SPECIAL FEATURE - No 4 (June 96)

Towards a new direction in tax strategy

EU Economy and Finance Ministers decided at their informal meeting (ECOFIN Council) in Verona on 13 April 1996 to appoint their personal representatives to a high level reflection group on tax policy in the EU. This group, chaired by Commissioner Mario Monti, will take forward work on the areas identified by the Commission in its paper for the Verona meeting on "Taxation in the European Union".⁽¹⁾

The Verona paper

The Commission's Verona paper marked a new direction in tax strategy by taking a global view of all forms of taxation in the light of the major challenges facing the Union: the Single Market, Economic and Monetary Union (EMU) and the fight against unemployment. It examines how tax policy can best contribute to these objectives, which are interlinked and mutually reinforcing, and underlines the need for a more closely co-ordinated approach to taxation at Community level. In particular, it argues that Member States need to act together to prevent the erosion of tax revenues and thereby to preserve their own sovereignty in tax matters.

Although they stressed the importance of subsidiarity in tax matters, ECOFIN Ministers welcomed the initiative to promote a strategic discussion of taxation and agreed to set up a high level group to pursue the reflection. The Commission expects this to lead to a deeper common awareness of the problems and to the identification, if possible, of elements for a more co-ordinated approach.

The reflection document for Verona took an overview of all forms of taxation (VAT, direct tax, other indirect taxes and social security contributions) in the light of the following concerns.

1. Stabilising tax revenues

The Commission's first concern, as set out in the paper, is stabilising Member States' revenue-collecting capacities. Over the last 15 years total tax revenues have been roughly constant, but there has been an alteration in the structure of taxation. The burden has shifted from the more mobile bases, such as capital, to less mobile ones, such as labour.

Between 1980 and 1993 the implicit tax rate on employed labour for the EU as a whole grew by a fifth, while the implicit rate on other factors, such as capital, fell by more than a tenth.

The Commission fears that unfair competition through the tax system for economic activity may endanger Member States' ability to halt or reverse this trend. Further increases in the tax burden may drive activity into the black economy. Moreover, the burden on labour might not be able to be made any heavier without worsening the effect on labour costs and employment.

2. Smooth functioning of the Single Market

The Single Market is the cornerstone of European integration. It has a key role in paving the way for EMU, creating economic growth and competitiveness, and stimulating employment.

As other regulatory and economic barriers are progressively removed, taxation is rightly seen as an important obstacle to completing the Single Market. Removing tax obstacles will bring economic benefits for citizens and for business.

A true Single Market should also reduce the opportunities for tax arbitrage ("choosing the tax"), avoidance and evasion.

A fully functioning Single Market requires:

• in VAT, a simpler, more objective and more modern system which, in applying tax on the origin principle, treats intra-Community transactions as equivalent to domestic ones;
• progress in approximating excise duty rates;
• in personal tax, non-discriminatory treatment of frontier workers and other non-resident taxpayers, and the ending of tax disadvantages linked to cross-border financial transactions; and
• in business tax, the abolition of tax barriers to cross-border income flows, such as the discriminatory treatment of subsidiaries and permanent establishments in other States.

3. Promoting employment

The need for action in the taxation field to promote employment was underlined in the Growth, Competitiveness and Employment White Paper⁽²⁾ and has since been restated by a number of European Councils. But to avoid increasing budget deficits, particularly in the run-up to EMU, Member States have made reducing labour taxation conditional on finding alternative sources of revenue. Creating a tax base with the necessary level of stability to fund labour tax reductions clearly requires greater Community co-ordination of tax policy. In the face of international tax competition no Member State can achieve this stability through acting alone.

