Article by Paul Morton, Head of Business for Oil Products Business, Royal Dutch Shell Group and UK representative on the CFE Fiscal Committee, published in the July 2001 issue of Tax Adviser. The seventh annual Confédération Fiscale Européenne (CFE) Forum took place in Brussels on 8 May. Mr Friedrich Rödler, Chairman of the CFE Fiscal Committee, introduced the first session on current national tax reforms in Germany, the Netherlands and France.
From 1 January 2001, the Netherlands has introduced a more analytical tax structure with three ‘boxes’ into which personal income is allocated. Box I includes income from employment, private business activities and home ownership. Income, net of interest, is taxed at rates from 33 per cent to 52 per cent. Box II includes income and gains from companies in which the taxpayer has an interest of at least five per cent; the tax rate is 25 per cent. Box III embraces savings and investment income. Assets are deemed to yield an annual return of four per cent irrespective of the actual return but capital gains are not taxed. A system like this was first introduced in the Netherlands in 1893! The assets are valued at 1 January and 31 December and the average is subject to tax at 30 per cent multiplied by the deemed four per cent return.
Although there are certainly advantages in the new regime, including a lowering of rates and a simplification of structure, there are also disadvantages. A new practice of ‘box-hopping’ has emerged, where taxpayers seek to place income in the most favourable box and complex anti-avoidance rules have been introduced. So although the new system is simpler, it is not as simple as it might have been. There has been some reduction in the available allowances and individual circumstances are not as well reflected as previously.
Capital assets which are privately held by the taxpayer but which are used in his business or by his company are not taxed in Box III (which would be logical) but in Box I because the legislator felt that the tax burden would otherwise be too low. This creates inequality in that e.g. the lessor of a building to a third party would pay 1.2 per cent tax on the average value of the building while the owner who uses it in his own business would pay 52 per cent tax on the rent and on capital gains.
The flat rate of tax on investment income is likely to have a distortive effect on the attractiveness of alternative investments. It could also result in an excessive tax burden in situations where the income from an investment is lower than the deemed four per cent return or where the value of an investment has actually declined.
There is also some doubt as to whether the flat rate tax will be treated as an income tax at all by some other States. This could have an impact on the application of tax treaties: e.g. in France, the Avoir Fiscal (tax credit) is only granted if the Dutch shareholder is taxed on the basis of his income; it appears that the Avoir Fiscal would therefore not be granted under the new regime to a Dutch shareholder.
There is also some distortion in that capital gains are not taxed except for substantial shareholdings under Box II. In a move which is quite unprecedented in the Netherlands, the new system will be reviewed by the Dutch Parliament in five years’ time so by 2007 there might be a different story to tell.
The tax burden in France is borne unevenly with a top rate of 54 per cent (reducing in time to 53.25 per cent and then 52.75 per cent – a ‘homeopathic’ tax reduction) applying to no more than a few thousand taxpayers. This is regarded as confiscatory and not viable in the long term. In addition there is a Solidarity Tax on capital which dates from 1982, in effect, an asset tax, charged on assets in excess of 650,000 Euros at a rate of 1.8 per cent (up from 0.55 per cent). In 1989 a ceiling was introduced whereby the asset tax and income tax could not together exceed 85 per cent of the actual income. It became very attractive to minimise income and the ceiling was partly withdrawn. At the highest levels, it was possible for the effective burden to exceed 100 per cent of annual income, especially where income arose from a family owned company.
Some French taxpayers were seeking refuge in Belgium! In 1996, an exit charge was introduced for those transferring their domicile from France based on the market value of their assets. This raised questions as to whether it interfered with the taxing rights of the new host state and whether there was an impact on the freedom of movement. A capital gains levy was introduced for offshore structures in preferential fiscal environments and CFC rules were extended to individuals.
It seems that France discriminates against non-French investments in that a tax credit is repaid where dividends are received from French companies but not in the case of foreign investments. Similarly, investments in French companies can be treated favourably (20 per cent tax rate) if lodged in a special account with a French bank but this relief is not available for foreign investments which are taxed at the normal rates.
The taxation of companies is also unfavourable as compared with other countries. There is a trend towards more economic double taxation (except where the Parent/Subsidiary directive applies) in that the tax credit on dividends received from other companies is reduced from 25 per cent to 15 per cent in 2001. Thus the residual tax at the underlying level is 22 per cent.
