Select Committee on European Communities Fifteenth Report



221. The history of the Commission's interest in harmonisation of corporate tax goes back to the report in 1962 of the Sagré Committee[140], which laid down three requirements for fiscal neutrality so that corporate taxation would not distort the market: the tax system should not influence the choice of the location of investment; it should not influence the choice of whether the investment is made directly or intermediated; and it should not provide an incentive for favouring one type of investment or one method of financing investment over another. Malcolm Gammie pointed out that the Commission had not built on this report by making concrete proposals (p 139), and Michael Devereux agreed that "it is difficult to discern any particular movement over the last 30 or 40 years" (Q 379).

222. We have already noted[141] that there is no explicit legal basis for advancing Community measures on direct taxation, and no Treaty requirement that corporate or other direct taxes should be harmonised. As Peter Wilmott said: "All there is is a requirement to harmonise indirect taxes … to the extent necessary to establish adequate functioning of the common market or now the internal market. There was no direct reference to direct taxation". He added that by the 1960s "people were coming to see that you could not make an artificial distinction between indirect taxes … and other forms of taxes on income, whether personal or corporate [that is, direct taxes]" (Q 391). But he thought that the lack of an explicit legal base might explain why the EU did not have a tax "policy", when it was "riddled with policies of one kind or another - agriculture, transport, trade, whatever" (Q 384). Our witnesses explained that devising a satisfactory system of corporate taxation presents technical as well as political problems. As market integration increases, it is increasingly difficult to say in which tax jurisdiction a company actually earns its profits, a problem faced by national tax authorities, which thus often have to make arbitrary decisions, and recognised by the OECD (Q 274). Michael Devereux suggested that although one can devise rules for attributing profit between tax jurisdictions "in economic terms [it] is almost a meaningless concept" (Q 382)[142].

223. The most recent attempt to come to grips with the issue of corporate tax harmonisation was the 1992 Ruding Committee report[143], which assessed the severity in existing cross-country distortions arising from separate corporate tax regimes, and the scope for limited measures to improve matters. On the basis of a business survey and other evidence, it concluded that corporate tax differences were an important factor in business location decisions, but were even more significant in the financial activities of a company. Its major recommendations to resolve the problems included measures to harmonise the corporate tax base (including historic cost depreciation allowances, and a uniform tax treatment of intangibles such as "goodwill"); a minimum tax rate of 30 per cent; and anti-discrimination proposals, including the abolition of withholding taxes on dividends, interest and royalties, and improved procedures for dealing with transfer pricing disputes. These ideas have not been taken up, and there has been no Commission initiative to provide, or even move significantly towards, a comprehensive solution.

224. The Government considers that it is "highly likely" that the relatively low level of corporate tax in the United Kingdom has influenced the location of industry, although the formal evidence is unclear (Q 142). It is generally agreed that corporate tax has an influence on the location decisions of companies, particularly for more mobile industries; in principle, it would be expected that these decisions would reflect the effective[144] rather than the nominal rate of tax. But of course, as Judith Mayhew (for the Corporation of London) said, "there are other issues people look at: such as the flexibility of the labour market; the availability of highly skilled workers; the infrastructure available; transport; education; … telecommunications; the IT infrastructure; the right types of buildings; and international access" (Q 109). State aids or other incentive measures will also influence decisions.

225. Malcolm Gammie summarised the dilemma as follows:

      "It may be plain to see the good sense in harmonising corporate profit taxes within a single market. It is unsurprising, however, that it is proving so intractable a task within Europe when corporate taxation has no clear theoretical basis, no agreed form and an uncertain jurisdictional basis - both in terms of the basis for claiming tax and the amount of the claim. And there is no legal framework within which to attempt to resolve any of those issues" (p 141).

226. We considered whether the lack of a harmonised or co-ordinated framework for corporate taxation actually mattered. UNICE[145] supports the argument that the current diversity of tax systems is an obstacle to cross-border integration. Malcolm Gammie listed a number of problems arising from the current diversity of systems[146], not least the sheer cost of complying with fifteen different tax régimes. He concluded that without co-ordination at Community level companies faced significant compliance and administration burdens, with a risk of double taxation "because countries will try and allocate too much profit to their particular jurisdiction" (Q 389).

