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Laurence Field, Crowe Clark Whitehill, London
Laurence Field is a Senior Tax and Corporate Business Partner at Crowe Clark Whitehill, London
Harmonization lies at the core of many of the European Union's governing principles: could Brexit be the catalyst for greater harmonization among the remaining Member States?
This article explores recent attempts at European harmonization, assessing Franco-German drives for closer cooperation and integration on tax; analyzing the European Commission's latest re-launch of the common consolidated corporate tax base (“CCCTB”); and looking at whether the U.K.’s decision to leave the European Union (“EU”) will be a catalyst for greater EU harmonization among the remaining Member States.
Harmonization lies at the core of many of the EU's governing principles and the CCCTB proposal should be viewed against the backdrop of the four fundamental freedoms upon which the EU was established—particularly the principle of free movement of capital. The internationalization of business, with increasing volumes of trade and business transactions flowing across borders, both between and within corporations, has caused particular issues for tax authorities. A significant proportion of total global trade flows takes place between entities in the same group or corporate structure. These intra-company flows and transfers are governed by the arm's-length principle and transfer pricing regulations. One of the major upshots of today's borderless world, exacerbated by continuous developments in technology driving digitization and further obscuring geographical boundaries, is that companies increasingly operate in a geography-transcending way, with clear jurisdictional authority often difficult to determine. National governments are now trying to grapple with how they should deal with this, as evidenced by some of the statements from the new U.S. President. Unsurprisingly, therefore, the EU has been considering methods—often centered on harmonization or convergence among national authorities—that seek to respond to the challenges associated with “borderless business.”
Generally speaking, EU harmonization (active attempts to achieve greater harmony, as opposed to passive convergence which occurs as a by-product rather than as an explicit end-goal) aims to create common standards across the internal market based on the underlying themes of consistency of law, regulation and practice. The aim is to achieve parity of treatment and the removal of competitive advantage, as well as to reduce the compliance and regulatory burden on those operating nationally or cross-border. Uniformity in law facilitates free trade, according to the model's theory.
The euro currency, launched in 1999, is one example. Currency union took place across 19 of the 28 EU Member States (the Eurozone) and the single currency entered financial markets on January 1 1999. The Member States that engaged in currency harmonization through the euro were Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain.
It is important to note that harmonization does not entail full uniformity—rather, it is the furthest point along the uniformity spectrum which is practical and achievable. Despite being a hallmark of many EU–driven ideas, not all harmonization attempts have been successful.
The most noteworthy recent attempt by the European Commission to increase tax harmonization across the EU came in the form of the financial transaction tax (“FTT”). The original proposal came in September 2011, and sought to “harmonise the tax base and set minimum rates for all transactions on (secondary) financial markets, once at least one EU party (financial institution) was involved in this transaction.” Minimum tax rates of 0.1 percent of the transaction value for transactions in shares and bonds and of 0.01 percent for derivative agreements (covering options, futures, contracts for difference or interest rate swaps) were proposed. All markets (e.g., regulated, over-the-counter), actors (e.g., banks, asset managers) and instruments (e.g., shares, bonds, derivatives) would be covered, to avoid the recharacterization of business and limit loopholes.
Trying to reach agreement across all 28 Member States proved too difficult, and by the time of the Economic and Financial Affairs Council (“ECOFIN”) meeting of finance ministers in mid-2012, it was clear that unanimous agreement would not be forthcoming. As a result, a group of 11 Member States—which retained an interest —agreed to take the FTT proposal forward under enhanced cooperation. In 2012, the subgroup of 11 Member States asked to introduce a common FTT based on the scope and objectives of the Commission's original proposal.
In early 2013, the Council of the European Union subsequently authorized the “FTT-11” to proceed under the enhanced cooperation mechanism. The revenue estimate for the proposal was 30–35 billion euros, equivalent to 0.4–0.5 percent of the combined GDP of participating states. However, little has been heard since then. The only meaningful development has been the announcement that Estonia has withdrawn its support for the proposal. With Estonia'a withdrawal, the enhanced cooperation group dwindles to 10. Given that the minimum threshold for invoking the enhanced cooperation procedure is a third of all Member States, the group of 10 is now just one withdrawal away from being forced to fold. The 10 states still interested in the FTT are Austria, Belgium, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain. An announcement was due in June 2016, which was pushed to December 2016, and now finalization is scheduled for “2017”. The quiet disappearance of the FTT from finance ministers' agendas should not be ruled out, as the protracted journey the proposal has taken to date hints at either a lack of ability to successfully implement the tax or a lack of true appetite to do so.
