Author: Callum Glennen
8 Dec 2016
n August, the EU issued an order to Apple and Ireland that left many stunned. Ireland was ordered to collect €13bn in unpaid taxes, plus interest, from Apple, in order to cancel out the effects of an alleged ‘sweetheart’ tax deal between the two. The sum was calculated from a decade of underpaid taxes, after profits were funnelled through an office the European Commission alleged had no employees, no functional premises and no real activities. The commission claimed a deal struck with the Irish Government capped Apple’s maximum tax rate at one percent, amounting to a breach of EU state aid rules. The request for payment was not well received. The US Treasury said the demand jeopardised economic partnership between the US and EU, and Apple CEO Tim Cook penned an open letter to the commission accusing them of “rewriting Apple’s history in Europe”, denying the company received any special treatment.
The issue of corporate tax evasion has flared up recently in the EU, with new efforts being made to ensure member states are not providing tax deals to individual companies. In 2015, a sweetheart deal struck in private between Starbucks and Dutch officials was also ruled to constitute unlawful state aid, and another between Fiat Chrysler and Luxembourg received the same treatment, with Amazon currently under investigation for its operations there too.
While tax rates remain the jurisdiction of member states, the way taxes are reported and calculated could soon be changing
However, along with these renewed efforts to ensure corporations pay what the EU defines as a fair amount of tax, a number of questions have arisen regarding how to enforce the rules. While public and political opinion seems to broadly be on the side of stronger regulation, greater efforts to restrict how member states calculate tax rates have raised questions as to the extent of the role the EU can play in managing taxation. While tax rates remain the jurisdiction of member states, the way taxes are reported and calculated could soon be changing, and this could change the way countries compete in regard to business relations.
Rules of engagement
Formally, the EU does not have a direct role in setting tax rates for individuals or corporations. What the EU does oversee is that individual nations comply with overall EU policies and regulations, which apply to a number of areas of the economy. The rules are designed to make sure national regulations are consistent with EU-wide policies, such as maintaining the free flow of goods and the ongoing promotion of economic growth. In terms of duties on products like petrol, tobacco and alcohol, agreements have been made to ensure rates are more or less aligned from country to country. In terms of corporate taxation, countries are free to set rates as they please, although the idea of harmonising rates across the EU has been raised many times.
Dr Anzhela Cédelle, a Senior Research Fellow at the University of Oxford’s Centre for Business Taxation, said that at the very beginning of the European Economic Community there was no mention of taxation, but the topic of regulating corporate tax has since been brought up with increasing frequency. From the 1960s onwards, documents including the Neumark Report were produced that encouraged the removal of ‘artificial’ economic barriers and a form of harmonisation on tax rates. The plan ultimately proved too difficult to implement.
“They had a number of proposals in the 70s and 80s that were attempts to introduce harmonisation measures, but that did not go anywhere”, Cédelle said. The sentiment for a more harmonised tax structure was also repeated in the Ruding Report of 1992, which investigated the impact of differing tax rates within the EU.
None of the extensive recommendations for harmonisation or corporate tax rates and tax bases were supported by member states
“The answer that the Ruding report gave was again a proposal for further harmonisation, but – as before – none of the extensive recommendations for harmonisation or corporate tax rates and tax bases were supported by member states”, said Cédelle. At the most basic level, the report called for upper and lower limits to be placed on where nations could set their tax rates.
The concern regarding competing corporate tax rates is that competition for business is producing a race to the bottom among member states. Cédelle said, looking at the history of tax rates in Europe, you could make the assumption competition is indeed driving corporate tax rates lower.
“If you take just random numbers from mid-90s, for instance, the average corporate income tax rate within the EU was 34-36 percent, whereas nowadays it will be between 20-24 percent. So, what we see is an increase in tax competition, facilitated by the fact that companies can move more freely within the EU.”
In and of themselves, lower rates are not a problem – they are the choice of a country’s leaders and, by extension, its electorate. However, the danger is companies can use the situation to actually avoiding paying tax through aggressive financial planning.
Back to base
The Organisation for Economic Cooperation and Development (OECD) has been the driving force behind the implementation of stronger regulations on tax avoidance. In 2013, the OECD unveiled its Action Plan on Base Erosion and Profit Shifting (BEPS), identifying 15 specific actions countries needed to implement in order to prevent international businesses exploiting regulations in order to pay little or no tax. A focus of the action plan was to identify companies that levered laws designed to prevent double taxation, in some cases allowing them to reduce their tax bill to virtually nothing. More recently, the EU has followed suit and adopted similar regulations to prevent BEPS within the union.
Dr Christoph Spengel, Chair of Business Administration and Taxation at the University of Mannheim, explained the whole process, which has so far taken only 15 months, has been adopted with a surprising amount of speed: “The anti-avoidance package was proposed in January and was adopted in June, so that’s a very quick process.”
The speed at which these rules have been adopted perhaps suggests how strongly public and political opinion has shifted against companies. Whatever the economic outcome, the general opinion appears to be that large, multinational companies are not currently paying their fair share of taxes, and new regulations need to be implemented to address this.
Aiding and abetting
Another shift in the way the EU is looking at tax laws has taken place in the way it is interpreting the laws it already has in place. In the most high-profile and public cases of tax avoidance, such as the Apple and Starbucks cases, EU courts have increasingly found violations of the state aid rules.
