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Bureau of National Affairs

No. 234
Friday December 7, 2001 Page G-1
ISSN 1523-567X
Tax, Budget & Accounting

International Taxes

Experts Praise EU Harmonization Effort
But Foresee Difficulties With Transition

Tax officials and practitioners Dec. 5 said a European Commission proposal to harmonize member countries' tax treatment of multinational corporations would bring welcome simplification to firms operating across borders, but staging a transition will present numerous difficulties.

The proposed system would represent a dramatic departure from the historic practice of separate accounting and arm's-length pricing between related companies in different countries, panelists said.

The Commission has concluded that companies operating within its member countries would benefit from the development of a single consolidated tax base with formula apportionment for their EU-wide activities, said Matthias Mors, who heads the EU effort for coordination of tax matters.

Companies currently have to comply with 15 different sets of company taxation rules and a multiplicity of tax conventions, at considerable cost, and a reform of these rules would enable the EU to achieve its goal of becoming the most competitive economy in the world by 2010, Mors said during an electronic forum sponsored by Tax Analysts, referring to an EU study released in October.

The study, Company Taxation in the Internal Market, identified a number of tax obstacles to cross-border economic activity and proposed a two-track strategy encompassing both targeted short-run and comprehensive longer-term initiatives to remove them.

The EU study covered several company tax issues, including: previous business tax reform efforts; rates of effective taxation of company income among member states; potential incremental reports; and potential comprehensive reforms that would provide EU companies with a consolidated corporate tax base for their EU activities to be allocated by formula among member states.

The existing corporate tax differentials permit corporate capital to flow to countries offering the lowest effective tax rates, and not the countries where capital could be most productively employed, Peter Sorensen of the University of Copenhagen said in comments submitted to the panel. The level of corporation tax depends on the location of investment and not on the shareholders' place of residence, he explained.

Participants included Mors; Jacques Sasseville, head of the tax treaty unit of the Organization for Economic Cooperation and Development; Albert Raedler of Linklaters Oppenhoff & Raedler in Munich; Stella Raventos-Calvo of Vila Raventos and Associates in Barcelona; Christoph Spengel, who worked on the Commission's study; Joann Martens Weiner, of Tax Analysts, who acted as moderator; John Cronin of Farleigh Dickinson University in New Jersey; and Joseph Guttentag, former international tax counsel at the U.S. Treasury Department.

 

Potential Need for Tax Harmonization

The Internet and related technologies have vastly eroded the type of fiscal sovereignty countries depended on 10 or 20 years ago and made tax inspectors "literally helpless," Guttentag said.

"Isn't it time to recognize that tax systems must adjust and that means not only EU but international cooperation and even, excuse the expression, more harmonization?" he added.

Spengel said differences in the statutory tax rates are the single most important factor in explaining variations between the effective levels of tax burdens for both domestic and cross-border investment.

"Given the considerable impact of the statutory tax rate on the effective tax burden, tax rates should be harmonized from an economic perspective," he said. "However, harmonization should proceed in steps."

The first stage should introduce a minimum corporate tax rate that should be accompanied by the harmonization of the corporation tax base, he explained.

Further, tax rate harmonization, in contrast to tax base harmonization, could be managed by the individual European member states, he added.

 

Potentially Effective Systems

Raventos-Calvo said she supported a step-by-step implementation of the home state taxation system--where groups of companies would be able to compute the taxable base for all their EU operations according to the tax code of their particular home state.

"It is based on mutual recognition and it keeps a certain degree of competition among the member states," she explained.

She added that the length of operation in a completely different system might lead to unforeseeable problems, but maintained that it remained the more viable of the two systems.

The study also proposed a common, consolidated tax base where groups of companies would be able to compute the taxable base for all their EU operations according to a new common tax code applicable across the European Union.

"The idea of having the tax payable in State A administered by the home StateFormulary Calculation of EU Profits

Although moving to a formulary method for calculating EU profits would be compatible with the OECD model treaty, Weiner asked whether complications might arise if the EU were to adopt this approach while the rest of the world operated on the arm's-length standard. .

The main difficulties with this approach, Sasseville said, relate to the application of the tax treaty provisions, primarily in Article 7 on business profits and Article 9 on associated enterprises, that are based on the separate entity and arm's-length principles.

"It is difficult to see how the formulary method could be compatible with the treaties concluded between the member states themselves but, presumably, those treaties would be renegotiated as part of the implementation of any comprehensive approach," he added.

Treaties concluded with non-EU states may also be affected, although restricting the application of the formulary method to the EU would avoid most difficulties, Sasseville said.

The consideration of formulary apportionment is one of the most critical proposals affecting "foreign"-based multinational corporations with activities in the EU and vice-versa, Guttentag added.

 

Tax Policy Spillover Outside EU

The EU proposals, to the extent that they help remove tax obstacles, might serve non-EU-based multinationals as well as EU-based firms. In the current European market, U.S.-based multinationals seem to have a benefit over EU-based companies, Guttentag said.

"For example, U.S. companies have been lobbying for years to have the EU treated as one country for purposes of our controlled foreign corporation legislation," he said. "It would be ironic if the proposals served to enhance the competitive positions of 'foreign' companies," he added.

 

Allocation of Profits Between Countries

The Commission has expressed favor to the long-term objective of providing companies with a single consolidated tax base system for their EU-wide activities and has described several alternative approaches for reaching this goal, Mors said.

Although it is too soon to judge the strength of their support, businesses appear to back the two-track proposal by the Commission, Mors added.

Spengel and Raventos-Calvo said they supported a harmonized imputation system while Raedler favored a shareholder relief system as a separate option.

Weiner said she favored a two-factor formula with an apportioned federal tax base, similar to the Canadian system, although it lacked consolidation.

"Without consolidation, companies doing business in several provinces can still shift income for tax purposes," she said.

Canada has the problem of having a formulary system in parallel with arm's length, Sasseville said. A federal abatement is given for provincial taxes, which are computed on the basis of the income allocated with the formula, even though the arm's-length principle may result in the same income being allocated to a foreign state, he said.

Raventos-Calvo noted that "all these measures would have a great impact and would help to reduce existing distortions and obstacles for business."

"It would help if businesses were to put more pressure on their national governments and not only on the Commission,"she said.

By Myrna Zelaya-Quesada

Copyright © 2001 by The Bureau of National Affairs, Inc., Washington D.C.

 

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