The difficulty in finding a route forward under enhanced cooperation, let alone with full unanimity, is symptomatic of the failure to achieve tax harmonization within the EU, especially considering the window of opportunity created by the public support for an FTT in the wake of the financial crisis and ensuing vilification of banks and the financial sector.
Despite fears from FTT proponents that the transaction tax will be gently forgotten, the European Commission—the executive arm of the EU—released its Corporate Tax Reform (“CTR”) package on October 26, 2016, centered around a relaunch of the CCCTB. That idea was also revived in 2011. At that time, the U.K. was one of the committed opponents of the proposal. This time, the package comes in the wake of the U.K.’s decision to leave the EU, giving new hope for champions of greater integration and harmonization throughout the bloc. But is this hope justified?
First, an overview of the CTR package, which has the underlying aim of providing for a modern and fairer tax system for business, as well as closing loopholes and providing new dispute resolution rules to mitigate double taxation. The three core pillars of the CTR package are:
A bit of detail on the technical structure of the European Commission's relaunched corporate tax package will be helpful here. The motivation for a CCCTB is to establish common rules for the tax base for corporate income tax. One tax return will need to be submitted in the Member State of “the main establishment” of a group of companies, with the overall group profit/loss being apportioned between Member States according to a formula tied to sales, assets and employees. The Commission envisages that the EU-wide system would be compulsory for large cross-border groups and optional for smaller companies.
Having encountered difficulties in trying to get the all-encompassing reform off the ground when launching the idea back in 2011, Pierre Moscovici, European Commissioner for Economic and Financial Affairs, Taxation and Customs, has tweaked his proposal this time around. Instead of pushing immediately for the full effects of a common consolidated corporate tax base (with its intimidating five-letter acronym “CCCTB”), Moscovici is now proposing that Member States sign up to a common corporate tax base (“CCTB”) as a first step; with “consolidation” (completing the CCCTB acronym) constituting “phase two” of the tax reform project.
Practically speaking, this would manifest itself through the initial introduction of harmonized rules to calculate a company's tax base in each and all of the EU Member States where it has operations. Tax revenues are then collected and distributed among the relevant Member States according to a formula for apportionment, with revenue allocation determined according to sales, workforce and turnover in each jurisdiction.
“These proposals have been around for a while,” says Claudia Ortiz, Chair of the Crowe Horwath International (Crowe) Tax Committee. “The idea was first floated in the early 1980s and was formally proposed in 2011—but those ideas got held up in technical and national squabbling and didn't seem to be going anywhere. As with many new paradigms, politics ýgot in the way of modernizing the tax system.”
Unsurprisingly, legislators are keen to capitalize on the public interest in corporate tax affairs, and this gives context to the timing of the relaunch, with CCCTB billed as a mechanism to ensure that multinational companies cannot dodge tax liabilities. Despite the weight and scale of populist support for “tax fairness” initiatives, the 2011 CCCTB push failed to make a serious mark, due in large part to objections centered on sovereignty and subsidiarity. These barriers to implementation will still need to be overcome under the new proposal.
However, despite the failures of 2011, the recent vote to leave the EU by the U.K. seems to have given the idea of a common set of tax rules fresh impetus. As counterintuitive as it sounds to say that a Member State revoking its membership increases the likelihood of harmonization, it should be viewed in the context of a key opponent being removed, which could represent a strengthening of the block's unity rather than a crumbling. However, the U.K. retains its membership for the time being, although its voice clearly carries less weight.
However, Wolfgang Kirschning, of Crowe's German practice, draws parallels with the 2012 bilateral initiative between France and Germany. “Both countries seemed to lose patience with Brussels and decided to work directly together to harmonize some aspects of their tax system. Unsurprisingly, little progress has been made. The tax systems are too different and the politics too complex. Little has been heard from the tax authorities on these matters for some time.”
