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EU Corporate Taxation

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Corporate taxation

EU Corporate taxation covers the following topics:

  • Corporate income tax, including Taxable income, capital gains, losses, witholding taxes and intercorporate dividends.
  • Taxes on payroll, including the Payroll tax and Social security contributions
  • Taxes on capital, including Net worth tax and Real estate tax

Detailed proposals for the harmonisation of corporate taxation have existed from the earliest
years of the European Community itself. The Neumark Report of 1962 recommended that
corporation tax systems should be harmonised along the lines of a split-rate system, with a
lower rate of tax on distributed (i.e. dividends) than on retained profits. In 1970 the Van den
Tempel Report advocated a classical corporation tax system throughout the Community;
and in 1975 the Commission itself tabled a proposal for a common partial imputation system,
with rates within a band of 45-55%. Finally, in 1992, the Ruding Report recommended
both substantial harmonisation of the corporate tax base and the harmonisation of tax rates
within a 30-40% band. None of these ambitious proposals were acted upon.
Through recent tax reforms, most European countries have reduced statutory corporate tax
rates, accompanying these measures with a simultaneous broadening of the corporate tax base
– mainly through less generous depreciation allowances. Because of these recent changes, the
dispersion in corporate tax rates between countries has been significantly reduced. Member States with corporate tax rates above the average (Germany, Belgium,
Portugal, Netherlands, Italy, Greece) have reduced the rates, decreasing, therefore, their
deviation from the European average, although the crisis have increase and will increase such rates. In most European countries, but not all, corporate tax
rates are converging.

The Irish Case

 Ireland, exceptionally, reduced the standard corporate tax rate from 24% in 2000 (which was already below the
European average) to 20% in 2001. Effective from 1 January of 2002, the standard corporate
tax rate was been reduced from 20% to 16%, and from January 2003 this rate has been
12.5%16. This rate of 12.5% were  applied to the trading income of small companies, which are companies with trading income not
exceeding €254,000 euros (£I 200,000). A 25% rate applied to certain nontrading income, such as Irish rental
and investment income. A reduction in the tax rate is available on income from the sale of goods
manufactured in Ireland and from some service activities, giving an effective rate of 10%. In some cases, the
rate of 10% also applied until December 2010. For more details concerning Irish
Corporate Tax reform, see  Haccius, C. (2000), “The Irish corporation tax revolution”, Bulletin for
International Fiscal Documentation, vol. 54, no.3, pp. 122-132.

If we calculate before the crisis the dispersion through the standard deviation for all EU Member
States, but excluding Ireland, we find that this indicator has decreased. If we include this data
for Ireland, the standard deviation is higher.

International tax policy discrepancies

A further important issue, however, concerns the direction taken by the national tax reforms.
These indicate the existence of a discrepancy with policy recommendations. A reform of
corporation taxation towards some form of neutral business taxation that leaves the return to
marginal investment untaxed (i.e. the switch to a cash-flow income tax, which leaves new
capital formation untaxed) has long been advocated. In this point, see Meade Committee (1978), The structure and reform of direct taxation, Institute for Fiscal Studies,
London, and Sinn, H. W. (1987), Capital income taxation and resource allocation, North-Holland,
Amsterdam. The switch to a cash-flow tax has also recommended as an alternative to the EU-wide
harmonisation of corporate income taxes (Cnossen and Bovenberg (1997), “Company tax co-ordination in
the European Union: Some further thoughts on the Ruding Committee Report”, M.I. Bleijer and T. Ter-
Minassian (eds), pp.164-178).

Most reforms, however, have been in the opposite direction.

An interesting paper in the subjet is the paper authored by Haufler, A. and Schjelderup, G (2000), “Corporate tax systems and cross country profit shifting”, (Oxford Economic Papers no 52). The paper analyses optimal taxation of corporate profits when
governments can choose both the rate and the base of the corporation tax, constrained to collect a given
amount of corporate tax revenue. This paper examines the effects of cross-border profit shifting on corporate
tax systems and the tax rate cut cum base broadening reforms observed over the past decade. These may be
motivated as an optimal policy adjustment to the rise in foreign direct investment. The authors conclude:
when foreign direct investment is permitted and firms can shift profits between countries trough transfer
pricing, it will be optimal for each government to distort investment decisions in order to reduce tax rates
and limit the incentive for profit shifting.