227. There are various views on what the solution might be. Malcolm Gammie floats the idea (p 142) of what he calls "home State taxation", where companies would compute and pay tax solely by the rules of their "home State", and the revenue would be divided according to where the company conducted its operations and activities within Europe. The CBI did not favour a universal integrated system, but with the aim of "enabling companies to do business as if they genuinely operate in a single European market" (Q 316) they were interested in the idea of an optional single European corporation tax, whereby companies with interests in several Member States could choose to be taxed on a single consolidated result. They accepted that there would then be a need for a single body (which they assumed would be the Commission) to administer the régime (Q 317); and they recognised the need for careful transitional arrangements "to ensure that there was a satisfactory toll-free transition from the current system to the optional European system" (Q 318). They did not believe that the existence of a parallel optional régime would inhibit Member States from setting their own corporation tax régime: "nor should it" (Q 328)[147]. There is however an issue of how the proceeds of such a tax might be allocated. Barclays Bank shrugged this off, referring to "one EU cake of profit that is returned once and divided up between the Member States on whatever appears to be a sensible basis" (Q 22). There is a danger that the information which might be needed to construct "a sensible basis" could be just as complex to prepare as tax returns are now, so Malcolm Gammie thought that there might be moves towards the sort of allocation by formula which operates as between states in the USA (Q 389).

228. There are some recent signs of movement in this area. The Paymaster General told us that the Commission had been asked to bring forward a mandate for a study on corporate taxation, and that the Government had "insisted that the Commission should also be required under the mandate to consider the beneficial impact of tax competition on the competitiveness of European business and employment in Europe". She promised that Parliament would be notified when the mandate was agreed (Q 421). Meanwhile, the Government's view was clear:

    "We actively argue against harmonisation of corporate tax rates. We do not believe that is the way forward. We want a competitive United Kingdom and European economy facing outwards into the global market and engaging in it. Questions about harmonisation of tax rates or bases are not helpful in those objectives" (Q 447).

The views of other Member States vary. We were told that "Germany probably could not agree on the harmonisation of … the normal corporate income tax rates"(Q 200). France does not wish "to harmonise corporate tax in the same way as we tried to do it for VAT" (Q 244). The Luxembourg Minister of Justice and the Budget, on the other hand, "would like to see a Directive on corporate taxation being adopted in parallel with a Directive on savings"[148].

229. We asked some of our witnesses to predict what might happen in this field. Malcolm Gammie believed that if corporate taxation was to be maintained at all rather than just withering because of the process of competition between Member States[149], Community measures of some sort would eventually be necessary. "The practicalities of running a [different] system in different Member States will reach a point where governments are persuaded that actually it is better to agree on a set of measures than to allow matters just to continue to develop through market pressure". The real question was whether the Community would wait until it was driven to action, or devise a policy in advance (QQ 404-405). "If you asked companies what they would like", he said, "they would prefer to have a coherent proposal that resolves all these issues rather than having to do it by an incremental process over many years" (Q 390). Peter Wilmott agreed that the initiative for change was more likely to come from business than from governments: "The more [companies] see that they are at the mercy of forces which they cannot understand or master, which may be either market forces literally in the sense of competition between tax jurisdictions or court cases at the national or European level that may or may not produce rational answers to the questions which were put to them, the more they feel that is unacceptable and the more likely they are" to ask the Commission to produce a proposal (Q 405).

230. In view of the increasing integration of business within the EU and increasing globalisation, there are some attractions for both companies and tax authorities in the idea of harmonised corporate taxation. The only comprehensive solution suggested to us was a system where companies would pay tax to, and by the rules of, their chosen "home State". But such a system presents various problems. It would in our view require a considerable degree of harmonisation of effective tax rates, to avoid businesses seeking out low-tax Member States in what some might regard as harmful tax competition. Because existing corporate tax structures are so diverse, we find it hard to envisage how agreement on a common system could be reached (even if the political will were there) and how the transition could be made. And the attribution of revenue to the various Member States in which businesses operated would require a centralised bureaucracy. Businesses may ultimately come to feel that to be a price worth paying for greater certainty, and we would well understand their wish to see Member States adopt policies to that end.

