden might not influence conditions of competition within the Community.  It was rather the differences in tax bases and structures that had this effect.  Thus harmonisation would be the logical step to take with regard to:

         taxes on company income, recommending the adoption of the two-tier or split-rate method of taxing distributed and undistributed profits, by which corporation tax is partially refunded on the distribution of profits; and

         any taxes directly affecting capital movements, such as taxes on capital transactions and interest and dividends.

Consequently, a number of Community level measures would be necessary to offset revenue losses resulting from the harmonisation.

The Neumark Committee proposed that double taxation be dealt with through a multilateral agreement replacing any bilateral arrangements in force.

3.2. Commission memorandum of 26 June 1967

In 1967, the Commissions programme for the harmonisation of direct taxes[civ] sought to:

         remove all tax barriers to capital movements, a single market and the expansion of investment;

         ensure tax neutrality in corporate restructuring operations or cross-border mergers;

         create conditions of equal competition for investments by aligning tax incentives and the methods of computing tax liability;

         remove differences between national schedular taxes and possibly in all taxes on company assets;

         introduce a uniform corporate tax base and method of calculating the taxable profits;

         approximate MS corporate tax rates;

         co-ordinate methods of inspection and collection; and

         eliminate double taxation that cannot be dealt with through harmonisation.[cv]

3.3. Commission memorandum of March 1969

In 1969, the Commission proposed the following measures to facilitate the interpenetration of EC capital markets through an adjustment of direct taxes:

         the revision of MSs withholding taxes on income from variable-yield securities and from bonds and debentures to enable tax to be claimed or refunded under the tax rules of each country and in cross-border situations.

         the harmonisation of tax rates because the tax in many cases was not reimbursable and rate differences between countries could colour investment decisions.

         the abolition of withholding tax on bond interest in order to help promote a European capital market for business and to attract inward investment. (Withholding tax on dividends could be tackled with less urgency since double taxation was often alleviated through double taxation arrangements between MSs.)

Thus, the Commissions slant was towards the full harmonisation[cvi] of the corporate tax systems of all MSs.  In the light of this, it presented detailed proposals on:

         the tax aspects of cross-border corporate restructuring[cvii]; and

         the tax treatment of multinational groups of companies[cviii].

3.4. The Commissions 1975 action programme and progress up to 1990

The 1969 proposals received little consideration by the Council.  Thus, in 1975, the Commission sought to inject renewed energy in its 1969 proposals.  In its action programme for taxation of 1975[cix], the Commission stressed the importance of the achievement of economic and monetary union.[cx]  However, the Commission admitted that until it was possible for the Community to bridle taxation as a means of achieving national economic and social objectives at Community level, harmonisation should in no way hamper the use of taxation as an instrument of national policy.  Thus restrictions should not be imposed on the MSs earlier than is necessary, especially as regards the rates of the main taxes and charges.[cxi]  The proposed 1975 programme consisted of two main parts:

1.          completing work of establishing tax conditions enabling the highest possible degree of liberalisation in the movement of persons, goods, services and capital and of interpenetration of economies;

2.          making preparations with a view to further European integration, to bringing closer together the respective burdens of those taxes and charges having any substantial impact on the ideal of European integration and therefore to use taxation as an instrument of common policies.[cxii]

Later on in 1975, the Commission proposed a directive for the harmonisation of the systems of company taxation and of withholding taxes on dividends[cxiii], suggesting the use of the imputation system of corporation tax and the alignment of rates.  In 1976, the Commission proposed an arbitration procedure to deal with double taxation arising from transfer pricing.  In 1978, it proposed a measure on the taxation of dividends distributed through collective investment schemes and started preparing measures on withholding tax on bond interest and the tax treatment of holding companies.

Unluckily, the Commissions efforts only served to secure co-operation between tax administrations.  The requirement of unanimity proved the stumbling-block preventing the approval of these measures by the Council of Ministers.  The 1975 proposal was criticised by the European Parliament on the basis that approximation of rates could only work if there was an approximation of tax bases MSs did not agree to the further surrender of fiscal sovereignty implicit in the measure and thus, discussion of this proposal ground to a halt.[cxiv]

In the Eighties, the Commission proposed the harmonisation of national periods for carrying over losses[cxv] and a common system of withholding tax on interest and royalties[cxvi]. The 1985 White Paper on completing the internal market[cxvii] urged the adoption of the outstanding proposals on mergers, parent-subsidiaries taxation and the transfer pricing arbitration; however, to no avail.

