Taxation in the European Union:
The Process of
Corporate Tax Harmonisation in the EC
Chetcuti. All Rights Reserved. harmonization
“Unlike VAT, direct
taxation is at a purely embryonic stage of harmonisation.”[ci]
Advocate-General Léger’s description of the record of tax harmonisation
through Community legislation in the domain of direct taxes.
In this part, I shall seek to demonstrate how the principles underpinning
the concept of the internal market have concretely moulded the fiscal
developments in the EC since 1962, in the light of the ideal of corporate tax
harmonisation advocated by Euro-enthusiasts.
of direct corporate taxation was first proposed in the 1962 report to the
Commission of the Fiscal and Financial Committee (the Neumark Committee).[cii]
The Committee recommended more action at Community level to address the
current state of affairs in the fields of company and dividend taxation:
situation is at such a point of confusion that an analysis in a systematic way
is required. It goes without saying
that harmonisation will have to be achieved …”[ciii]
Committee held that differences in total tax burden might not influence
conditions of competition within the Community.
It was rather the differences in tax bases and structures that had this
effect. Thus harmonisation would be
the logical step to take with regard to:
taxes on company income, recommending the adoption of the
‘two-tier’ or ‘split-rate’ method of taxing distributed and
undistributed profits, by which corporation tax is partially refunded on the
distribution of profits; and
any taxes directly affecting capital movements, such as taxes on
capital transactions and interest and dividends.
number of Community level measures would be necessary to offset revenue losses
resulting from the harmonisation.
Committee proposed that double taxation be dealt with through a multilateral
agreement replacing any bilateral arrangements in force.
In 1967, the
Commission’s programme for the harmonisation of direct taxes[civ]
remove all tax barriers to capital movements, a single market and
the expansion of investment;
ensure tax neutrality in corporate restructuring operations or
create conditions of equal competition for investments by aligning
tax incentives and the methods of computing tax liability;
remove differences between national schedular taxes and possibly
in all taxes on company assets;
introduce a uniform corporate tax base and method of calculating
the taxable profits;
approximate MS corporate tax rates;
co-ordinate methods of inspection and collection; and
eliminate double taxation that cannot be dealt with through
the Commission proposed the following measures to facilitate the
interpenetration of EC capital markets through an adjustment of direct taxes:
the revision of MSs’ withholding taxes on income from
variable-yield securities and from bonds and debentures to enable tax to be
claimed or refunded under the tax rules of each country and in cross-border
the harmonisation of tax rates because the tax in many cases was
not reimbursable and rate differences between countries could colour investment
the abolition of withholding tax on bond interest in order to help
promote a European capital market for business and to attract inward investment.
(Withholding tax on dividends could be tackled with less urgency since double
taxation was often alleviated through double taxation arrangements between MSs.)
Commission’s slant was towards the full harmonisation[cvi]
of the corporate tax systems of all MSs. In
the light of this, it presented detailed proposals on:
the tax aspects of cross-border corporate restructuring[cvii];
the tax treatment of multinational groups of companies[cviii].
proposals received little consideration by the Council.
Thus, in 1975, the Commission sought to inject renewed energy in its 1969
proposals. In its action programme
for taxation of 1975[cix],
the Commission stressed the importance of the achievement of economic and
However, the Commission admitted that until it was possible for the
Community to bridle taxation as a means of achieving national economic and
social objectives at Community level, harmonisation should in no way hamper the
use of taxation as an instrument of national policy.
Thus restrictions should not be imposed on the MSs earlier than is
necessary, especially as regards the rates of the main taxes and charges.[cxi]
The proposed 1975 programme consisted of two main parts:
completing work of establishing tax conditions enabling the highest
possible degree of liberalisation in the movement of persons, goods, services
and capital and of interpenetration of economies;
making preparations with a view to further European integration, to
bringing closer together the respective burdens of those taxes and charges
having any substantial impact on the ideal of European integration and therefore
to use taxation as an instrument of common policies.[cxii]
Later on in 1975,
the Commission proposed a directive for the harmonisation of the systems of
company taxation and of withholding taxes on dividends[cxiii],
suggesting the use of the imputation system of corporation tax and the alignment
of rates. In 1976, the Commission
proposed an arbitration procedure to deal with double taxation arising from
transfer pricing. In 1978, it
proposed a measure on the taxation of dividends distributed through collective
investment schemes and started preparing measures on withholding tax on bond
interest and the tax treatment of holding companies.