231. Meanwhile, failing a comprehensive solution, there would in our judgement be a case for an optional single European corporation tax along the lines suggested by the CBI, which would help multinational companies by simplifying their tax accounting and cutting out battles over which tax jurisdiction was applicable. However, it too would result in problems of revenue allocation for EU governments and potential bureaucratic burdens.


232. We discussed above[150] the minor proposals which the Commission has made for amendments to the current system of VAT. But the Commission has also published a Communication[151] which, although it makes no legislative proposals, floats ideas for fundamental changes to the VAT régime.

233. The current system of VAT is destination-based. For goods which are to be exported, no tax is paid in the Member State of origin, but VAT is imposed in the importing country. Tax can therefore be fraudulently evaded by diverting goods which have been zero-rated for export back into the domestic shadow economy. The abolition in 1993 of frontier formalities for goods traded across internal EC borders, as part of the completion of the Single Market, was bound to increase the scope for such fraud. The Commission therefore made proposals in 1987[152] which would have ended zero-rating on exports within the EC, introducing instead a VAT system which would have taxed goods and services in the same way whether they were destined for consumption domestically or in another Member State. Thus sales to other Member States would have become subject in the exporting Member State to VAT, credit for which would have been given by the authorities in the importing Member State. The Commission refers to this as the "origin-based system".

234. In the event, these proposals were not agreed; instead the zero-rating arrangements were retained, with some modifications. However, the danger of increased fraud as a result of the abolition of checks at borders was recognised. This system was therefore explicitly designated the "transitional régime", and a commitment was added to the Sixth VAT Directive that it should be replaced by a "definitive régime" which would be based on taxation in the country of origin. The Commission was supposed to submit proposals for such a system by the end of 1994, and it was generally expected that they would be based on the same principles as the Commission's former (1987) proposals.

235. Before any specific new proposals had come forward, however, the October 1994 ECOFIN Council laid down the ambitious criteria which any new régime would have to satisfy. It would have to be demonstrably better than the present system, and in particular to represent a fundamental simplification of the system with no distortion of competition; reduce burdens on businesses and administrations; ensure that the right revenue reached the right Exchequer at the right time; and create no increased opportunity for fraud. The UK Government had its own fifth condition, the ability to maintain those zero rates in force at the time the definitive system was adopted.

236. The Commission did not consider that a system based on the 1987 proposals could meet these objectives. It therefore produced in July 1996 a Communication on A work programme for progression to a new common system of VAT for the Single Market[153], exploring ideas for a definitive régime. Commissioner Monti left us in no doubt of the Commission's ambitions when he said that the proposal was "designed both to modernise and simplify the existing VAT system and in due course to transform it into a real common system with a single place of taxation[154] for a company in its country of origin" (Q 229). The essential characteristic of the new régime would be that each business in the EU would have a single place of registration, taxation and deduction of input tax. This would mean the elimination of any distinction between domestic and cross-border transactions within the Community: all the Community-wide business of a firm would be taxed on the basis of the legislation of the country in which the firm was registered. There would be a new mechanism for redistributing VAT revenues, on the basis of statistical data on consumption rather than declarations by businesses. Commissioner Monti pointed out that unless some system of this kind was introduced, as it had been successfully in Canada, there would have to be a complex clearing system which would negate the potential benefit to business of having to complete only one set of returns (Q 236).

237. HM Customs and Excise considered that the advantages of the single place of taxation might be over-rated, as far as small businesses were concerned. They told us that of some 1.6-1.7 million businesses registered for VAT in the United Kingdom, only some 70,000-80,000 were involved in importing or exporting (Q 362). And even if a United Kingdom firm was engaged in cross-border trading, it would under the present system have to register and account for VAT in another Member State only if it was selling goods direct to individuals in that country by mail order or from a shop, not if it was simply exporting goods. For services, the normal place of supply is where the supplier is established[155], so cross-border provision should not create VAT complications. And even where there might be liability for VAT in another Member State, only firms exceeding the turnover threshold would have to register. It follows that it is only larger businesses with multinational operations which are likely at present to be required to register in more than one Member State, and which would therefore benefit from a new system. Smaller United Kingdom businesses might actually suffer if the paperwork became more complex (QQ 352-353).