3.5. The 1990 Package of three

The Nineties saw the Commission reconsider its approach. The ideal of complete harmonisation of company taxation proved too radical a revolution since MSs were keen to hold on to their fiscal sovereignty.  The Commission now chose to adopt the more practical approach of seeking the convergence of corporate tax systems in line with the principle of subsidiarity.  In a communication on guidelines on company taxation[cxviii], Madame Christiane Scrivener[cxix], then Commissioner for Taxation and Customs Union, indicated that according to this new approach, the Community would limit itself to introducing measures essential for the completion of the internal market, leaving MSs free to determine their own taxation arrangements, save where they conflicted with the principles of the EC Treaty and created distortions within the common market.  The controversial 1975 harmonisation proposal was formally withdrawn and the Community committed itself to work in close co-operation with the MSs to set priorities and define proposals.  This resulted in a package of three successfully adopted in July 1990 and proposals on taking account of foreign losses and the abolition of withholding taxes on group interest and royalty payments.

In general, the package of three aims to facilitate the formation of intra-EC, cross-border groups and seeks to remove the fiscal obstacles associated therewith.[cxx]

3.5.1. The parent-subsidiary directive[cxxi]

This directive is aimed at abolishing the withholding tax on intercompany dividends paid by subsidiaries to parent companies within the EC and therefore at the elimination of double taxation of such distributions.  Under this directive, double taxation is eliminated as follows: the country of residence of the parent company must either exempt from tax profit distributions by a subsidiary to its parent or allow the parent a tax credit for the withholding tax  and the corporation tax paid by the subsidiary on the profits out of which the dividends are paid.  The state where the subsidiary is resident must not impose any withholding tax at all on such distributions.[cxxii]  It was Germanys unwillingness to abolish entirely the withholding tax on outbound intercompany dividends that constituted the primary cause for the delay in the adoption of the package.[cxxiii]

3.5.2. The merger directive[cxxiv]

The merger directive ensures the removal of the fiscal barriers to cross-borer mergers, divisions, transfers of assets and exchanges of shares resulting from the taxation of latent capital gains at the time one of these operations takes place by postponing the realisation of capital gains on assets or shares involved in a merger until they are actually sold by the newly-merged company.[cxxv]

3.5.3. The Arbitration Convention

The Arbitration Convention is a multilateral convention between MSs introducing a revolutionary innovation in international tax law: a compulsory arbitral procedure which binds tax administrations to eliminate international double taxation.  This procedure must be invoked by the competent authority of MSs should they fail to come to a mutual agreement on the applicable transfer price and to adequately eliminate double taxation within two years after a case has been submitted to them by the taxpayer concerned.  A recommendation will then be issued by the arbitral commission which will only bind the parties to the arbitration if these are still unable to reach agreement within six months after the recommendation is issued. The Arbitration Convention applies only to transfer pricing disputes and not to other disputes encountered in the context of a double taxation agreement.[cxxvi]

3.6. The Ruding Committee

The Committee of Independent Experts on Company Taxation (the Ruding Committee) was set up in the wake of the Commissions communication of April 1990 on corporate taxation.  Its mandate was to evaluate the importance of taxation for business decisions with respect to investment and international allocation of profits between enterprises. 

The committee addressed three main issues:

         whether differences in MSs taxation cause major distortions in the functioning of the internal market, particularly with regard to investment decisions and competition;

         if such distortions do arise, whether they are likely to be eliminated by market forces and tax competition between MSs or whether action at EC level would be required; and

         what measures might be needed at EC level to eliminate these distortions.[cxxvii]

In 1992, the Ruding Committee reported to the Commission on ways of reforming the taxation of EC companies in an increasingly unified internal market and broadly endorsed the convergence approach to MS corporate taxation.

Following its analysis of differences in rates, tax bases, dividend taxation and the tax treatment of cross-border flows of income (dividends, interest and royalties), the committee concluded that there was evidence that tax differences between MSs could affect investment location and distort competition and that, despite the tax convergence that had already taken place, action was necessary at the Community level to produce a significant reduction in the distortions affecting the operation of the internal market.

