On 23 October 2001, the European Commission issued a document running to several hundred pages which dealt with what it considered to be the tax obstacles facing companies in the internal market. At page 372, the paper gets round to stating: ‘the existence of the 15 systems is the source of the majority of the obstacles’. Unless you are familiar with tax policy, the humour of this may be lost on you.
This publication was the result of input from panels of experts – the first, and seemingly the most influential, comprised academics and theoreticians.
By the time that accountants – who would actually have to implement any suggested changes – became involved, it was too late materially to alter the document. So there are no prizes for guessing that the result is detailed and academic.
The document highlights some fairly obvious problem areas – for example, loss set off across borders, transfer pricing and group restructuring. It concludes – eventually – that the main vehicle for solving these issues is a form of harmonised tax system.
But it raises questions of its own. What does this all mean for companies? What are the tax harmonisation options? What about small companies?
The first question is simple to answer. There will be little immediate impact on companies in the near future, since it takes around 25 years for any new direct tax measure to obtain EU approval.
In response to the second question, there are four different proposals relating to tax harmonisation and co-ordination. These are: home state taxation, common consolidated base, European Union company income tax and a single compulsory ‘harmonised tax base’. Under home state taxation, companies would compute their taxable profits on the basis of their home state’s tax rules.
There would be an agreed formula for splitting the profits between the states in which the company operated and then taxing them at the rate applicable in those states. For example, if a company based in the UK generated total profits of £100,000, with £75,000 in the UK and £25,000 in Sweden, 75% of profits would be subject to UK tax, with 25% subject to Swedish tax rates.
Such a system is not free of legal and practical obstacles, but at least it would not require any significant changes to domestic tax law or any wholescale harmonisation of the tax bases. For small businesses, this might be the only arrangement which was deliverable and simple enough for companies to understand and operate effectively.
The common consolidated tax base (CCTB) is the ‘esperanto’ solution to tax harmonisation. The idea is to set up a separate EU ‘corporation tax system’. The domestic systems will remain, probably intact, but this optional additional system would be adopted across the EU to enable companies to work out their taxable profits in each of the states in which they operate. The profits would then be subject to the domestic tax rates of those states.
The third option, the European Union Company Income Tax, would be similar to CCTB, but would be administered by a new central institution which would apply a single corporation tax rate to the profits. After taking tax revenues to fund the EU institutions, it would then distribute the remaining amount to the EU states following a formula. This would create a huge tier of bureaucracy.
It would take longer to achieve a single compulsory ‘harmonised tax base’ than it does to pass tax measures into EU law – the 25 years mentioned previously. If ever successful, it would mean the wholesale harmonisation of the tax bases of all EU member countries, the replacement of existing tax codes and probably in the setting of a standard rate of corporation tax across the Union.
With the exception of the first – home state taxation – the proposals would require endless negotiation. But the problem, which must be urgently addressed, is the need to help small businesses overcome tax obstacles which prevent them from enjoying the benefits of the single market. Large companies are more likely to have the resources to enable them to deal with the complexities of the 15 different tax systems and, in some cases, can benefit by ‘cherry picking’ between tax systems which best suit them.
The possible answer – and one not yet considered by the EU – is to introduce a zero rate of corporation tax. This was introduced in the UK as a way of taking clubs and associations out of the tax net. In most EU countries, the corporation tax take from defined small companies amounts to no more than 2-3%.
These businesses would still pay payroll taxes and irrecoverable VAT, while the economic stimulus of being able to operate much more freely would significantly outweigh the loss in corporation tax revenues. Let us hope governments can think small, really small, to help small businesses.
- Chas Roy-Chowdhury is head of taxation at ACCA.
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