4. The need for greater co-ordination

There is a clear contrast between the need for progress in taxation and the rate at which it so far been achieved, which is much slower than that in many other areas of European integration. Tax co-ordination at the Community level has suffered from two main obstacles: the decision-making rules and the lack of an overall perspective showing the economic and social downside of failing to reach decisions. The repeated failure to make progress has substantially contributed not only to maintaining distortions in the Single Market, but also to creating opportunities for tax base erosion and generating unemployment. Trying to correct the revenue loss produced by tax erosion of the more mobile bases has unwanted adverse effects on employment. A deliberate and limited pooling of fiscal sovereignty by individual Member States to their collective decision-making would, however, have avoided an unconscious surrender of sovereignty by each of them to market forces in a field that should remain the prerogative of public policy.

A line of action

The Commission is convinced that in the current circumstances inactivity is not an option: it slows down the realisation of the Single Market, jeopardises tax revenues, and denies Member States the freedom to restructure their tax systems. For its part, and fully respecting the subsidiarity principle, the Commission will examine and, where appropriate, put forward solutions to those problems which Member States cannot resolve by acting individually. The solutions will be appropriate to the issues: there is no issue of tax harmonisation for its own sake, although some degree of harmonisation will be proposed where necessary.

In addition to tackling individual problems (in VAT, excise, direct tax, etc.), the Commission is also reflecting more widely on whether a minimum level of effective taxation throughout the EU would help provide the necessary stability of revenues in the various fields of taxation. Arriving at such a level would require consideration not only of nominal tax rates but also of the way of calculating the taxable income. Clearly, as the EU is part of the global market, it should not be so high that it risks driving business or wealth out of the Union

Tax and cross-border workers

The Commission attaches great importance to promoting freedom of movement for workers, especially in border regions. This freedom is still frustrated by a number of tax provisions. These can cause people who live in one Member State and work in another to be taxed less favourably in the other Member State than people who both live and work there, and gives rise to numerous complaints to the Commission.

In principle, employed and self-employed people are taxed in the country in which they carry on the activity, and most Member States have different tax arrangements for non-residents. Under these arrangements, only income from sources within the country of the activity is taxed. Other worldwide income is not taxed, and no reliefs are generally given for family circumstances or for various other deductions for which residents are eligible. Such advantages are normally given by the country of residence. In practice, however cross-border workers often cannot receive the benefit of such reliefs in their country of residence, if they have insufficient taxable income there. There is an exception to this rule for certain frontier workers, where some Member States have made bilateral agreements to tax their income where they live.

The Commission made a proposal in 1979 to harmonise income tax provisions with respect to freedom of movement for workers within the Community. Despite discussions over several years, the Council did not adopt it, as some Member States opposed taxing frontier workers' income in their country of residence. The Commission withdrew its proposal in 1992. But, on 21 December 1993 it came back with a Recommendation on the taxation of certain items of income received by non-residents in a Member State other than that in which they are resident ⁽³⁾ . This covered both employees and the self-employed, as well as pensions and income from other activities, and set out rules to ensure the non-discriminatory taxation of non-residents by the state of activity, where they were in a comparable position to its own residents.

The Court of Justice has since confirmed this approach in two important judgments. On 14 February 1995, in the Schumacker case (C-279/93), it held that a non-resident should not be taxed more heavily than a resident, if the non-resident derives all or nearly all of his income from the state of employment and does not have sufficient income in the state of residence to enable his personal and family circumstances to be taken into account for tax purposes there. The Wielockx judgment (C-80/94 of 11/8/1995) applied the same reasoning for the self-employed. The Commission has asked Member States to review their tax legislation in the light of these Court decisions and say what amendments they are making if any are necessary. A number of States have already adapted their personal income tax legislation to bring it in line with the decisions or the Commission's earlier Recommendation.

