Europe must start looking for new ways to get around a taxing problem

Date: 25/04/02

Mattias Levin looks at the possibilities for any future convergence of corporate taxation across the European Union.

ANYONE familiar with EU affairs knows that taxation is a non-starter.

Taxation is regarded as a core part of national sovereignty and a key policy instrument in shaping the society. Therefore, apart from indirect taxes, the Community institutions have no competence in the policy area.

However, as the single market programme has continued to peel away layers of obstacles to the free movement of goods, services, capital and labour, taxation is increasingly standing out as the major remaining one.

Tax obstacles are particularly acute for companies, as they are increasingly active on a European level.

Currently, they must comply with 15 tax systems. This is costly and is manna from heaven for tax lawyers who, apart from helping companies comply with this jungle, also make a decent living out of advising companies how to play national tax systems against each other.

These systems differ significantly. To a large extent this is natural, as taxes reflect differences in economic situations and deliberate policy choices.

However, over recent decades, these differences have increased, as company taxation has become more complex.

In the 1970s, countries tried to compensate for the then negative effects of the oil shocks by granting companies state aid and exemptions from taxation.

In the wake of the liberalisation of capital flows in the 1980s, such schemes became even more popular, as countries started to compete for the location of productive activity by granting preferential tax regimes.

Apart from making tax systems more complex, the increasing use of such regimes led to a significant erosion of tax revenue.

By the mid-1990s, this situation had reached such proportions that the European Commission started fearing a 'race to the bottom', with member states out-competing each other to such an extent that corporate incomes would become virtually untaxed.

Fearing that taxation in such a case would be shifted over to less mobile tax bases (read: labour), the then Internal Market Commissioner Mario Monti in 1997 pushed the Council to adopt a tax package dealing with capital income taxation.

One part was a Code of Conduct, under which member states would eliminate, by 2003, those regimes that distorted investment decisions in the single market. This would make the calculation of taxable profits more comparable between member states.

No matter whether the deadline is met or whether the code will have to be extended, it is necessary to think of strategies beyond its scope. The aim of the code is to make tax bases less complex.

Even so, 15 systems for calculating taxable income will remain, continuing to act as an impediment to the realisation of the full benefits of the single market.

A new CEPS report, An EU company without an EU tax?, takes a closer look at these long-term options for taxing corporations in Europe.

It acknowledges the spectacular failures that earlier proposals in this field have invariably experienced.

In 1992, the Ruding Committee (named after the then Dutch finance minister) recommended that corporate tax rates be set between 30 and 40 per cent, but member states politely but firmly refused to contemplate these proposals.

Nevertheless, continuing market integration, the advent of the euro and the agreement on a European Company Statute make it nonsensical to continue taxing corporations along national lines. It also goes against the goals of the Lisbon Process, under which the EU has pledged to become the most competitive economy in the world by 2010.

Therefore, the CEPS report argues that in the long run, member states should all calculate taxable corporate income in the same way, while remaining free to tax this income at rates free for them to set.

In other words, the EU should have a common corporate tax base.

Considering the current base divergence it would be difficult to reach agreement on such a base, however.

Therefore, the CEPS report proposes two intermediate systems:

• Home-State Taxation: this would allow companies to incorporate in one member state for tax purposes. Taxable income on their EU-wide operations would be calculated according to that member state's tax rules. This taxable income would then be apportioned to member states according to the share of that member state in the company's production and taxed at that member state's corporate tax rate.
• Optional Common Base Taxation: another option is that EU leaders agree on a 16th system for calculating taxable corporate income. Each member state would then allow companies the choice of having their tax base calculated either according to the national system or according to the 'EU way'.

If a company chose the EU-system, the taxable income would be apportioned between member states in the same manner as under Home State Taxation.

These intermediate systems reduce complexity for firms but transfer part of that complexity to national tax administrations who will have to manage calculations and apportionments.

The main advantage lies in their dynamic effects: both systems would set in motion a process of converging national tax bases, thus bringing the EU closer to the long-term goal of one single corporate tax base.

So, what are the prospects of any of these intermediate systems being implemented?

It would be naïve to consider it a smooth ride. There are, however, two reasons to be optimistic.

First, reform is more necessary now than ever before. The euro and the integrating single market are making national company taxation increasingly anachronistic.

Second, tax base convergence leaves the member states' freedom to set rates untouched.

A common tax base is not a proposal for reducing taxes. Instead, it is a proposal for reducing compliance costs.

Therefore, the proposals have the potential of being revenue neutral, which may go a long way to decreasing the opposition of member states and their various tax administrations.

A first test of member states' resolve in this matter will occur by the end of the month, when the Commission is hosting a conference on...ways of converging corporate tax bases.

• Mattias Levin is a research fellow at the Brussels-based Centre for European Policy Studies. www.ceps.be.

Major feature looking at the possibilities for any future convergence of corporate taxation across the European Union.

http://ec.europa.eu/taxation_customs/taxation/company_tax/index_en.htm http://ec.europa.eu/taxation_customs/taxation/company_tax/index_en.htm

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