The Ruding Committee recommended:

3.       the removal of measures which discriminate in favour of domestic companies or against investment in other Community countries (for instance, by the more favourable treatment of domestic-source dividends than of foreign-source dividends) and which constitute a distortion in MSs tax systems which impedes cross-frontier investment and shareholdings; and

4.       the prevention of excessive competition, aimed at attracting mobile investment, by fixing a minimum corporation tax rate of 30 per cent and a minimum tax base.

3.7. Commission guidelines and strategy

On 24 June 1992 the Commission issued a series of guidelines setting out its views on corporate taxation in the single market as a result of the Ruding Committees report.

The Commission agreed with the committee on the following issues:

1.       the priority of eliminating double taxation of cross-border flows;

2.       that the scope of the parent-subsidiaries directive should be extended to cover all parent companies subject to corporation tax, whatever their legal form;

3.       the need to extend the scope of the mergers directive to all types of undertakings in the context of transfers of assets.

The Commission also proposed the following measures to eliminate double taxation in the context of the single market:

         a common approach to the definition and treatment of thin capitalisation in order to prevent the double taxation resulting from the application of different rules in the MSs (e.g. where interest payments made between associated companies situated in different MSs are unilaterally reclassified as dividends);

         the establishment of common rules governing the allocation of headquarter costs and the definition of costs borne by the shareholder, to ensure their deductibility in at least one state;

         completion of the network of double taxation treaties settled between MSs, and conclusion of agreements with non-member countries in strict accordance with the non-discrimination rules in the EC Treaty; and

         initiating discussions with MSs to ensure that foreign-source dividends are not taxed more heavily than their domestic-source counterparts.[cxxviii]

On the other hand, the Commission opined that some of the committees recommendations on the convergence of corporation tax rates, bases and systems went beyond what was strictly necessary at Community level.  The Commissioner for Taxation, Mme Scrivener, reiterated the view that following 1992, the Commissions decisions in the field of company taxation should be taken at the lowest appropriate level strictly consistently with the principle of subsidiarity.  The Commission would therefore consult with all interested parties while respecting the respective responsibilities of the Community and the MSs.  Thus, while the proposals for a minimum corporation tax rate and tax base for company profits were worth examining, the 30 per cent minimum corporation tax rate proposed by the committee was considered too high. Moreover, the Commission did not see the need for a maximum rate.

The suggestion that smaller unincorporated businesses, usually subject to income taxation, should be given the option of being taxed as companies, was sympathetically received by the Commission on the basis that this would reinforce the self-financing capacity of SMEs as the rate of corporation tax is usually well below marginal rates of income tax.

While the Council agreed with the priority of eliminating double taxation of cross-border flows of income, it still has not implemented further pending measures to achieve this.

In March 1996, in a paper entitled Taxation in the European Union[cxxix], the Commission once again highlighted the need to eliminate distortions in the internal market caused by both direct and indirect taxation. In the context of direct taxation, it indicated that it would present new proposals for eliminating tax barriers to cross-frontier activity, beginning with a proposal on the elimination of double taxation on royalties and interest between associated companies. The March 1996 document re-emphasised reducing the discriminatory treatment of subsidiaries established in other MSs, and indicated that the proposal that would allow parent companies to offset losses of subsidiaries is also still very much on the Commissions agenda.[cxxx]

3.8. Mutual assistance between tax authorities

The mutual assistance directive[cxxxi], was the first directive on direct tax and now applies to taxes on income and capital, value added tax and certain excise duties.  It sought to create a framework for the exchange of information between tax authorities of MSs, in order to curb practices of cross-frontier tax evasion and tax avoidance which affect the operation of the common market by distorting capital movements and conditions of competition.  It was felt that national measures and bilateral agreements could not counter the internationalisation of tax avoidance or evasion.  However, the directive may have had little practical impact principally because of the established exchange of information provisions in tax treaties.

3.9. Non-discrimination and the ECJ

3.9.1. The principle of non-discriminatory taxation

For MSs, the fundamental principle of non-discrimination and therefore of equal treatment entails that, in imposing direct taxes, MSs should avoid any type of discrimination on the basis of nationality.[cxxxii]  This rules out formal discrimination on grounds of nationality (overt discrimination) and also disallows differences in fiscal treatment formally based on grounds other than nationality but which produce the ultimate effect of discriminating on grounds of nationality (covert discrimination).[cxxxiii]  The latter type includes discrimination on grounds of residence, since non-residents of a MS are in their majority non-nationals.