Commission’s efforts only served to secure co-operation between tax
administrations. The requirement of
unanimity proved the stumbling-block preventing the approval of these measures
by the Council of Ministers. The
1975 proposal was criticised by the European Parliament on the basis that
approximation of rates could only work if there was an approximation of tax
bases – MSs did not agree to the further surrender of fiscal sovereignty
implicit in the measure and thus, discussion of this proposal ground to a halt.[cxiv]
the Eighties, the Commission proposed the harmonisation of national periods for
carrying over losses[cxv]
and a common system of withholding tax on interest and royalties[cxvi].
The 1985 White Paper on completing the internal market[cxvii]
urged the adoption of the outstanding proposals on mergers, parent-subsidiaries
taxation and the transfer pricing arbitration; however, to no avail.
The Nineties saw
the Commission reconsider its approach. The ideal of complete harmonisation of
company taxation proved too radical a revolution since MSs were keen to hold on
to their fiscal sovereignty. The
Commission now chose to adopt the more practical approach of seeking the
convergence of corporate tax systems in line with the principle of subsidiarity.
In a communication on guidelines on company taxation[cxviii],
Madame Christiane Scrivener[cxix],
then Commissioner for Taxation and Customs Union, indicated that according to
this new approach, the Community would limit itself to introducing measures
essential for the completion of the internal market, leaving MSs free to
determine their own taxation arrangements, save where they conflicted with the
principles of the EC Treaty and created distortions within the common market.
The controversial 1975 harmonisation proposal was formally withdrawn and
the Community committed itself to work in close co-operation with the MSs to set
priorities and define proposals. This
resulted in a ‘package of three’ successfully adopted in July 1990 and
proposals on taking account of foreign losses and the abolition of withholding
taxes on group interest and royalty payments.
In general, the
package of three aims to facilitate the formation of intra-EC, cross-border
groups and seeks to remove the fiscal obstacles associated therewith.[cxx]
This directive is
aimed at abolishing the withholding tax on intercompany dividends paid by
subsidiaries to parent companies within the EC and therefore at the elimination
of double taxation of such distributions. Under
this directive, double taxation is eliminated as follows: the country of
residence of the parent company must either exempt from tax profit distributions
by a subsidiary to its parent or allow the parent a tax credit for the
withholding tax and the corporation tax paid by the subsidiary on the profits
out of which the dividends are paid. The
state where the subsidiary is resident must not impose any withholding tax at
all on such distributions.[cxxii]
It was Germany’s unwillingness to abolish entirely the withholding tax
on outbound intercompany dividends that constituted the primary cause for the
delay in the adoption of the package.[cxxiii]
directive ensures the removal of the fiscal barriers to cross-borer mergers,
divisions, transfers of assets and exchanges of shares resulting from the
taxation of latent capital gains at the time one of these operations takes place
by postponing the realisation of capital gains on assets or shares involved in a
merger until they are actually sold by the newly-merged company.[cxxv]
Convention is a multilateral convention between MSs introducing a revolutionary
innovation in international tax law: a compulsory arbitral procedure which binds
tax administrations to eliminate international double taxation.
This procedure must be invoked by the competent authority of MSs should
they fail to come to a mutual agreement on the applicable transfer price and to
adequately eliminate double taxation within two years after a case has been
submitted to them by the taxpayer concerned.
A recommendation will then be issued by the arbitral commission which
will only bind the parties to the arbitration if these are still unable to reach
agreement within six months after the recommendation is issued. The Arbitration
Convention applies only to transfer pricing disputes and not to other disputes
encountered in the context of a double taxation agreement.[cxxvi]
Committee of Independent Experts on Company Taxation (the Ruding Committee) was
set up in the wake of the Commission’s communication of April 1990 on
corporate taxation. Its mandate was
to “evaluate the importance of taxation for business decisions with respect to
investment and international allocation of profits between enterprises”.
committee addressed three main issues:
whether differences in MSs’ taxation cause major distortions in
the functioning of the internal market, particularly with regard to investment
decisions and competition;
if such distortions do arise, whether they are likely to be
eliminated by market forces and tax competition between MSs or whether action at
EC level would be required; and
what measures might be needed at EC level to eliminate these
1992, the Ruding Committee reported to the Commission on ways of reforming the
taxation of EC companies in an increasingly unified internal market and broadly
endorsed the convergence approach to MS corporate taxation.
its analysis of differences in rates, tax bases, dividend taxation and the tax
treatment of cross-border flows of income (dividends, interest and royalties),
the committee concluded that there was evidence that tax differences between MSs
could affect investment location and distort competition and that, despite the
tax convergence that had already taken place, action was necessary at the
Community level to produce a significant reduction in the distortions affecting
the operation of the internal market.
