CCCTB: the right treatment for cross-border business?

Emrah Arbak argues that a common consolidated corporate tax base offers a way out of costly rules for European businesses.

Ask tax managers in Europe to name their chief concern and most will point to transfer-pricing. Put simply, these arrangements refer to the valuation of transactions within a group of companies. A group is expected to have more or less full control over its internal pricing decisions, so why are internal transactions more disconcerting than, say, the group's external purchases? To the untrained eye, the issue appears innocuous.

The matter becomes sticky when the group has foreign entities located in lower-tax countries. In these cases, transfer pricing can be used to divvy up costs and, therefore, profits. Such a group can diminish its aggregate tax obligations by paying an exorbitant price for the goods, services, or assets provided by the foreign subsidiary.

The transfer-pricing regulations attempt to inhibit these tax-motivated profit-shifting practices by ensuring that internal transactions are properly priced. But in many cases, there is little guidance on what a 'proper' charge should be. The result is a complex set of procedures that are both costly to comply with and to enforce.

A 2004 European Commission survey confirms that the documentation requirements represent a major difficulty for over 80% of businesses around Europe. To make things worse, the authorities appear to be in no mood to allow any breaches. A recent Ernst & Young report found that more than three-quarters of the tax professionals interviewed expect to undergo a transfer pricing examination within the next two years. Complex rules often give rise to unexpected outcomes, so a lot of companies seek professional help. The Ernst & Young survey also found that an overwhelming majority of the interviewed experts plan to hire external advisers to mitigate their legal risks. Indeed, the increasing reliance on auditors is apparent from their swelling earnings. In the UK, the top four audit firms' earnings from tax services alone grew 19% between 2004 and 2006, reaching more than £1.6 billion, or nearly a quarter of revenues.

Are we destined to live with these costly rules? The common consolidated corporate tax base (CCCTB) project offers a way out. Expected to mature into a proposal by September 2008, the regime allows corporations to pool their EU-wide profits for tax purposes. In order to avoid adding apples to oranges, a common profit definition is to be used. This means that EU member states will need to harmonise their use of depreciation allowances and other aspects of corporate income calculation. Once properly consolidated, the profits are shared among member states according to a pre-determined mechanism, which are then subject to taxation.

By pooling EU-wide profits, the regime removes the fiscal impact of intra-group profit allocation. In addition to resolving transfer-pricing problems, this also allows instant loss-offsetting. To top it off, the regime will be optional, so an unwilling corporation can opt out. To sum up, the regime promises to make pan-EU business more attractive. A recent survey by KPMG found that a clear majority of businesses support the idea of such a regime. But not everyone is sympathetic.

Some fear that the CCCTB may undermine tax revenues, especially in small, 'business-friendly' supply economies. The use of sales-by-destination in the sharing formula may reduce revenues as export-generated profits are taxed elsewhere. But the supply economies also happen to have favourable corporate taxes. So, most corporations will probably not divert their profits to higher tax regimes by opting in. And even if they did, their cost reductions must be considerable. Is it not hypocritical to claim to be business-friendly while blocking the development of a beneficial regime?

There is also the suspicion - amplified by the most unlikely voices - that consolidation will eventually become mandatory. A community-wide co-ordination on this issue appears highly unlikely, at least at this moment. Certain members will benefit from offering an optional regime that is perceived to be less taxing. But having a mandatory regime in some of the member states within the consolidated area will create authority problems. According to the current details of the project, a group's consolidation decision rests with its headquarters. The legality of imposed consolidation in one state may then be challenged by a dissenting corporation based in an optional state. In short, the current details of the optional regime offer no legal basis to set up a mandatory regime.

Others see the project as a crusade to harmonise taxes altogether. But base harmonisation can never achieve such an ambitious goal. Just look at evidence from the attempts to harmonise value-added tax. Though the laws have been around for more than three decades, the basic rates are nowhere near converging, ranging from 16% to 25%. There is no reason to fear that the CCCTB will be any different. To give an analogy from sports, applying the same rules to all teams does not make all games end in a tie.

Will CCCTB be a success? The answer depends on how well the proposal is tailored in the upcoming months. Several details merit attention. First, the regime will not be available to all corporations. Certain entities, such as those that are not sufficiently owned by the group, do not qualify. But this may mean that the regime will be available to only a few companies. If the eligibility criteria are too restrictive, the potential benefits will be limited.

Second, the common base should materialise. Although some exceptions may be temporarily permitted, the harmonisation of the tax base is essential for the ultimate value of the project. If, for whatever reason, a common base is not used, profit-shifting may still have a fiscal impact. In addition, a non-harmonised base will be a clear blow to the aim of realising compliance cost reductions and ending legal certainties, as corporations will still need to consider the different calculation methods available in each member state.

Third, the sharing mechanism needs to be thoroughly debated. This is necessary not just for political reasons but also for efficiency's sake. The new regime will unravel novel tax planning strategies - some innocent, others less so. More deliberation is needed to avoid substituting old troubles with new ones.

Fourth, since tax measures require unanimity in the Council of Ministers, the project may be implemented under so-called enhanced co-operation rules with less than full co-operation. Certain member states, including the Benelux countries, France, Germany, Italy and Spain, appear to be supportive. Others, such as Estonia, Ireland, Slovakia and possibly the UK oppose the project. But it should not be forgotten that the regime's ultimate value hinges on its community-wide availability. It is not clear if enhanced co-operation can achieve the uniform implementation of the regime, putting, among other things, base harmonisation into question. In short, the effort will not be worthwhile if only a few countries join in. The Commission and all the interested parties should do all they can to convince their governments to consider joining the regime.

The CCCTB has the potential to be very good for Europe. The literature supports the regime as a seamless way of taxing profits. Surveys have uncovered a sizeable interest and the project should not fall prey to idleness, narrow national interests or the paranoid fear that any step forward is a step closer to full tax harmonisation. It is time to stop bickering about the size of slices and start making the entire pie bigger.

• Emrah Arbak is a research assistant at the Centre for European Policy Studies, Brussels.

Emrah Arbak argues that a common consolidated corporate tax base offers a way out of costly rules for European businesses.

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