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Recent EU developments in direct taxation

Category Technical Articles
AuthorTechnical Department
Article published in the April 2002 issue of Tax Adviser by Paul Farmer, Pump Court Tax Chambers. Paul was previously Head of the Direct Taxation Unit in the Customs and Taxation Directorate General of the European Commission and Legal Secretary to Advocate General Jacobs at the European Court of Justice.

In 1990 the Council of Ministers (ECOFIN) astonished everyone by reaching agreement quite suddenly on three rather ancient Commission proposals which became the Parent-Subsidiary Directive, Merger Directive and Arbitration Convention.

In the ensuing period of optimism discussions were held on two further Commission proposals, and in 1992 the Ruding Committee (a committee of independent experts on company taxation, which was set up by the European Commission under the Chairmanship of Onno Ruding) presented its grand vision for the future of European company taxation. There followed a period of crushing anticlimax as things returned to their normal state and discussions gradually ground to a halt.

The political process was rekindled in the late nineties by Commissioner Monti who – taking inspiration from the Organization for Economic Cooperation and Development (OECD) harmful tax exercise – promoted discussions in ECOFIN on a package of three measures: a Code of Conduct eliminating ‘harmful’ practices in the field of business taxation, a proposal for a Directive to ensure effective taxation of cross-border savings income and a proposal for a Directive eliminating withholding taxes on interest and royalty payments between associated companies.

Since the discussions started in 1997, the tax package has dominated the political agenda. The politics of the package are immensely complex. Designed to overcome the difficulty of securing unanimous agreement in the Council, the package offers something to everyone or nearly everyone. Its different parts, in particular the Savings Directive and the Code, must progress in parallel: if one part stalls it affects the discussions on the other parts.

The early stages of the negotiations proved difficult, mainly because of the United Kingdom’s (UK’s) opposition to the Savings proposal in the form presented by the Commission. The Commission proposal envisaged a ‘co-existence model’ under which member states could choose between ensuring minimum taxation of cross-border savings income by imposing a withholding tax and providing information automatically to the investor’s state of residence. A breakthrough came in June 2000 at the European Council (EC) in Feira, where following lengthy discussions it was agreed that all member states would exchange information automatically after a seven-year transitional period. Three member states, namely Austria, Belgium and Luxembourg, declared their intention to avail themselves of the transitional period.

At the same time the Feira agreement added a new complication to the process. It was decided that, before the Directive was adopted, ‘sufficient reassurances’ should be obtained from certain third countries (the United States (US), Andorra, Liechtenstein, Monaco, San Marino and Switzerland) and from member states’ dependent and associated territories that they would participate in the arrangements. To that end ECOFIN at its meeting in October 2001 conferred on the Commission, acting ‘in close conjunction’ with the Presidency (a compromise formula intended to preserve Commission and member state prerogatives) a mandate to enter into formal negotiations.

The negotiations were never going to be easy. Apart from the United States (US), the countries and territories have little to gain other than international respectability. They are willing to co-operate, but have demands of their own. In the case of Switzerland, for example, there is a series of negotiations under way covering a range of areas which the Swiss insist should commence and progress in parallel. Moreover, for some of them, most notably Switzerland, cooperation in the form of automatic information exchange would entail the abolition of bank secrecy rules.

In the meantime much of the detailed technical work on the package has now been completed. The text of the Interest and Royalties proposal was agreed under the French Presidency. At the end of 2001 under the Belgian Presidency ECOFIN approved for the purposes of negotiations with third countries the text of a new Savings proposal presented by the Commission to give effect to the Feira conclusions. In early March 2002 ECOFIN approved a standard format for information exchange under the Directive. The Code of Conduct group set up by ECOFIN in March 1998 reported to ECOFIN at the end of 1999, identifying 66 harmful regimes in member states and their dependent and associated territories. The group then set to work on establishing guidelines for standstill and roll back of the measures and concentrated on the three areas of finance branches, holding companies and headquarter companies with a view to ensuring a balanced approach in comparable situations. This led to a further report at the end of 2000. Since then further discussions have taken place, notably in the area of transparency in transfer pricing.