If harmonization between two Member States—and two Member States, in France and Germany, that are keen to harmonize—is this difficult, the likelihood of success for an EU–wide proposal must be called into question.
So far, the response of European leaders to the Brexit vote seems to be more Europe, not less. And tax doesn't seem to be an exception. While the U.K. is content to go its own way, the economic imperatives of the single currency, along with a political desire to be seen to be on the side of people, rather than large companies, seem to be driving these proposals on harmonization.
Does Brexit mean that the political barriers to a CCCTB have been removed? Probably not. The U.K. retains its EU membership until such point as Article 50–based negotiations are concluded, and it was not the only Member State to reject CCCTB first time around—Bulgaria, Ireland, Malta, the Netherlands, Poland, Romania, Slovenia and Sweden were also among those in opposition. Reacting to the Commission's relaunch attempt, Denmark's Minister for Taxation, Karsten Lauritzen, threatened that the country would leave the EU if CCCTB is implemented across the bloc.
Opposition to, and criticism of, the CCCTB proposal has largely been based on two arguments: that of sovereignty, and that of subsidiarity.
The rise of populist sentiment and the idea of a more united or unified EU post-Brexit certainly raise the chances, but CCCTB could nevertheless be difficult to square.Jesus Romero, Chair of Crowe's European Tax Committee, expresses some doubts about whether the proposals would be implemented soon: “Controlling the shape and size of the tax base is a crucial role for national governments, who will each need to agree the proposals. Giving up control over these issues could be viewed as a significant loss of sovereignty.”
On sovereignty, a possible sticking point for opposing states is that it is not acceptable for Member States to have freedom to choose the tax rate without also having freedom in relation to the tax base.
Different states have different economic bases, and finding a “one size fits all” tax base will undoubtedly create winners and losers. It is also difficult for the EU to impose a bloc-wide mechanism for one tax without taking into account the holistic way in which national authorities compose tax policy—that is, looking at the interplay and interconnectedness of different taxes.
The rehashed CCCTB proposals would only apply to large companies with a turnover greater than 750 million euros. “This provides some hope to the Commission,” says Hans Missaar, Head of Tax at Crowe Horwath Peak in the Netherlands. “National governments would still be able to control the method of tax calculation for smaller companies. These companies are more likely to be locally owned and their owners are voters in national elections. There is an opportunity for the Commission to sell the story that they can deal with the multinationals, while freeing up national governments to encourage the growth of smaller businesses.”
Atlanta-based Jim Dawson of Crowe Horwath LLP says, “while we need to understand more about the proposals, they could be a mixed blessing for U.S. companies operating in the EU. A common tax base with clearer rules might provide more certainty regarding tax treatment and may even reduce compliance costs in the long run. However, any change to the law requires changes to the underlying corporate information systems that big businesses use to ensure they can comply with the law in different territories. The investment needed and the time to implement those changes should not be underestimated.”
Aside from not wanting to cede sovereignty, other claims levied against the harmonization proposal include the argument that there is little sense in implementing a regional solution to a global problem. CCCTB is mostly limited to the EU in its effects and application, while the tax avoidance issues that it purports to counter are global in nature. The U.K. and other opponents advocate for the adoption of OECD–proposed measures that had global agreement and which came out of the more all-encompassing project to tackle tax base erosion and profit shifting. With the U.K. leaving the EU and apparently using tax policy as a negotiation tool, even the commitment to OECD measures must be in doubt.
And finally, national governments oppose the CCCTB on the grounds that it is not in harmony with the principle of subsidiarity—that is, the notion that issues should be dealt with by the most local administrative body possible. In other words, an issue should not be dealt with on an EU-wide basis if the underlying aims are better achieved at national level. Only if national-level bodies cannot effectively deal with an issue should it be handed up the chain to the European executive.
In the UK's opposition paper, it was highlighted that the issues raised in 2011—chiefly concerns around sovereignty and subsidiarity—remain unresolved under the relaunched proposal.
Jane Ellison, the U.K.’s Financial Secretary to the Treasury, outlined the U.K.’s subsidiarity concerns bluntly in her explanatory memorandum dated November 29, 2016.
“The Commission has not adequately provided evidence of the change in circumstances since its previous proposal which had acknowledged adverse effects on investment, employment and GDP.”
