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December 14, 2007

Taxing times ahead for the EU

Taxing times ahead for the EU

Cross-border tax issues are under the EC spotlight following a report that recommends a quicker treatment of cross-border offsets. However, European correspondent Jeremy Woolfe discovers that no reform will be possible in the near future, meaning that barriers to EU tax competitiveness are likely to remain

The question of the offset of tax losses from one part of a corporate group against profits at headquarters located in a different EU member state is a problem that is re-emerging in Brussels. Pressing commercial interests are being swamped by complexities, however, meaning that steps are being taken with extreme caution.

The latest move is a report from the European Parliament that presses for tax offsets to be made possible. Currently, corporations may wait for three to five years for cross-border losses to become “definitive”, says European MP Piia-Noora Kauppi. She wants reform now and without delay.

In her report, entitled ‘Tax Treatment of Losses in Cross-Border Situations’, the politically centre-right Kauppi writes: “The difference in tax treatment of branches and subsidiaries in a domestic situation, as opposed to a cross-border case, interferes with logical investment decisions.”

Tax obstacles

Kauppi says this distorts the smooth function of the single market and exerts a drag on the European economy. Her position is that the EU, which arguably has the largest competitive single market in the world, must quickly be made “tax-competitive”. She contrasts the EU internal market, characterised by a large number of tax-induced obstacles, with other single markets, notably the US, Japan and China, each with harmonised codes.

Amplifying on the idea of economic obstacles, a commission official tells TA that in the EU single market, a company may make a profit of, for example, 200 units in its home country but lose 100 units in a start-up operation elsewhere. In this example, the company has to pay full national corporation tax on the 200 units but its investment loss is “stranded”, the commission says. The EC’s aim is to press for a solution.

Unfortunately, solving such legislative puzzle in the EU, with its 27 different jurisdictions, often happens at a snail’s pace. One incident that launched the tax loss issue was the Marks & Spencer ruling in the European Court of Justice (ECJ), which came in December 2005 following years of legal opposition in the UK courts. The ECJ decision allowed the retailer to gain a €44 million ($64 million) rebate from its UK tax bill, as offset against tax losses from its continental European subsidiaries. Significantly, the ECJ worded its judgment to make clear that it opposed that tax losses might be taken into account twice, and other tax avoidance risks. However, in the face of support for the UK government’s opposition (from Finland, France, Germany, Greece, Ireland, the Netherlands and Sweden) the judgment did force the tax loss issue into the open.

Also in 2005, the EC published a communication entitled ‘The contribution of taxation and customs policies to the Lisbon Strategy’. Then, in December 2006, the commission published another communication, ‘Tax Treatment of Losses in Cross-Border Situations’. This document sets out clearly many inconsistencies of the EU corporate taxation set-up, one being that it unfairly favours large companies in comparison with SMEs.

Three approaches The communication describes three alternative approaches. The first is a definitive transfer of losses or profits, without recapture. The commission opposes this, as it could shift tax bases across borders. Secondly, it raises the possibility of a temporary loss transfer that allows for that loss to be recaptured by the national exchequer of the subsidiary once the subsidiary returns to profit. Finally, the communication puts forward the idea of applying a worldwide system by which all foreign profits and losses are taken into account at an entity’s headquarters.

As it turned out, the commission’s initiative fell largely on deaf ears: in March, the EU’s Economic and Financial Affairs Council did no more than note the communication’s existence.

Tax avoidance manoeuvres There is concern hasty reform could lead to opportunities for companies to manoeuvre their positions to avoid paying corporation tax. An extreme example could be an EU multinational allocating its profits to low-tax countries, such as Estonia, where corporation tax is zero. In parallel, it could then engineer its losses to transfer to, for example, Germany, where federal and local taxes still mount up to around 30 percent.

The commission’s next step was another communication, ‘Tax Abuse’, which has just been released. While attempting to deal with Kauppi’s concern, its aim is to improve the “co-ordination of national anti-abuse rules”, the commission says. This is against a background where some EU member states have already implemented what the commission describes as anti-abuse rules.

The new document suggests how co-operation between the member states could help. It shows them how they comply with EU single market treaty obligations, and the paper copes with double taxation. The communication covers matters such as rules against particular types of avoidance schemes, such as thin capitalisation and letter box companies, purporting to provide intra-group services without adequate physical existence.

Linked to the whole cross-border tax loss challenge is another major challenge – to set up a European common consolidated corporate tax base (CCCTB). The European Parliament Committee on Legal Affairs holds the view that a CCCTB “would help, most of all, to tackle the difficulties which arise in relation to cross-border losses”.

Drawn-out process How long it is before Kauppi’s paper will stimulate results is anyone’s guess. There will be liaison with parliament, though this body is known to be somewhat toothless for taxation. It is also expected there will be noticeable noise from lobbyists.

This procedure could finally be followed by regulation, or, more likely, a directive. If it is a directive, it would have to be transposed into 27 different national legislative codes. Then the EC would have to verify that the transpositions conformed to the directive. Finally, the directive would be implemented across the EU, effectively becoming law.

This drawn-out process could take another three, six or more years. Kauppi fears this is ample time for the EU economy to fall behind the US, Japan, China and other rivals.

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