By Johann Benson, Transatlantic Economy Analyst
In December 2005, the European Court of Justice ruled on a case that highlighted some of the problems that arise when firms operating in the EU’s Single Market have to deal with 28 separate tax systems. The Court found that British tax provisions constituted “a restriction on the freedom of establishment” because retailer Marks & Spencer had not been allowed to offset losses incurred by its subsidiaries in Belgium, Germany, and France against profits from its domestic operations. In addition, EU member states are increasingly concerned about tax competition, which helps multinational companies lower their overall EU tax burden.
The European Commission’s proposed Common Consolidated Corporate Tax Base (CCCTB) would help address the concerns of both businesses and governments. The CCCTB “is a single set of rules that companies operating within the EU could use to calculate their taxable profits” and would allow companies to file a single tax return for all of their EU activity. Profits would then be taxed by each member state using individual national rates, but only after a formulary reallocation based on, for example, number of employees, payroll, tangible assets, and sales by destination.
At issue is the fragmented and competitive nature of the European corporate tax system, which still lacks the level of cross-border coordination seen in the setting of VAT rates. While tax competition among EU member states has driven down corporate rates, VAT rates have had a regulated minimum of 15% since 1993. However, competition stems not just from disparate rates, but also from differences in the tax base. The Netherlands, for example, has an official corporate tax rate of 25 percent, but it is selective about how it defines taxable profit, allowing many firms to take advantage of a much lower effective tax rate. This again contrasts with the regulation of VAT rates, for which EU Directives ensure a more uniform application of rules.
Serving to increase the ire of many Europeans, the biggest tax-avoidance stories of recent years tended to involve American companies, such as Amazon, Google, and Starbucks. According to OECD figures, complex profit-shifting strategies allow some multinational companies to pay just 5% in corporate taxes, while smaller businesses pay 30%. In sum, the European Commission estimates that tax evasion and avoidance costs the EU around 1 trillion euros every year, much of it at Germany’s expense. Some fear that without a global agreement on anti-tax-avoidance measures, the CCCTB could drive more profits to non-EU locations. However, it would also give the EU a stronger bargaining position on anti-tax-avoidance measures within the G20 and create a more level playing field in the EU Single Market.
According to Algirdas Šemeta, the European Commissioner for Taxation, Customs, Audit and Anti-fraud, the CCCTB is “an initiative which is awaited by 80% of businesses.” European businesses are particularly frustrated by the aforementioned inability to consolidate EU-wide profits and losses, as well as tax hurdles to cross-border mergers and frequent cases of double taxation, which still occur despite hundreds of bilateral tax treaties. Meanwhile, national governments have other concerns that the CCCTB could help address – tax competition, tax-avoidance schemes, and even cases of double non-taxation. Nonetheless, the CCCTB still faces resistance from national governments – most notably, from Ireland.
Although the European Commission is not currently seeking to harmonize tax rates, France and Germany are already pushing for greater tax convergence to counter tax competition, making Ireland suspicious that the CCCTB is a “trojan horse” for introducing tax harmonization across the EU. The Irish tend to view their 12.5% corporate tax rate as an integral part of their “business model,” pointing out that individual countries can use lower tax rates to offset other disadvantages. In fact, the newest member states of the EU have an effective average tax rate of 16.3%, whereas the EU-15 countries average 24.7 percent. For this reason, complete harmonization of tax rates is probably undesirable, but establishing upper and lower limits for statutory rates would eliminate large distortions in the Single Market. H. Onno Ruding, former Minister of Finance of The Netherlands, supports the creation of a CCCTB with a broad tax base and more closely aligned statutory rates in the range of about 20-25%. He argues that this would create more transparency, with easier national comparisons, and fewer legal disputes.
As for the immediate economic effects, a study commissioned by the Irish Finance Department estimated that a mandatory CCCTB would raise aggregate corporate tax collections by about 2% across the EU. However, a voluntary CCCTB would result in a 0.6% reduction of EU corporation tax revenue, as it is estimated that only 9% of companies would benefit from a consolidated tax return and therefore choose this option. The European Commission’s own impact assessment attributes the “lion’s share” of economic gains to lower compliance costs.
Nonetheless, the importance of the CCCTB would grow in the long-run. Firstly, through the growth and expansion of SMEs beyond their domestic markets, and secondly, by attracting new foreign firms to the Single Market. Philippe de Buck, the Director General of BUSINESSEUROPE, has noted that estimates of tax-related compliance costs in the EU are in the range of 2% to 4% of corporate income, “making the EU a less attractive place to do business compared with other economic blocs, such as the USA, Japan, or China, which are perceived as a single market by businesses.” Notably, tax and customs administrations of EU member states already cooperate and exchange information to detect and reduce tax fraud, and the most recent VAT regulation “establishes the information that Member States must collect, store in their domestic databases and make electronically available to other Member States.” With the worldwide push to fight tax evasion and avoidance gaining steam, increased cooperation among national tax authorities is inevitable, making this an ideal time to introduce the CCCTB and position the EU to better compete in the global economy of tomorrow.