Corporate tax and the EU court

Court rulings are forcing the pace of EU tax harmonisation

WHILE European Union governments do their best to avoid harmonising taxation, the EU's court of justice is busy doing it for them. Repeatedly, the court has ruled against national tax laws that discriminate between EU citizens on grounds of nationality, or hinder them setting up in other EU countries. Because these rulings also apply to companies, the effect has been to force governments to begin to alter, and in effect harmonise, tax laws.

Sometimes the result is to hit purely local companies with the same rules as multinationals. Thus, in Britain, transfer prices of goods or services between a London head office and its subsidiary in, say, Dover, used to escape tax rules that applied if the subsidiary were in Calais. Now, to pre-empt a hostile EU ruling, the law has been altered, for all but smallish firms, to catch purely British transactions too.

Much the same has happened with rules on “thin capitalisation”. This is the term used when a multinational finances its subsidiary in a high-tax country with debt, rather than equity, and charges a fat rate of interest. This shifts profit from the subsidiary to the parent, and high-tax countries naturally had rules against it.

Germany was one such. Its taxmen refused to allow as an expense all the interest paid by the German subsidiary of a Dutch company, Lankhorst-Hohorst, to its parent. The Dutch went to the EU court, arguing that had both parent and subsidiary been German, the interest would have been allowed in full. In late 2002, they won. Numerous companies in Britain then launched a group action to reclaim tax they had previously paid. Germany and Britain have now altered their “thin cap” rules so that they apply to purely local firms and multinationals alike.

The Dutch government lost a similar case last September. Bosal Holdings, a Dutch car-parts firm, had set up subsidiaries in other EU countries. Could it charge the finance costs as an expense? No, said Dutch law, only for subsidiaries in the Netherlands. Wrong, said the EU court, and the Dutch had to alter their rules.

In these cases, the taxmen have hung on to their revenues by being tough to all alike. But what if Marks & Spencer, a British retailing group, wins its challenge to a law that prevents it offsetting its French subsidiary's losses against group profits, as it could have done if the loss had been made in Britain? An EU ruling is due soon, and M&S hopes to gain at least £30m ($55m). A raft of multinationals have brought a group action in Britain. It could cost the state billions. Yet changing the law to deny offset even for local losses would be a giant step.

Dividends too are at issue. Hoechst, a German chemical group now merged into Aventis, in 2000 won a challenge to Britain's “advance” tax on dividends from its subsidiary there. There is a new case from Finland, whose law gives shareholders credit for Finnish, but only Finnish, corporation tax paid by the company. Here too the taxmen can expect to lose.

The real Europe-wide stinger, though, is the de Lasteyrie case, brought by a Frenchman who moved to Belgium. In French law, this meant he realised certain capital gains (though he had not sold the shares concerned) and must pay tax. No, he argued, that limits my freedom to set up in another EU country. Last March, the court ruled for him. The European Commission promptly said it would sue Germany if a similar German “exit tax” were not amended.

Of the 15 “old” EU countries, 12 have exit taxes. All are probably illegal. And that applies to firms as well as to individuals. In sum, any EU firm will soon be free - at least in tax terms - to shift to some low-tax EU country: Ireland, say, with its 12.5% corporate-tax rate, as against Germany's 38% or France's 34%. No wonder those two high-taxers are keen on harmonising corporation tax - at some level, that is, nearer their own.

European Court of Justice rulings are forcing the pace of EU tax harmonisation.

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