Ruding Committee recommended:
the removal of measures which discriminate in favour of domestic
companies or against investment in other Community countries (for instance, by
the more favourable treatment of domestic-source dividends than of
foreign-source dividends) and which constitute a distortion in MSs’ tax
systems which impedes cross-frontier investment and shareholdings; and
the prevention of excessive competition, aimed at attracting mobile
investment, by fixing a minimum corporation tax rate of 30 per cent and a
minimum tax base.
24 June 1992 the Commission issued a series of guidelines setting out its views
on corporate taxation in the single market as a result of the Ruding
Commission agreed with the committee on the following issues:
the priority of eliminating double taxation of cross-border flows;
that the scope of the parent-subsidiaries directive should be extended to
cover all parent companies subject to corporation tax, whatever their legal
the need to extend the scope of the mergers directive to all types of
undertakings in the context of transfers of assets.
also proposed the following measures to eliminate double taxation in the context
of the single market:
a common approach to the definition and treatment of thin
capitalisation in order to prevent the double taxation resulting from the
application of different rules in the MSs (e.g. where interest payments made
between associated companies situated in different MSs are unilaterally
reclassified as dividends);
the establishment of common rules governing the allocation of
headquarter costs and the definition of costs borne by the shareholder, to
ensure their deductibility in at least one state;
completion of the network of double taxation treaties settled
between MSs, and conclusion of agreements with non-member countries in strict
accordance with the non-discrimination rules in the EC Treaty; and
initiating discussions with MSs to ensure that foreign-source
dividends are not taxed more heavily than their domestic-source counterparts. [cxxviii]
the other hand, the Commission opined that some of the committee’s
recommendations on the convergence of corporation tax rates, bases and systems
went beyond what was strictly necessary at Community level.
The Commissioner for Taxation, Mme Scrivener, reiterated the view that
following 1992, the Commission’s decisions in the field of company taxation
should be taken at the lowest appropriate level strictly consistently with the
principle of subsidiarity. The
Commission would therefore consult with all interested parties while respecting
the respective responsibilities of the Community and the MSs.
Thus, while the proposals for a minimum corporation tax rate and tax base
for company profits were worth examining, the 30 per cent minimum corporation
tax rate proposed by the committee was considered too high. Moreover, the
Commission did not see the need for a maximum rate.
suggestion that smaller unincorporated businesses, usually subject to income
taxation, should be given the option of being taxed as companies, was
sympathetically received by the Commission on the basis that this would
reinforce the self-financing capacity of SMEs as the rate of corporation tax is
usually well below marginal rates of income tax.
While the Council
agreed with the priority of eliminating double taxation of cross-border flows of
income, it still has not implemented further pending measures to achieve this.
In March 1996, in
a paper entitled Taxation in the European Union[cxxix],
the Commission once again highlighted the need to eliminate distortions in the
internal market caused by both direct and indirect taxation. In the context of
direct taxation, it indicated that it would present new proposals for
eliminating tax barriers to cross-frontier activity, beginning with a proposal
on the elimination of double taxation on royalties and interest between
associated companies. The March 1996 document re-emphasised reducing the
discriminatory treatment of subsidiaries established in other MSs, and indicated
that the proposal that would allow parent companies to offset losses of
subsidiaries is also still very much on the Commission’s agenda.[cxxx]
mutual assistance directive[cxxxi],
was the first directive on direct tax and now applies to taxes on income and
capital, value added tax and certain excise duties.
It sought to create a framework for the exchange of information between
tax authorities of MSs, in order to curb practices of cross-frontier tax evasion
and tax avoidance which affect the operation of the common market by distorting
capital movements and conditions of competition. It was felt that national measures and bilateral agreements
could not counter the internationalisation of tax avoidance or evasion.
However, the directive may have had little practical impact principally
because of the established exchange of information provisions in tax treaties.