According to this paper of Haufler and Schjelderup, one possible reason for the discrepancy
between policy recommendations and actual corporate tax reforms may lie in the increasing
internationalisation of national economies, in particular through the growing importance of
multinational corporations. In conditions of growing volumes of foreign direct investment
(FDI), competition for “paper profits” causes Member States to distort their corporation tax
structures in the direction of lower statutory tax rates, compensated for by a broadening of the
tax base.
This creates a case for a minimum EU corporate tax rate, which could help to combat profitshifting
strategies by multinational firms. The Ruding Committee proposed this measure in
its report in 1992. According to Haufler in its 1999 Paper “Prospects for Co-ordination of Corporate Taxation and the Taxation of Interest Income
in the European Union”, Fiscal Studies, vol. 20. no 2, pp. 133-153, the growing importance of transfer pricing
in internationally integrated firms leads to highly elastic responses of paper profits to nominal
tax rate differentials. . The paper evaluates the recent proposals for a co-ordinated capital tax policy in the European Union, focusing on an EU wide minimum withholding
tax on interest income and alternative ways to increase the effective tax rate on corporate profits. The paper
concludes that some aggregate efficiency gains can be expected from EU co-ordination proposals, but
additional tax collections will be limited largely to the group of small savers while highly mobile large-scale
investors are likely to avoid the EU tax.

A minimum EU corporation tax rate would prevent competition for
profit tax revenues, according to Deveraux, M.P. (1992) in its 1992 Paper “The Ruding Committee Report: an economic assessment” (Fiscal Studies, vol. 13,
no2, pp. 96-107.)

Nevertheless, multinational firms can avoid high EU corporate tax rates through profit
shifting to other, low tax jurisdictions in which the firm operates. Multinational firms may
react to tax harmonisation measures in Europe either by relocating production to non-member
states (if they derive low firm-specific rents from locating in Europe) or by shifting profits to
low-tax countries outside the Union. So it is possible for multinational firms to locate in avoid high EU corporate tax rates.

The problem is therefore wider. In the presence of world-wide mobility of tax bases, tax
policy co-ordination at the EU level is not enough; it needs to be at an international level.
As some authors propose, a possible alternative, following the US example, could be to
supplement the traditional arm’s-length–pricing rule with the “comparable profits method”.
This regulation gives US tax authorities the right to correct corporation taxes on the basis of
the profitability of comparable firms in the same branch over a longer time period. A more
systematic solution would be an EU-wide application of formula apportionment (or unitary
taxation), as currently employed by the US for firms operating in several States.

The EC Commission has proposed several approaches for providing companies with a consolidated
tax base for their EU-wide activities, including a European Company Tax and a  compulsory, fully Harmonised Tax Base.
In order to discuss these proposals, the Commission organised a conference in Brussels on 29
April 2002, which agreed that companies operating in more than one country should be taxed
on the basis of a consolidated tax base. For smaller companies (SMEs), the preference was
for  a Home State Taxation (HST); for larger, an optional Common Consolidated Tax Base (CCTB). The Commission announced that it was working on a pilot
project covering SMEs and companies using the European Company Statute (Societas
Europeae). The project could initially be implemented in a restricted number of Member
States which were favourable to the proposals.

There was little support at the conference for the harmonisation of rates, or even a minimum rate.

Two qualifying observations are necessary.
· The way in which corporate tax systems develop in the future may depend to a
considerable extent upon international developments. The ability of multi-national
companies, in particular, to shift profits between jurisdictions argues for some general
agreement on apportionment.
· The direction of recent tax reforms – a reduction of nominal rates combined with a
broadening of the tax base – is not necessarily economically optimum. There are strong
arguments for a system which exempts new capital formation from taxation.