The reforms in Germany, effective 1 January 2001, have focused on corporate tax, income tax (85 per cent of German business are formed as partnerships) and trade tax. Under the Tax Reduction Law, both nominal tax rates and fiscal depreciation rates have been reduced (rate lowering and base broadening). Over the period 1999 to 2005 top income tax rates will reduce from 53 per cent to 42 per cent (starting rates from 25.9 per cent to 15 per cent) and corporation tax rates reduce from 40 per cent/30 per cent split rate to 25 per cent single rate (trade tax is separate). Deprecation rates fall from 30 per cent to 20 per cent for moveable assets and from four per cent to three per cent for buildings.
The full imputation system has been abolished; it was complex, open to abuse, dividend stripping, and discriminated against foreign income and, as such, was probably incompatible with EU law. The new system for individuals is similar to that of Austria under which half of the income received from companies is taxed; the 25 per cent tax charge is the final tax burden. Since half of the income is effectively taxed, half of the associated expenses are disallowed. For companies, dividends received from other companies is altogether exempt from tax (whether domestic or foreign income) and associated expenses, having a direct economic link, are altogether disallowed. For foreign dividends, five per cent of associated expenses cannot be deducted.
Capital gains on share disposals are dealt with in the same way and the hope is that this will encourage reorganisation and simplification of the entangled shareholding structures prevalent in Germany.
The new regime will impact investment decisions. There is now more incentive to reinvest than under the previous system in which retained earnings were taxed at a higher rate than distributed profits. The new regime will also encourage foreign investment in lower tax countries.
Eighty five per cent of German businesses are carried on in partnership and only 15 per cent constituted as companies. Reform of partnership taxation attracted considerable attention with a ‘check the box’ regime and a flat rate calculation of trade tax and income tax being rejected. Instead, trade tax is not imposed on business income but instead reflected in the income tax charge.
The new regime sacrifices full neutrality as between companies and partnerships in favour of simplicity and clarity and also fails to achieve full neutrality as between debt and equity financing.
Several delegates questioned whether the ‘Box III’ treatment of investment income in the Netherlands (the effectively fixed 1.2 per cent tax on capital) conflicted with bilateral agreements or with EU law such as the Verkooijen case. The rate also seems to be too high in relation to actual returns on equity of listed companies (although there is some compensation in that wealth tax has been abolished in the Netherlands). ‘Box III’ assets were worth acquiring with debt as loans could be deducted in arriving at the value of net assets. Third party loans could also reduce income under Boxes I and II.
In June 2000 the European Commission issued a proposal for an amending Council Directive regarding the VAT arrangements applicable to certain services supplied by electronic means. The context of the proposals is the increasingly widespread application of e-commerce technology, the effect of globalisation, and the rise in importation of intangibles and intellectual property. The release of the proposals in June 2000 by the Commission prompted an immediate reaction from the US that they went too far and yet not far enough! For B2B transactions (business to business), there are no particular problems, with the reverse charge mechanism working satisfactorily. The bulk of e-commerce transactions are B2B and the recipient will often have business premises which can be simply identified as the place of supply. There is concern about the scope for avoidance by routing services through low tax jurisdictions.
The B2C arena (business to consumer) is much narrower but is where most questions arise. The Commission has proposed that a non-EU supplier should have the option of a single place of registration of his choice. Given the current spread of VAT rates, the Council is unable to agree to this, fearing that all non-EU suppliers would register in Luxembourg! The view offered by France, that a non-EU supplier must register in all 15 Member States, could result in serious confrontation with the World Trade Organisation even though the amount of revenue concerned in quite small. There is a consensus that another way forward must be found, as a confrontation would not be helpful.
A simplified scheme has emerged, which echoes earlier work by the OECD. The text issued on the 6 March suggests a single point of contact for non-EU suppliers with tax being charged at the rate applicable in the place of consumption. The supplier would report to a single fiscal authority, submitting a return every three months. That authority would distribute the tax to the other fiscal authorities as appropriate. This would be a concessionary scheme under art. 26 of the sixth VAT directive linked to the exchange of information provisions. It could be implemented under existing systems and all communication between supplier and tax authority would be electronic. Under the Swedish Presidency, the Council has applied considerable energy to resolving the remaining difficulties.
By the end of April, 14 out of 15 Member States had reached agreement but one country then entirely reversed its position (rumours from the audience suggested that this might be the UK). This country was concerned that the European developments were running ahead of the work of the OECD and proposed a moratorium on taxation of e-commerce.
The rejection of this view by other Member States was perhaps the clearest message on any such issue for at least 15 years. This new view was at odds with the principles which had been developed over the last three years by the Commission; members had been close to agreement; the new measure is supported by the business community; there was longer term potential for wider modernisation of VAT; it was consistent with a 1998 ECOFIN decision; the US accepted the EU position, etc. Resolution can only be achieved at a political level, perhaps at the ECOFIN meeting in June or after the UK elections.
