“At the heart of every major political upheaval lies a fiscal revolution,” said Thomas Piketty in his groundbreaking Capital in the Twenty-First Century. Indeed, the Ancien Régime was eradicated in France by abolishing fiscal privileges of the social elites and led to the establishment of a much-needed modern system of taxation. Today, the rules for corporate taxation in Europe are yet again outdated, as they are the outcome of a system designed in the post-war era. In light of the “Lux Leaks” scandal, which revealed dubious corporate structures in Luxembourg, the corporate tax landscape is changing again. The public scrutiny of such practices has moved the tax debate from a purely technical one, to a political and moral one.
In the current framework, it is legitimate for governments to offer advantageous conditions to businesses. The process only becomes illegal State aid if and when other companies operating in the same jurisdiction (be they European or not) cannot access the same treatment. This is the notion of “selectivity” that the European Commission is currently applying in its investigations, seen by many as departing from past practice and highly controversial. The Commission is now questioning the legality of individual tax rulings as opposed to general schemes.
The Commission’s investigations
Although the impact of the investigations on Apple, Amazon, Fiat Finance and Trade and Starbucks is likely to be costly, with DG Competition expected to demand full recovery of revenues lost through illegal State Aid, the impact of EU State Aid cases could be even broader. More investigations could be opened, as the European Commission is reportedly looking into the tax structure of another 100 companies. Commissioners Margrethe Vestager for Competition and Pierre Moscovici for Economic Affairs and Taxation have stated that achieving tax transparency and preventing tax avoidance is their main objective. The Commission has taken some steps to achieving this: it has proposed a Directive on the automatic exchange of cross-border tax rulings between Member States’ tax authorities. This will enable central tax authorities to have a comprehensive tax rulings database to methodologically assess what was previously commercially confident information. Going forward, Member States will be equipped with the information they need to effectively target companies that try to escape paying their fair share of taxes.
The Common Consolidated Corporate Tax Base
But Member States must give priority to greater coordination of tax policies, first because it would act as a catalyst for a European economic union. The move towards a fiscal union is imperative for a functioning monetary union. However, the politics of the integration process have become increasingly contested in Europe, demonstrated by the stalled talks surrounding the Common Consolidated Corporate Tax Base (“CCCTB”). As a result, a re-launch of the proposal is expected in the first quarter of 2016. However, it may still be difficult to find an agreement, and there is some consensus in the European Parliament to drop consolidation (“CCTB”). The need for fiscal capacity has emerged as a necessary complement to the monetary union. Member states can coordinate their fiscal policies through the CCCTB as the proposal would create a common European framework to allocate taxable corporate profits amongst EU countries. Therefore it is important for the Commission that the talks of the CCCTB succeed, despite prior blockage in the Council.
Member States have long espoused a traditional strategy of tax competition as a means to economic development and to attract Foreign Direct Investment (FDI). Countries such as Ireland, Luxembourg, the Netherlands and the UK openly deploy such a strategy, and it has even become key to their economic model. However, a plethora of political economy literature suggests that governments can pursue alternative strategies to attract inward investment, not requiring aggressive tax strategies leading to a race to the bottom. Indeed, a harmonized tax-based system would actually greatly enhance Europe’s ability to attract FDI. For example, fair tax rates can provide for an educated work force, high wages, well developed infrastructure or other public goods as is demonstrated by the Nordic European states. This high-value strategy is something that Member States could pursue, but it would require countries to stop marketing themselves as a low-tax country to foreign investors.
The OECD’s BEPS agenda
EU State aid investigations into Member States’ tax practices have already led to Member States proactively changing their domestic tax systems, for example Ireland is closing the so-called Double Irish structure. This is a structure of tying the tax residence to the management seat of a company. As a result, Irish companies incorporated in Ireland, but controlled by persons located in another EU member state, will not be taxed in Ireland. This led to a process whereby profits were being shifted from the tax resident to the non-resident entities using transfer pricing rulings. Similarly the OECD’s Base Erosion and Profit Shifting (BEPS) agenda is shaping countries’ new patent box regimes.
A more controversial development at the European level that will keep governments and multinational corporations on their toes this autumn is the Commission’s objective to go beyond the OECD’s BEPS measures to demand public disclosure of country-by-country reporting (“CBCR”), as opposed to limiting the information to tax authorities. Businesses have been cautious about such an arrangement, as there is the possibility that the competitive position of companies could be undermined by greater levels of disclosure. The move is strongly supported by the left of centre factions in the European Parliament, who are keeping up political pressure on the Commission to progress on the corporate tax reform agenda. This is causing controversy amongst Member States, who are at odds with the issue. There is also consensus among them not to give into the European Parliament with respect to public disclosure of tax rulings.
Of course, it is not a question of disputing domestic tax reform as necessary to attract investment; in fact, it is legal for a company to attempt to reduce its taxes and doing so is a legitimate business endeavor. However, policymakers, governments and international bodies (the OECD and the G20) are increasingly holding the view that strategies designed for no other purpose than avoiding or mitigating taxes need to be curtailed.
Mikaela d’Angelo is Consultant in FTI Consulting’s financial services team in Brussels