“The Reasoned Opinion [of May 11 2011] sets out Parliament's view [actually that of the Commons alone] that the CCCTB proposal contravenes EU principles of proportionality and subsidiarity, and is therefore unlawful,” says Ellison's note.
The U.K.’s claim of a damaging impact on GDP is corroborated by Irish impact estimates carried out by the Economic and Social Research Institute (“ESRI”).The ESRI has modeled the potential impact of an EU–wide CCCTB, concluding that Ireland's economic output could be 1.5 percent lower than it would be in the continued absence of CCCTB. Acknowledging that the proposal could lower the administrative burden for some companies, the ESRI report warned of the initiative's impact on smaller countries: “If the corporate income on which taxes are levied is shared amongst countries for firms operating in multiple locations, the risk for a small country such as Ireland is that the tax base here is reduced.”
The ESRI raised the concern that smaller states with low headline corporate tax rates—for which Ireland is the European poster-boy—will suffer under CCCTB because the attractive tax rate (a “sacrosanct” 12.5 percent rate in the case of Ireland) would be applicable to a smaller portion of the corporation's income.
In spite of the well-documented opposition of the seven national parliaments that have lodged formal objections, seven objecting out of 29 is not a large proportion. With the U.K. on the way out, at least in theory if not yet in practice, the number of (publicly) harmonization-opposing states is actually fairly small.
Further, in light of a Trump victory in the U.S. election, what impact will this, in conjunction wtih Brexit, have for European harmonization? Francois Hollande, French President, in the aftermath of Trump's victory said that there would be a period of uncertainty globally, adding: “This context calls for a united Europe, capable of expressing itself and upholding its policies.” Gerard Araud, French Ambassador to the U.S., was quoted in the Financial Times as saying that, after Brexit and the U.S. election, “the world is coming apart before our eyes.”
All of this points towards increased European unity/unification and harmonization, driven by the likes of France and Germany, two countries which have always favored creating common standards across the internal market.
With the double “shock” of the U.K. shunning its relationship with the EU and its “special relationship” with the U.S. becoming increasingly uncertain with a more isolationist President, there is a strong incentive for EU Member States to come together politically. The appetite for this, in practice, remains to be seen.
As part of the Brexit negotiation tension, Chancellor of the Exchequer Philip Hammond has warned that Britain would look to pursue an aggressive tax policy and engage in low-tax competition if it was not granted good access to the EU's single/common market post-Brexit. Hammond responded to a question posed by German newspaper Welt am Sonntag about his willingness to turn the U.K. into “the tax haven of Europe” by saying that: “the British people are not going to lie down and say, ‘too bad, we've been wounded’.”
“If we are forced to be something different, then we will have to become something different,” warned Hammond. “We will change our model, and we will come back, and we will be competitively engaged.”
While Theresa May will seek to tread a conciliatory and non-adversarial path, it is clear the U.K. will not be averse to aggressive tax competition that very much flies in the face of harmonization attempts, if Brexit negotiations look like leaving the country at a competitive disadvantage.
The Prime Minister's January 17 speech at Lancaster House outlined her Brexit blueprint and largely aligned with that view of conciliatory rhetoric, underscored by allusions to loosely-veiled threats if conciliatory action is not favorable to the U.K.
With the U.K. out of the way, there may be a case for harmonization between and among the remaining EU Member States actually increasing down the line. Whether the response to Brexit (once some meaningful exit negotiations have started to take shape) is greater fragmentation (with other Member States electing to trigger Article 50) or greater integration (with remaining Member States embracing a more tight-knit brotherhood after being shunned by one of their more troublesome members) remains to be seen.
Regardless, this should be viewed realistically. Brexit negotiations between the EU and U.K. are, at least in the immediate short term, likely to distract attention and resources away from any meaningful harmonization efforts.
Corporate tax harmonization through CCCTB has been four decades in the making, but this is an idea that won't go away. It would certainly be ironic, though, if the Brexit vote was the thing that ultimately helped turn the idea of a common tax base into reality.
Laurence Field is a Senior Tax and Corporate Business Partner at national audit, tax and advisory firm Crowe Clark Whitehill, London, the U.K. representative firm of Crowe Horwath International.He may be contacted at: firstname.lastname@example.org
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