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All together now?

Category Technical Articles
AuthorTechnical Department
Robin Godman writes about European corporate tax harmonisation: Article published in the August 2002 issue of Tax Adviser. Robin Godman is a Senior Tax Adviser with a major multinational oil company and a director of one of its subsidiaries. Any opinions expressed in this article are entirely his own.
Key Points

  • Lower taxes encourage inward investment
  • EU's ability to intervene in national tax systems
  • Move towards harmonisation will be driven by business interests not EU

We have heard much about the idea of a single market, and no doubt soon we shall hear even more about a single currency. But how does all this effect British corporation tax? Does, for example, the phrase ‘corporate tax harmonisation’ mean the end of our beloved scheduler system on the diktat of Brussels? And how can fifteen separate tax systems be welded into one? Vexed questions indeed.

Given that one of the European Union (EU)’s stated aims has been the creation of a single market, it is not surprising that it should be looking at ways to eliminate the distortions and asymmetries that inevitably crop up when 15 disparate tax systems work together. In essence, European corporate tax harmonisation is all about the elimination of these distortions.

One of the most effective ways to encourage investment is to lower taxes on businesses operating inside a territory. Countries can also attract particular industries by reducing specific taxes. More technical reasons might influence a business to set up in one country, but not another: where two tax systems do not work properly and a business is at risk of being taxed on the same income in two countries, the company will probably invest elsewhere. Other examples include systems that imposed more severe restrictions on non-residents than they did on residents, or restricted the ability of residents to do business in another territory by taxing profits made abroad more heavily than income arising at home. An example of where the United Kingdom (UK) possibly discriminates in this regard is that the taxation of dividends on both individuals and companies differs depending on the residency status of the payer.

The action to eliminate each distortion varies from requiring a fundamental change to a country’s tax system such as ordering the rate of tax to be lowered, to convergence in the way residents and non-residents are treated.

No specific authority

The EU has no specific authority to intervene in national corporate tax systems. It can only proceed by relying on a broad purposive interpretation of Treaty articles. Under art. 94 the Council can issue directives regarding ‘…such laws regulations or administrative provisions … as directly affect the … functioning of the common market.’ Article 239 requires member states to ‘…negotiate with each other…to…abolish double taxation’ (this was invoked to encourage the convention on transfer pricing disputes). Article 308 allows regulations to be made to promote Community policy. In addition there are a number of articles that prohibit discrimination on grounds of nationality (art. 12), protect the free movement of workers (art. 39), services (art. 49), goods (art. 28) and capital and payments (art. 56). All these articles are of direct effect; furthermore, following the European Court of Justice (ECJ) cases of Finanzamt Köln-Altstadt v Schumacker (Case C-279/93) [1995] BTC 251, and Asscher v Staatssecretaris von Financiën (Case C-107/94) [1996] BTC 563, member states must make sure that their internal tax systems are consistent with EU law, which is of considerable importance where distortions are concerned. A further power is that under art. 88 and 89, and subsequent regulations, the EU can review state aid, although ‘derogations’ can be obtained for such aid, and some countries seem to be more successful in obtaining these than others.

Another way the EU can intervene is through the ECJ. The idea that the ECJ is some kind of all-pervading supreme court of appeal is a fiction that still enjoys some currency, especially in Britain. In fact it is not, although its effect could be argued to be analogous to that of a supreme court, because under the EU treaties, member states are required to apply interpretations of EU laws determined by the ECJ. Therein lies the point: the ECJ can only decide on points of interpretation of EU law that are referred to it; it has no jurisdiction to hear appeals on all points of law arising in member states. So its ability to ‘reach’ into domestic law, and therefore member states’ corporate taxation, is confined to relevant areas, such as those that relate to distortions in the single market. Although the ECJ can have a profound effect on aspects of a state’s corporate taxation, it has no authority to order a restructuring of an internal direct tax system.

However, harmonisation is not a new idea. As long ago as 1960 the Neumark report was commissioned to look at the problems of disparate tax systems and how they might affect the common market. Its conclusion was to recommend corporate tax harmonisation, but there has been little real progress, because up to 1977 only Directive 77/799, concerning the exchange of information on taxpayers between member states, had been adopted. Since then just two further directives have been issued: 90/434 which concerned the merger of enterprises in member states and 90/435 regarding double taxation, neither of which required much change in the UK. Directives can be enforced by the Commission through the ECJ initiating proceedings against member states that do not comply. Apart from directives, the only other measure has been the convention to settle transfer pricing disputes by arbitration, and even this should be distinguished from the directives, because a Convention is not EU law; rather it is an agreement under public international law, and falls, consequently, within the purview of member states’ domestic courts. Indeed, there has been little progress in corporate tax harmonisation largely because of member states being very reluctant to have their internal tax systems tampered with. And there has been some drift away from the idea of direct intervention.