The EU is committed to ensuring non-discrimination and free movement within the single market. Tax rules that disrupt mobility will be investigated, as will any regulations that result in people or corporations being able to dodge tax. The intention of this is to ensure the member governments are not able to lure firms away from other EU countries or erode each other’s tax bases. EU members have signed a code of conduct on the issue, which is not legally binding but does signal the EU’s intention to investigate in the area.
State aid is a connected matter, defined by the EU as an advantage offered by a state to a particular company or industry that is not offered to its peers. It may affect trade between member states or distort competition in some way. It is generally prohibited, although exceptions can be made under specific circumstances.
The EU is committed to ensuring non-discrimination and free movement within the single market. Tax rules that disrupt mobility will be investigated
Ultimately, this is what the EU has used to attack Apple and Ireland’s tax relationship. With Apple denying any wrongdoing, the matter will be referred to the European Court of Justice (ECJ).
Dr Michael Lang, Head of the Institute for Austrian and International Tax Law at the Vienna University of Economics, said that, recently, the ECJ has been applying a broader interpretation of the state aid laws. “I think what has happened recently, not just under the influence of the ECJ but the commission as well, is that the state aid rules have become much more effective than in the past. Of course, it might still not be the end of the process, because finally the court has to check whether this interpretation is in line with the law, but there is a certain message, I would say.”
Indeed, whether this is an acceptable interpretation is up to the courts, but Lang said he feels, in this case, the laws are being stretched further than originally intended. “In my view, I think they go too far and they give a meaning to the state aid rules which is very difficult to argue from a legal perspective. So, coming from the principle of legal certainty and the rule of law, I think it’s quite problematic to attach this meaning to the existing rules.”
With no appetite for limiting tax rates, the EU has now turned to making corporate tax reporting systems more transparent. This is best seen in the ongoing effort to introduce a Common Consolidated Corporate Tax Base (CCCTB) for member states. The CCCTB would effectively harmonise the different tax systems in use across Europe into one, allowing greater clarity and transparency surrounding how taxes are calculated. Member states would retain complete control over what their tax rates would be, but the system for reporting tax would be the same from country to country. A less ambitious version of these regulations also under consideration would be a Common Corporate Tax Base, removing the consolidation aspect.
The CCCTB rules were originally proposed in 2011, but at the time proved far too ambitious to be adopted. While the modern version has not yet been adopted (only having been introduced in 2016 and likely to go through many revisions), the rules could offer a number of benefits to companies, as well as states.
“The CCCTB, if adopted, will not mean that there will be no competition, because member states are still free to determine tax rates, even if the tax base is identical”, Lang explained. “But, of course, tax competition becomes much more transparent in a world where the tax base is harmonised, and where countries only compete by setting different rates.”
Member states would retain complete control over what their tax rates would be, but the system for reporting tax would be the same from country to country
Lang also said this may serve to reduce costs for some businesses. “It would reduce compliance costs for companies, because they wouldn’t be exposed to so many different tax systems anymore, and they would have at least the advantage that within Europe they have a harmonised tax base. So I think, for European companies, such a system would make them much more competitive than the existing 28 different tax systems.”
Cédelle said the benefits to companies will differ depending on their size and operating locations, but in the short term there would likely be a large initial expense in converting to a new system. While it may introduce a more business-friendly environment overall, the cost of converting the tax systems in use at each national branch of a company would be quite steep. “I think further work needs to be done in order to make it fulfil the role that the commission wants it to fulfil.”
Another question raised by the increasing amount of focus placed on corporate taxation is whether companies are underpaying their tax bills to a significant enough extent to warrant all these new regulations. Spengel said he believed the speed the European Commission has moved has been surprising, and whether the issue is urgent enough to warrant such haste is unclear.
“There is no clear evidence, there is no clear measure, and there is no clear figure. What is profit shifting all about? What is the amount we talk about? Is this 100 million? Is this one trillion? There is no clear evidence, and I think that it’s on the political agenda and these days it seems very popular to blame and shame multinationals, but no one has an idea of the impact on economic activity.”
Spengel added that, while ensuring the profits of multinationals are taxed is popular with the public, member states are not struggling for money. He said his country, Germany, is just one example. “We have the highest employment ratio ever since the Federal Republic of Germany was founded, we have the highest tax revenues ever. So, I don’t see that it’s really necessary to act so quickly, it’s just popular.”
He also warned the new regulations could have a negative impact on competition between European companies and their international rivals. “If EU-based multinationals have to report on their non-tax performance, wherever they are active, they tell competitors something about their value drivers, their value creation train. So you have GlaxoSmithKlein, or you have Merck in Germany, and they report about their activities worldwide. And Pfizer does not have to report. They get insights into the competitiveness of their competitors, and that’s a kind of internal secret on where you are profitable and where you are not, and so that’s more than taxes I would say.”
Tomorrow’s taxes today
Overall, both popular and political opinion has shifted strongly in the direction of ensuring multinational companies are forced to pay more taxes than they currently do. While the EU has been pushing the limit of what its laws are capable of having a say over, regulations are quickly catching up to make sure the EU has the tools at its disposal to rein corporations in. While the proposed regulations are still up for debate, what form they will take as laws is yet to be determined. Although, with intentions clear, the way corporations in Europe are taxed and regulated is undoubtedly soon to change. While the new rules may eventually reduce compliance costs, they will likely pose significant challenges for companies in the short term.