ECOFIN has set itself the end of this year as the deadline for final adoption of the package. A number of hurdles must still be overcome. Hitherto the Code Group has worked by consensus where unanimity could not be achieved. ECOFIN must still therefore reach unanimous agreement on the 66 measures. The success of the package mainly hinges however on ECOFIN’s reaction to the results of the negotiations with third countries and dependent and associated territories. ECOFIN is due to receive reports from the Commission and the member states concerned (essentially the UK and the Netherlands) in June, although on current progress further discussion under the Danish Presidency seems likely. While the outcome and timetable therefore remain uncertain, one should not underestimate the political capital which finance ministers have invested in this process and their desire to have the matter finally settled.

But what of the future? Is there life in Brussels after the tax package?
In April 2001 the Commission, under Commissioner Bolkestein, set the tone for future work in the tax area by issuing a Communication on tax policy. The Communication had a number of key messages on direct taxation:

  • the Commission saw no reason for across-the-board harmonization of personal taxes, although better co-ordination in some areas (e.g. pensions, savings taxation) would help prevent double taxation or non-taxation and combat tax evasion;
    · there was a stronger case for action on company taxation, particularly with regard to tax base ( as distinct from rates);
    · numerous tax obstacles were contrary to the rules of the EC Treaty, and the Commission would be more proactive in ensuring compliance;
    · the Commission continued to support the principle of qualified majority voting for certain areas of direct taxation but recognized that for the present the unanimity requirement would remain; and
    · against that background it would explore the utility of soft law initiatives (best practice guidelines developed by member state working groups, Commission recommendations and communications) where progress by legislative means proved difficult.

    What the Commission had in mind by soft law initiatives was illustrated by its Communication on the elimination of tax obstacles to cross-border occupational pension provision, which appeared shortly before the Policy Communication. Discussions have been held on and off for years in Brussels on the tax obstacles to cross-border pension provision, with little result. During that period there have been significant developments in the European Court of Justice. The court in the early nineties in its ruling in Bachmann ( Hanns-Martin Bachmann v Belgian State Case C-204/90 [1992] ECR 1 2 249) had recognized the right of member states to restrict certain tax advantages to pension or insurance services offered by companies established in their territory. In later rulings however, although not explicitly overturning the Bachmann judgment, the court qualified it to the point where it was difficult to see in what circumstances it would apply. In effect the case law had overtaken the political process. Instead of proposing legislation (which would probably have got nowhere) the Commission therefore decided to issue a Communication setting out its view that discrimination against foreign pension providers was contrary to the Treaty articles on the fundamental freedoms and requiring member states to bring their legislation into line. At the same time the Commission sought to engage member states politically by meeting their concerns about safeguarding tax revenues in the event of cross-border pension provision. It also sought to promote discussions on how to tackle the more structural problem of double taxation arising for citizens from the mismatch in member states’ pension arrangements.

    The Commission’s strategy met with some success: in October 2001 ECOFIN approved the Communication and asked a Council working group to study further the proposals on information exchange and the elimination of double taxation and non-taxation arising from the differences in taxation arrangements. In the meantime the Commission has begun taking steps to ensure that member states comply with their Treaty obligations.

    The other important Commission initiative in 2001 was the Communication and report on company taxation. The documents were presented in response to a request by ECOFIN in July 1999 to investigate:

    (1) the impact of differentials in the effective level of corporation tax in member states on the location of economic activity and investment; and
    (2) tax provisions which constitute obstacles to cross-border activity in the internal market.