Why is so much energy being devoted to the B2C question when the amount of revenue involved is so small? It is seen as a route to much wider modernisation and reform of VAT and a good model for the treatment of services generally together with the distance sale of goods. But while the way forward remains deadlocked at a political level, it is difficult to maintain the general level of enthusiasm in the Commission.
It does not seem sensible to burden non-EU (mainly US) suppliers with onerous registration or tax collection requirements because of the inadequacies of the EU VAT system. The problem is not so much a potential conflict between the EU and the US but rather a conflict between the territoriality principle and e-commerce, which knows no borders. Perhaps we need a ‘world tax authority’ to eliminate the territoriality principle for indirect tax but, of course, this is the stuff of science fiction!
The current proposals are not workable in that the requirement to register for tax is unenforceable and counterproductive. Third countries might be moved to retaliate. A better way forward is to remove e-commerce from the scope of VAT with an exemption for on-line services. The loss in revenue may be balanced by the effect of economic growth.
The final speaker was Joann Weiner, formerly of the US Treasury Department in Brussels. She has worked on the framework conditions concerning the taxation of electronic commerce elaborated at the Ottawa conference some three years ago.
She commented first on the Swedish compromise on the Commission proposals. This would not achieve neutrality if it applied only to non-EU suppliers (i.e. the normal registration rules would apply to EU suppliers); this might prove fatal to moving the proposal forward.
She then turned to the reaction in the US to the Commission proposals. It had been swift; in fact on the same day as the proposals were released the Deputy Secretary of the US Treasury Department, Eizenstat, issued a statement noting the Administration’s serious concerns with both the substance and the process in the Commission’s proposals. The US administration and the business community disapproved of unilateral measures and regarded the proposals as not neutral (in that digitally delivered books, for example, would suffer a higher VAT rate than physically delivered books which benefit from various exemptions) and therefore contrary to OECD principles and not good policy. The OECD framework conditions regard e-commerce as not being the supply of goods. The Commission goes further in not only treating these supplies as not being of goods but positively defining them as supplies of services.
The OECD TAGs (Technical Advisory Groups) have concluded that there is no simple solution because it is not technically possible to identify the place of consumption. The supplier does not know where the consumer actually is and cannot conclusively determine this from either the e-mail address or a credit card mailing address. In the US, where there are more than 40,000 taxing jurisdictions, revenues are allocated according to formulae. Until fundamental questions like this had been satisfactorily resolved at an international level, Mrs Weiner could not support implementation of the Commission proposals. The US sales tax experience was not really relevant to the EU. The US has constitutional prohibitions on out of state vendors collecting tax for the state of consumption so mail order sales cannot be taxed in the state of the consumer. The implications for e-commerce are not yet clear. Internet vendors feel that, by extension from mail order, they have a right not to pay tax. The US market is not neutral to start with whereas the staring point in the EU is one of neutrality.
Proposals to tax the use of the Internet in the US were seen by some as ludicrous. On the other hand, the Internet Tax Elimination Act proposed by Congress in 1999 aimed to exempt all supplies of goods acquired through e-commerce. The Advisory Commission on e-commerce failed to reach agreement by the required super-majority but did advocate that there should be no new or discriminatory taxes.
An important question is how much use is actually made of the Internet by consumers in the EU? Fewer than one in three homes have a connection and high access charges have resulted in low usage as compared with the US. In the long term, the Internet should not be tax-free because this would shift the burden onto other things. However, she concluded by urging against irreversible actions at this point, ahead of international progress.
The discussion was opened by Kenneth Walker, the reporter of the Economic and Social Committee on its Opinion on the Commission proposals. The Economic and Social Committee found the proposals problematic in that they would be unenforceable for companies outside the EU. More fundamentally, VAT on e-commerce has to be tackled on a global basis; the EU would be premature in going it alone.
VAT is regarded as a tax on consumption but it could be regarded as a tax on the provision of goods and services instead. As such it could legitimately be collected in the country of origin which would reduce the opportunities for fraud. A complete re-think of the VAT system was required.
David Holmes of the OECD referred to a number of reports and consultative documents which have been published on the OECD web-site. The OECD regards solutions to the registration question as an intermediate stage. Ultimately what was needed was a technological solution to a technological problem. Entirely new ways of collecting tax were needed; perhaps solutions would emerge over the next ten years.
On the question of enforceability, there appeared to be less concern now than a year ago. The large number of small companies doing business on the Internet were consolidating and transforming into a smaller number of larger companies, which did tend to comply with their legal obligations. Another participant noted that companies were likely to want to take advantage of legal protections of intellectual property afforded by states in which they would be properly registered.
After a lively debate, the meeting was brought to a close by Mr François Lambrechts, vice-president of the CFE.
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