Differences in taxation between Member States

Corporate tax rates of local and central government⁽⁴⁾ (Basic rates, in %)

	1980	1985	1991	1993	1994
B	48	45	39	39	39
DK	37	50	38	38	34
D	61.5/44.3	61.7/44.3	56.5/44.3	58.6/46.0	45/30
GR		49	46(40)(5)	46(35)(6)	40(35)(7)
E	33	33	35	35	35
F	50	50	34/42	34	33.3
IRL	45	50(10)(8)	43(10)(9)	40(10)(10)	40
I	36.3	47.8/36	47.8/36	47.8/36	52.2
L	45.5	45.5	39.4	39.4	39.4
NL	46	42	35	35	35
A	61.5/38.3	61.5/38.3	39	39	34
P	51.2/44	51.2/44	39.6	39.6	39.6
SF	40	40	40	25	25
S	40	52	30	30	28
UK	52	40	34	33	33

Community law on direct taxation

The most important EC Treaty principles for direct taxation are the:

• free movement of people (Article 48)
• free provision of services (Article 59)
• right of establishment (Article 52)
• free movement of capital (Article 67).

In addition to the primary legislation in the EC Treaty, the Council has adopted some specific secondary legislation for direct taxation. These Directives provide common rules in the following important areas:

• The Mutual Assistance Directive (77/799 of 19/12/1977) gives a framework for administrative co-operation between Member States' tax authorities, notably in the exchange of information. This is to combat tax avoidance and evasion within the Union, and so reduce budgetary losses from cross-border economic activities. The Directive has since been extended to cover indirect taxes.
• The Mergers Directive (90/434 of 23/7/1990) allows companies of a Member State to reorganise their businesses without being confronted with tax obstacles, and so to benefit more fully from the opportunities of the Single Market. It defers the tax charge on certain cross-border reorganisations.
• The Parent-Subsidiary Directive (90/435 of 23/7/1990) also improves the Single Market for cross-border activities. It removes tax obstacles in certain circumstances to the distribution of profits from a subsidiary company to its parent in another Member State.
• The Capital Duty Directive (69/335 of 17/7/1969) abolishes all capital duties on mergers and transfers of business, and ensures that the raising of capital is not charged with other taxes of the same nature.
• Member States have also entered into a Convention, based on a Commission proposal for a Directive, to refer to arbitration any differences of opinion between them when they reassess transfer prices between connected companies for tax purposes (Arbitration Convention of 23/7/1990). This will avoid double taxation.

The Commission has also made six direct tax proposals which are currently on the Council's table. These include:

• Proposals to extend the scope of the Mergers and Parent-Subsidiary Directives to ensure greater uniformity as to the forms of company that can benefit from the two 1990 Directives. These two proposals are currently being examined in the Council.
• A 1991 proposal to take into account the losses of subsidiaries and permanent establishments in other Member States in calculating the taxable profits of Community enterprises.
• A 1989 proposal for a common system of withholding tax on interest income.
• A 1989 proposal to extend the scope of the Mutual Assistance Directive to override internal privacy laws where there is reasonable suspicion of significant tax evasion.

⁽²⁾ COM (93) 700

⁽³⁾ Commission Recommendation 94/79/EC see EC Official Journal N.L39 of 10/2/1994

⁽⁴⁾ Where two rates are given, the former reflects the tax rate on retentions, the latter the tax rate on distributions.

⁽⁵⁾ A lower rate (e.g. 40% in 1991)applies where companies are quoted on the Athens Stock Market.

⁽⁶⁾ A lower rate (e.g. 40% in 1991)applies where companies are quoted on the Athens Stock Market.

⁽⁷⁾ A lower rate (e.g. 40% in 1991)applies where companies are quoted on the Athens Stock Market.

⁽⁸⁾ Figures in brackets are the tax rates applicable in manufacturing
industry.

⁽⁹⁾ Figures in brackets are the tax rates applicable in manufacturing
industry.

⁽¹⁰⁾ Figures in brackets are the tax rates applicable in manufacturing
industry.

⁽¹¹⁾1990: West Germany

⁽¹²⁾ 1987

⁽¹³⁾ 1987

⁽¹⁴⁾ 1987

⁽¹⁵⁾ 1987

⁽¹⁶⁾ 1987

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