MSs, the fundamental principle of non-discrimination and therefore of equal
treatment entails that, in imposing direct taxes, MSs should avoid any type of
discrimination on the basis of nationality.[cxxxii]
This rules out formal discrimination on grounds of nationality (overt
discrimination) and also disallows differences in fiscal treatment formally
based on grounds other than nationality but which produce the ultimate effect of
discriminating on grounds of nationality (covert discrimination).[cxxxiii]
The latter type includes discrimination on grounds of residence, since
non-residents of a MS are in their majority non-nationals.
treatment has to be distinguished from mere differential treatment.
The former arises through the application of different rules to
comparable situations or through the application of the same rules to different
situations, and is therefore disallowed. On
the other hand, MSs are not barred from fixing different rates of taxation or
from establishing different criteria for the imposition of taxation.
This as long as such differential treatment is imposed objectively and
not directly or indirectly on the grounds of the taxpayer’s nationality.
Hence, the mere fact that an EC national carries a heavier tax burden in a host
state than some locals does not by itself constitute discrimination.
Such taxpayer would only be entitled to challenge the imposition of
taxation there as discriminatory if he is subjected to taxation on a basis
different from that on which tax is imposed on locals in equivalent positions.
fact that every MS is bound to treat nationals of other MSs no less favourably
than its own nationals, i.e. the prohibition of discrimination on grounds of
nationality does not prevent a MS from applying on its own territory a tax
treatment that is less favourable to its own nationals than to the nationals of
this reason, in Hurd v Jones,[cxxxiv]
the Court of Justice found that a MS was justified in taxing remuneration paid
to its own nationals in circumstances where similar remuneration paid to
nationals of other MSs was exempt from tax, as the situation was wholly internal
to the MS. The same reasoning
applies to a MS subjecting one of its own nationals to a higher tax burden
because he did not reside in that state even though he worked and kept most of
his assets there.[cxxxv]
In the absence of a foreign element enabling the application of the
treaty provisions of freedom of establishment, such laws cannot be prevented.
this does not mean that a MS may discriminate against one of its own nationals
who is seeking to rely on one of the rights or freedoms guaranteed under the
Thus, a Dutch national residing in Belgium and who pursues an activity as
a self-employed person in both states (generating taxable income in both states)
is entitled, in his state of origin, to rely on the non-discrimination
provisions of the treaty.[cxxxvii]
has been established by the Court of Justice that, for the sake of fiscal
cohesion, restrictions on free movement, including discriminatory taxation, may
be justified in tax terms. According
to the principle of fiscal cohesion, there must be a correlation between the
sums that are deducted from taxable income and the sums that are actually
subjected to tax. Therefore, a
MS’s system might offset the loss of revenue resulting from the deductibility
of insurance premiums from total taxable income by taxing the later payments of
pensions, annuities or capital sums by insurers. Therefore, for the sake of the
cohesion of the tax system, in the event of the state being obliged to allow the
deduction of life assurance contributions paid in another MS, it should be able
to tax the sums payable by the insurers.[cxxxviii]
Bachmann v Belgian State[cxxxix],
the European Court of Justice (ECJ) ruled, as regards the freedom to provide
cross-border services, that requiring a business to be established in the host
state may be justified if it is indispensable for the attainment of an objective
in the public interest. In this
particular case, the issue revolved around Belgian rules restricting the
deduction, for income tax purposes, of contributions paid for insurance against
sickness, invalidity or old age or for life insurance, to those paid in Belgium.
The ECJ conceded that this would deter those
seeking insurance from approaching firms established in other MSs, thereby
restricting such firms’ freedom to provide cross-border services.
However, the ECJ found that these were justified as the
requirement of establishment was indispensable
to preserve the ‘cohesion’ of the applicable national tax system.
the other hand, in Asscher v Staatssecretaris van
Financiën, the Netherlands tax authorities sought to justify applying a
higher initial rate of income tax to non-resident than to resident taxpayers on
the basis that social security contributions were no longer deductible in the
Netherlands. The Court held that
there was “no direct link between the application of a higher rate to the
income of certain non-residents who receive less than 90% of their worldwide
income in the Netherlands and the fact that no social security contributions
[were] levied on the income of such non-residents from sources in the
Thus Article 43 of the EC Treaty comes into play, preventing MSs from
applying to nationals of other MSs pursuing self-employed activities on their
territories higher rates of income tax than those applicable to residents
pursuing the same activity; this insofar as there is no objective difference
between the situation of such taxpayers who are resident or treated as resident
that would justify that treatment.[cxli]
ICI v Colmer (HMIT), the Court rejected the United Kingdom's submission
that fiscal cohesion required that consortium relief, whereby the members of a
consortium could transfer losses incurred by subsidiaries of a holding company
owned by them for relief against their own profits, be limited to cases where
the majority of the subsidiaries in question were United Kingdom residents.