    The first part of the Communication and report present the results of economic modelling conducted by the Commission with the aid of a panel of academic economists. The report concludes that there are large differences in effective rates and that the main driver for the differences is the nominal tax rate (rather than tax base). Even when preferential regimes are eliminated, differences in nominal rates will offer alternative possibilities of arbitrages. The Commission is however extremely circumspect about drawing policy conclusions from its study. It concludes that the study does not of itself provide convincing evidence for recommending specific action on tax rates, and that the extent to which it is possible to live with inefficiencies due to differences in national practices in corporate taxation is in any event ultimately a matter of political choice.

    In the second part of the study, the Commission identifies a series of obstacles to cross-border business activity. Although largely repeating the findings of the Ruding Committee ten years earlier, the report notes the increasing significance of transfer pricing as an issue for multinational companies. The Commission proposes two different kinds of solutions to the problems. First, it proposes a series of ‘targeted’ solutions, i.e. specific solutions for individual problems. These comprise a mix of legislative proposals (amendment of the existing directives, refurbishment of the existing proposal on cross-border losses etc.), soft law initiatives (best practice guidelines, communications, and recommendations) and legal steps. One of the more innovative ideas is that of a Joint Forum on Transfer Pricing involving representatives of tax authorities and industry. The purpose of the forum would be to bring the two sides together in order to build on the OECD work and develop best practice in the area of transfer pricing methodologies, documentation requirements and so forth.

The second category of solutions is more ambitious. The Commission concludes that, since the various problems faced by multinational companies result from their being subject to up to 15 tax systems, the most satisfactory long-term solution would be a single consolidated tax base. Having come to that conclusion the Commission reviews the various models that were presented to it. It refrains however from making any specific recommendation at this stage and instead proposes that there should first be a wide-ranging debate on the issue.

Conclusions and outlook

Until recently European tax discussions were rather one-dimensional in the sense of mainly serving a tax authority agenda. By its recent initiatives the Commission has sought to redress the balance. At the same time the general tone of its recent statements is unashamedly pragmatic. The Commission is aware of where member states’ main interests lie and what is achievable – it is shaping its policy accordingly.

So what of the future? On the assumption that the tax package is adopted this year, member states will still need to meet regularly to discuss the follow-up on both the Code of Conduct and the Savings Directive. Discussions are also taking place on how to bring about a more general improvement in administrative co-operation between tax authorities under the Mutual Assistance Directive.

On pensions a Council working party is due to report back to ECOFIN by the end of the year on the need for improved information exchange and arrangements to overcome double taxation and non-taxation. In the latter area the EU work may be expected to build on discussions that have since taken place in the OECD. The influence of the Communication will be greatly enhanced if the Commission’s view of the law is endorsed by the Court of Justice in two cases that are currently pending: Danner and Skandia, references for preliminary rulings from the Finnish and Swedish courts respectively.

In the area of company taxation the Commission will promote a debate over the coming year on its proposal for a single consolidated base and on the different models examined in the study. It has established a website dedicated to the study and plans a high level conference in the Spring. It will doubtless also be pressing the Danish presidency to put the study on the agenda for ECOFIN during its presidency.

In the meantime it has lost no time in beginning work on its less ambitious ideas. It has begun a series of meetings with member states in order to explore the scope for proposals amending the Parent-Subsidiary and Merger Directives. The Joint Transfer Pricing Forum has also been discussed with member states and has had a generally favourable reception. It is not unrealistic to expect the establishment of the forum or something like it later this year.

Last, but not least, litigation in the European Court of Justice (ECJ) is set to become be a much more prominent feature of Commission policy over the coming years. The case law of the ECJ has developed rapidly over the last ten years as a result of proceedings brought by taxpayers in the national courts. As things stand at present, the most effective way for the Commission to break down the more serious tax obstacles to cross-border activity and movement is simply to ensure better compliance with existing Treaty obligations. At the same time the Commission may, as it did with pensions, seek to combine any legal steps with policy initiatives in areas of general concern with a view to ensuring a more co-ordinated response.

Technical Department
020 7235 9381

April 2002 by


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