238. HM Customs and Excise do not deny the danger of fraud arising from the zero-rating of exports. But Martin Brown suggested that changing to the origin system would simply change the nature of the fraud, with importers claiming VAT refunds when no goods had changed hands (Q 358). Under either system, evasion could only be overcome through mutual assistance, using spot audits checked with other Member States through the VAT Information Exchange System (Q 359). The risk of fraud would not be removed by the single place of taxation system; it would now no longer relate specifically to export transactions, but would be liable to arise for any trades between companies registered for VAT in different Member States. Moreover, HM Customs and Excise had doubts about whether the proposed system of revenue allocation could work, given the difference in Member States' statistical systems and tax collection systems (Q 353).

239. We considered whether a common VAT system would necessarily imply common rates of VAT. The Commission Communication says that the new system would require the Member States "to embark on a legislative harmonisation process which is more extensive than has ever before been contemplated in the field of indirect taxation … in order to restore the economic efficiency of VAT as a system of taxation"[156]. It claims that "the introduction of a single [standard] rate would provide a perfect solution avoiding any tax-related distortion of competition and, above all, ensuring that the tax is applied simply and uniformly throughout the Union[157] - nevertheless, an approximation within a band could prove sufficient. The decision setting the rate should be a political one and should take account of the general need for sufficient revenue, the need to share the burden among the main types of statutory contributions and charges (direct taxation, indirect taxation, social contributions) and the thrust of medium-term tax policy". Harmonisation of the number and scope of reduced rates "is necessary from a purely technical standpoint … The Commission remains convinced that only a small number of rates is compatible with the objective of simplifying the tax"[158]. And exemptions and other derogations should be limited in order to ensure as wide a base as possible for the tax.

240. In his evidence to us, Commissioner Monti was clear that, with a single place of taxation, "a higher degree of convergence of rates" would be needed (Q 235), but he did not specify whether he thought that rates or bases would have to be identical. HM Customs and Excise explained (Q 349) that, under the present arrangements, Member States could opt for two reduced rates[159], but in addition they were allowed to continue to use lower (or zero) rates that were in operation before the Directive came into force. It was under these provisions that the United Kingdom continued to zero-rate goods like public transport, young children's clothing, food, books and newspapers. Some other Member States had a zero rate, and some had rates between zero and 5 per cent for various products.

241. The Irish Government takes the view that a certain initial degree of VAT approximation was essential for the Single Market to function; but it considers that this level was largely achieved by 1993, and that whereas in general the present system works well, plans for a common VAT system "would most likely create problems". It sees strong barriers to political agreement on a new system (p 176). The Chairman of the CBI Tax Committee believes that "a single [VAT] taxation base for ease of registration and compliance requirements is the sort of thing that the Single Market should facilitate", though "that does not necessarily mean that the whole European system must be totally harmonised and made more rigid" (Q 326). But he recognised that with a single place of taxation there would have to be "a reasonable approximation of rules", and measures to stop firms from exploiting differences in rates (Q 330).

242. Sectors with special interests have drawn our attention to their concerns. The Food and Drink Federation claims that abandoning the zero rate of VAT on basic foodstuffs "would threaten United Kingdom economic stability by adding to inflation, … would hit poorer households particularly hard, [and] would cause considerable damage to the industry's competitiveness"; it considers that "it is quite possible to simplify the VAT system without threatening the zero rate" (pp 173-174). The Newspaper Society asks us to "recommend the avoidance of the harmful consequences of harmonisation, through preservation of the zero rate on the printed word", arguing that such matters should remain the prerogative of Member States (pp 179-180). The House Builders Federation tells us that: "Across Europe the industry believes that VAT harmonisation on housing would damage employment in construction and reduce access to housing"[160].