The Ruding Report

Although the Ruding report of 1992 was somewhat radical in its proposals, not much more was heard until three proposals were put forward in 1997 by the Commission as a package to tackle harmful tax competition. These are noteworthy because the first two are draft directives representing the current proposals for change. The first proposed a minimum withholding tax on portfolio interest of 20 per cent or alternatively a pan-European exchange of relevant information; after considerable debate, the latter was chosen, but with a seven year transitional period, because countries such as Luxembourg were concerned about the loss of secrecy in their banking industry. The second concerns cross-border interest and royalties between associated companies, the text of which was agreed in December 2001. The third part is a code of conduct which identifies 66 harmful practices in the tax regimes of member states, including finance branches, holding companies, headquarter companies, and transparency in transfer pricing, with a view to adopting the measures towards the end of 2002, although unanimous agreement will have to be achieved in relation to the measures necessary to counter the harmful practices. Probably the main difference between the package and previous initiatives is that finance ministers appear to be keen to conclude measures in this area, which represents a significant step forward when compared to the almost total absence of success in legislation to deal with corporate tax harmonisation so far.

Against this background, the Commission has been looking at other means to make progress. In April 2001 it issued a ‘Communication on tax policy’ which – while seeing no reason for EU wide harmonisation in personal taxation – was more robust with regard to corporate taxation, specifically targeting the tax base, rather than tax rates, with an eye on the sensitivities of member states and their individual tax systems. It has also decided to explore an area that has become known as ‘soft law’. Essentially, where no progress has been possible in legislation, soft law could be used instead to make the point, taking the form of guide lines of best practice developed by working groups made up from member states, recommendations issued by the Commission, and communications, such as the Communication on tax policy issued in April 2001 under Commissioner Bolkestein. But soft law is not without its dangers and can be readily criticised. It has been defined as being ‘rules of conduct which, in principle, have no legally binding force but which nevertheless may have practical effects’. From a legal point of view, soft law does not necessarily have the protection of judicial review, and does raise questions concerning enforceability. In addition, can it be challenged in the ECJ? Also, there is the question of it being undemocratic: to what extent is soft law being used by the Commission to circumvent the more formal legislative procedures in order to promote its own agenda?


In addition, ECJ decisions are likely to influence Commission policy in the future. But there are questions to be raised here too. One is that case law has inherent problems in the context of policy making, because case law is by its very nature reactive, and bound to be limited to the facts of the case concerned, rather than encompassing the broader picture that policy making demands. Another relates to the technical competence of the ECJ to hear tax cases.

This question arose in the Wielockx v Inspecteur der Directe Belastingen (Case C-80/94) [1995] BTC 415 case, where the decision contradicted the decision in the Bachmann v Belgian State (Case C-204/90) {1992} BTC 337 case of three years before on the same arguments, and where the ECJ seemed to have difficulty with aspects of Belgian tax law. It has also been accused of not having experience in international direct tax law. But from a practical point of view, ECJ decisions have so far had a relatively low impact on both revenues and domestic tax policy.

So where does all this leave us? We have seen that the EU has no authority to impose change in domestic tax systems, that the Commission has largely failed to make headway in legislation, and that the ECJ has not really had much of an impact in the domestic arena. Indeed, if the EU did try to introduce a fully harmonised tax system, it is likely to encounter fierce resistance from its member states. Even in the more limited circumstances of discriminatory practices, where a member state is required to remove low rates of tax designed to attract specific industries, it can introduce a low general rate, as Ireland did when it introduced a 12.5 per cent rate of tax that the EU was powerless to prevent. Unanimity is another reason why progress has been so slow; while the Commission can propose measures that in its opinion are beneficial, unanimity at Council level means that an individual member state can veto a measure that it feels is against its interests. And there does seem to be no long-term plan for corporate tax harmonisation, despite the several reports that have recommended radical reforms. A possible cause of this is that the draftsmen of the early treaties did not appear to anticipate the need for it, unlike the area of direct taxation, which was well catered for in the form of value added tax (VAT).

Wholesale harmonisation is a long way off. The Commission said, when it tabled the package in 1997, ‘“ … nor is it intended to be the start of a process of wholesale tax harmonisation which would be incompatible with the Subsidarity principle’; in other words, domestic tax systems would not be interfered with. It is also likely that the tax systems of member states will harmonise of their own accord, because businesses want tax coordination and more countries are moving their rules to be consistent with international accounting standards. Indeed, following Enron, these will probably become a great deal more exacting, thereby giving the fiscal authorities greater encouragement to rely on them, with the result that to a degree, harmonisation will take place automatically, possibly leaving Brussels overtaken by events.

Technical Department
020 7235 9381

August 2002 by Robin Godman


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