3.9.2. Discrimination v differential treatment

Discriminatory treatment has to be distinguished from mere differential treatment.   The former arises through the application of different rules to comparable situations or through the application of the same rules to different situations, and is therefore disallowed.  On the other hand, MSs are not barred from fixing different rates of taxation or from establishing different criteria for the imposition of taxation.  This as long as such differential treatment is imposed objectively and not directly or indirectly on the grounds of the taxpayers nationality. Hence, the mere fact that an EC national carries a heavier tax burden in a host state than some locals does not by itself constitute discrimination.  Such taxpayer would only be entitled to challenge the imposition of taxation there as discriminatory if he is subjected to taxation on a basis different from that on which tax is imposed on locals in equivalent positions.

3.9.3. Reverse discrimination

The fact that every MS is bound to treat nationals of other MSs no less favourably than its own nationals, i.e. the prohibition of discrimination on grounds of nationality does not prevent a MS from applying on its own territory a tax treatment that is less favourable to its own nationals than to the nationals of other MSs.

For this reason, in Hurd v Jones,[cxxxiv] the Court of Justice found that a MS was justified in taxing remuneration paid to its own nationals in circumstances where similar remuneration paid to nationals of other MSs was exempt from tax, as the situation was wholly internal to the MS.  The same reasoning applies to a MS subjecting one of its own nationals to a higher tax burden because he did not reside in that state even though he worked and kept most of his assets there.[cxxxv]  In the absence of a foreign element enabling the application of the treaty provisions of freedom of establishment, such laws cannot be prevented.

However, this does not mean that a MS may discriminate against one of its own nationals who is seeking to rely on one of the rights or freedoms guaranteed under the treaty.[cxxxvi]  Thus, a Dutch national residing in Belgium and who pursues an activity as a self-employed person in both states (generating taxable income in both states) is entitled, in his state of origin, to rely on the non-discrimination provisions of the treaty.[cxxxvii]

3.9.4. Fiscal cohesion and non-discrimination in tax rates

It has been established by the Court of Justice that, for the sake of fiscal cohesion, restrictions on free movement, including discriminatory taxation, may be justified in tax terms.  According to the principle of fiscal cohesion, there must be a correlation between the sums that are deducted from taxable income and the sums that are actually subjected to tax.  Therefore, a MSs system might offset the loss of revenue resulting from the deductibility of insurance premiums from total taxable income by taxing the later payments of pensions, annuities or capital sums by insurers. Therefore, for the sake of the cohesion of the tax system, in the event of the state being obliged to allow the deduction of life assurance contributions paid in another MS, it should be able to tax the sums payable by the insurers.[cxxxviii]

In Bachmann v Belgian State[cxxxix], the European Court of Justice (ECJ) ruled, as regards the freedom to provide cross-border services, that requiring a business to be established in the host state may be justified if it is indispensable for the attainment of an objective in the public interest.  In this particular case, the issue revolved around Belgian rules restricting the deduction, for income tax purposes, of contributions paid for insurance against sickness, invalidity or old age or for life insurance, to those paid in Belgium.  The ECJ conceded that this would deter those seeking insurance from approaching firms established in other MSs, thereby restricting such firms freedom to provide cross-border services.  However, the ECJ found that these were justified as the requirement of establishment was indispensable to preserve the cohesion of the applicable national tax system.

On the other hand, in Asscher v Staatssecretaris van Financin, the Netherlands tax authorities sought to justify applying a higher initial rate of income tax to non-resident than to resident taxpayers on the basis that social security contributions were no longer deductible in the Netherlands.  The Court held that there was no direct link between the application of a higher rate to the income of certain non-residents who receive less than 90% of their worldwide income in the Netherlands and the fact that no social security contributions [were] levied on the income of such non-residents from sources in the Netherlands.[cxl]  Thus Article 43 of the EC Treaty comes into play, preventing MSs from applying to nationals of other MSs pursuing self-employed activities on their territories higher rates of income tax than those applicable to residents pursuing the same activity; this insofar as there is no objective difference between the situation of such taxpayers who are resident or treated as resident that would justify that treatment.[cxli]

In ICI v Colmer (HMIT), the Court rejected the United Kingdom’s submission that fiscal cohesion required that consortium relief, whereby the members of a consortium could transfer losses incurred by subsidiaries of a holding company owned by them for relief against their own profits, be limited to cases where the majority of the subsidiaries in question were United Kingdom residents. 