243. Asked whether he thought further harmonisation of VAT was essential for the success of the Single Market, Martin Brown of HM Customs and Excise replied: "We have got a Single Market that works at the moment". The big step forward had been getting rid of frontier documentation in 1993: even the Commission accepted that the transitional system "has, on the whole, functioned satisfactorily". Further minor adjustments would be needed to deal with inconsistencies, "but not harmonisation of rates, not harmonisation of coverage according to the grand vision of the Commission's Communication" (Q 354).

244. We have considered whether we should welcome or deplore the apparent loss of momentum on the issue of VAT. There seemed to be two main arguments for change.

245. First, the single place of taxation system is presented as having significant advantages for businesses - in particular for small firms wishing to export, which would have to grapple with the bureaucracy of only one Member State. We were initially attracted to it for this reason, but we then found that in fact small firms would benefit only in rare circumstances, and the proposed system for redistributing revenue might well lead to more rather than less bureaucracy.

246. The other main reason for considering a new VAT system would be if it offered a real likelihood of reducing the scope for fraud on goods traded between Member States. This is a matter of considerable concern to us, particularly in the context of enlargement. Unfortunately, it does not seem that changing the VAT treatment of traded goods would eliminate the scope for fraud. We note that changing from the present destination-based system to the origin-based system proposed by the Commission in 1987 would merely have changed the method of operation of fraudsters, and we fear that the same might be true of the single place of taxation system.

247. Moreover, we note other major drawbacks to the single place of taxation system. Without considerable convergence of national VAT bases and rates, businesses would have an interest in establishing themselves where VAT rates were lowest (because they could then sell their products more cheaply all over the European Union). This would erode overall VAT revenues. In addition, we think that the concentration of business registration in low tax Member States would create enforcement problems, because enforcement is likely to be more difficult if revenue authorities have to tax business activities which are occurring well outside their territory.

248. We conclude that there seems to be no compelling argument for a completely new system of VAT. A change to a system based on a single place of taxation would impose comprehensive new restrictions on the VAT policies of Member States, as far as we can see to no particular benefit. We judge that if the Commission were to bring forward such a proposal it would fail the test of proportionality.

140   See p 139. Back

141   See paragraph 103.  Back

142   And in any case it was increasingly difficult to define "profits" because of the blurring of the distinction between equity and debt. Back

143   Report of the committee of independent experts on company taxation, Commission of the European Communities, March 1992.  Back

144   That is, the rate adjusted to allow for differences in the tax base and in allowances.  Back

145   Company taxation in the Single Market: a business perspective(op cit). Back

146   The absence of relief for losses in one Member State against profits in another; the risk of transfer pricing adjustments to profits leading to double taxation (and administrative costs); the application of withholding tax in other Member States which cannot be credited against domestic tax liability; the risk of borrowing costs being disallowed; the difficulties of ensuring that company management structures match the various legal and tax structures, and of reorganising European operations and group structures without incurring undue tax costs (p 141). Back

147   Neither the CBI (Q 318) nor the Corporation of London (Q 120) saw it as helpful to link this idea to the proposals for a European Company Statute, which the CBI thought should be confined to issues of corporate governance. Back

148   loc cit. Back

149   A solution which would be efficient in economic terms, in the sense that it would remove distortions (Professor Devereux: Q 392), but might not be politically acceptable. Back

150   See paragraphs 200-216. Back

151   9466/96 COM(96) 328. Back

152   COM(87) 320. Back

153   9466/96. Back

154   Our italics: we shall use that term to refer to the proposed system. Back

155   Exceptions include services related to land, which are regarded as taking place where the land is located. Back

156   loc cit, p 25. Back

157   A further factor leading to pressure for harmonisation of VAT rates may be the use of VAT as one of the Own Resources for financing the EU budget.  Back

158   loc cit, p 18. Back

159   That is, rates below the standard minimum rate of 15 per cent. Back

160   They submitted a document produced by the European Union of Developers and House Builders (not printed with this Report) claiming that harmonisation of VAT rates on housing is not necessary because housing is not tradable over borders; arguing that if VAT were applied to new houses, it would also have to be introduced for the sale of existing houses, which would have adverse social consequences; and adding that because housebuilding is highly labour-intensive, retaining or introducing reduced VAT rates would be an effective way of creating jobs.  Back

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