clearly results from these cases that a mere threat to fiscal revenues of a MS
does not qualify for consideration as fiscal cohesion in the sense recognised by
facet of the principle of equal treatment requires MSs to provide tax breaks,
exemptions and other substantive fiscal rights without discriminating on the
basis of nationality. Therefore Article 43 of the treaty has the effect of
prohibiting rules limiting exemption from taxation on transfers of property in
group reorganisations exclusively to transactions between companies incorporated
under national law. Excluding
similar companies formed in other MSs amounts to indirect discrimination on
grounds of nationality.[cxlii]
of overpaid tax
principle of equal treatment in respect of remuneration that is guaranteed by
Article 39(2) of the EC Treaty would be rendered ineffective if MSs could
undermine it through discriminatory provisions on income tax.
Thus, Article 7 of Regulation 1612/68 specifically provides that EC
nationals working in other MSs are to enjoy the same tax advantages as their
Domestic measures that make the repayment of overpaid tax subject to
discriminatory residential requirements will thus breach Community law.
Biehl v Administration des Contributions du Grande-Duché de Luxembourg[cxliv],
the ECJ held that a local law that has the effect of depriving workers of the
right to the repayment of overpaid tax when they leave the country or take up
residence there in the course of a tax year when that right is available to
permanent residents, is plainly discriminatory.
Even though the law uses the criterion of permanent residence to
determine the availability of the right – in fact, in Luxembourg, the
criterion was residence or occupying a salaried occupation for at least nine
months in the course of a tax year – and the criterion is applied irrespective
of nationality, the risk is that it will work against nationals of other MSs
since they are the ones who most often leave the country or take up residence
there in the course of a year. The
availability of a non-contentious procedure enabling temporarily resident
taxpayers to request repayment of overpaid tax, by showing that the application
of the law will produce unfair consequences for them, will not remedy the
discriminatory effect of the tax law.[cxlv]
R v Commissioners of Inland Revenue, ex parte Commerzbank AG[cxlvi],
the taxpayer, Commerzbank AG, was a
bank resident in Germany which had paid tax on interest received by its UK
branch. By virtue of the UK-US
double taxation convention , the charged interest was exempt from tax and
therefore the UK tax paid was recovered[cxlvii].
The claim for repayment supplement was refused on the basis that the income to
which the overpaid tax related was exempt because the taxpayer was not
UK-resident, whereas it would have been chargeable had the taxpayer been
resident. The ECJ held that the
concept of the “seat” of a company could be equated with the concept of
nationality for individuals. This use of the criterion of residence for
granting interest on refunded tax could lead to indirect discrimination in
contravention of EC law. Thus the UK was found to have breached the right
of establishment protected in Article 43 and 48 of the EC Treaty.[cxlviii]
to allow tax deductions may amount to discrimination contrary to Articles 39,
43 and 49 of the EC Treaty. In Wielockx
v Inspecteur der Directe Belastingen[cxlix],
the tax payer was a Belgian national and resident, who earned all of his taxable
income from a physiotherapy practice in the Netherlands.
Under a double taxation agreement, his Dutch income was taxable in the
Netherlands. Nonetheless, under
Dutch law, he was a non-resident and therefore not entitled to deduct
contributions he made to his pension reserve.
The ECJ stated that a non-resident taxpayer was to be given the same tax
treatment as regards deductions from his taxable income as a resident.
Otherwise, taxpayers such as Wielockx would suffer a greater overall tax
burden and hence discrimination.[cl]
treaty protects the right of a company to establish itself in another MS through
a branch or subsidiary, or through a transfer of its assets to a company
incorporated under the laws of another MS.
This does not mean that the treaty gives companies the right simply to
transfer their residence from one MS to another; so MSs’ tax rules requiring
official consent before a company is allowed to transfer residence from one
state to another do not constitute an infringement of or per se interfere
with, the right of establishment.[cli]
Why several of the Commission’s proposals failed
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