It clearly results from these cases that a mere threat to fiscal revenues of a MS does not qualify for consideration as fiscal cohesion in the sense recognised by the Court.

3.9.5. Tax breaks and exemptions

Another facet of the principle of equal treatment requires MSs to provide tax breaks, exemptions and other substantive fiscal rights without discriminating on the basis of nationality.  Therefore Article 43 of the treaty has the effect of prohibiting rules limiting exemption from taxation on transfers of property in group reorganisations exclusively to transactions between companies incorporated under national law.  Excluding similar companies formed in other MSs amounts to indirect discrimination on grounds of nationality.[cxlii]

3.9.6. Repayment of overpaid tax

The principle of equal treatment in respect of remuneration that is guaranteed by Article 39(2) of the EC Treaty would be rendered ineffective if MSs could undermine it through discriminatory provisions on income tax.  Thus, Article 7 of Regulation 1612/68 specifically provides that EC nationals working in other MSs are to enjoy the same tax advantages as their local counterparts.[cxliii]  Domestic measures that make the repayment of overpaid tax subject to discriminatory residential requirements will thus breach Community law.

In Biehl v Administration des Contributions du Grande-Duch de Luxembourg[cxliv], the ECJ held that a local law that has the effect of depriving workers of the right to the repayment of overpaid tax when they leave the country or take up residence there in the course of a tax year when that right is available to permanent residents, is plainly discriminatory.  Even though the law uses the criterion of permanent residence to determine the availability of the right in fact, in Luxembourg, the criterion was residence or occupying a salaried occupation for at least nine months in the course of a tax year and the criterion is applied irrespective of nationality, the risk is that it will work against nationals of other MSs since they are the ones who most often leave the country or take up residence there in the course of a year.  The availability of a non-contentious procedure enabling temporarily resident taxpayers to request repayment of overpaid tax, by showing that the application of the law will produce unfair consequences for them, will not remedy the discriminatory effect of the tax law.[cxlv]

In R v Commissioners of Inland Revenue, ex parte Commerzbank AG[cxlvi], the taxpayer, Commerzbank AG,  was a bank resident in Germany which had paid tax on interest received by its UK branch.  By virtue of the UK-US double taxation convention , the charged interest was exempt from tax and therefore the UK tax paid was recovered[cxlvii]. The claim for repayment supplement was refused on the basis that the income to which the overpaid tax related was exempt because the taxpayer was not UK-resident, whereas it would have been chargeable had the taxpayer been resident.  The ECJ held that the concept of the seat of a company could be equated with the concept of nationality for individuals.  This use of the criterion of residence for granting interest on refunded tax could lead to indirect discrimination in contravention of EC law.  Thus the UK was found to have breached the right of establishment protected in Article 43 and 48 of the EC Treaty.[cxlviii]

3.9.7. Tax deductions

Refusal to allow tax deductions may amount to discrimination contrary to Articles 39, 43 and 49 of the EC Treaty.  In Wielockx v Inspecteur der Directe Belastingen[cxlix], the tax payer was a Belgian national and resident, who earned all of his taxable income from a physiotherapy practice in the Netherlands.  Under a double taxation agreement, his Dutch income was taxable in the Netherlands.  Nonetheless, under Dutch law, he was a non-resident and therefore not entitled to deduct contributions he made to his pension reserve.  The ECJ stated that a non-resident taxpayer was to be given the same tax treatment as regards deductions from his taxable income as a resident.  Otherwise, taxpayers such as Wielockx would suffer a greater overall tax burden and hence discrimination.[cl]

3.9.8. Transfer of residence

The treaty protects the right of a company to establish itself in another MS through a branch or subsidiary, or through a transfer of its assets to a company incorporated under the laws of another MS.  This does not mean that the treaty gives companies the right simply to transfer their residence from one MS to another; so MSs tax rules requiring official consent before a company is allowed to transfer residence from one state to another do not constitute an infringement of or per se interfere with, the right of establishment.[cli] bullet-red.png

4. Why several of the Commissions proposals failed