As the Member States of the European Union struggle with the causes and consequences of the global economic crisis one notable aspect has been the ongoing effect on EU-wide and national tax policies. The harmonization of tax regimes has been a goal of the European Union since its inception and the crisis created an opportunity for the Member States to align their national tax policies as part of the economic and political initiatives needed to avoid a Europe-wide recession.
Indeed, when the crisis began many European states reacted in broadly similar ways by adjusting government spending and cutting labor taxes and, to a lesser extent, capital taxes. The result, according to a recent European Union survey, was that in 2009 overall tax ratios reached their lowest point since the beginning of the decade. But as recovery has proved slower than expected, a diversity has developed in fiscal policies both between the Member States and by type of tax despite the common challenge being to increase tax revenues without stalling recovery.
States which have been forced to call on bailout funds may have had tax changes effectively forced on them by the bailout conditions but in most other cases the tax elements of national austerity packages have been driven by the political complexion of the government. Perhaps the clearest example of this can be seen in France by contrasting the tax measures taken by President Nicolas Sarkozy in the first part of 2012 with those announced by President Francois Hollande after his socialist party won the May elections.
The overall result has been significant uncertainty about tax policy in many countries in Europe since 2009 and remarkable changes in fiscal direction. In July, after having previously promised not to raise taxes, Spain’s prime minister, Mariano Rajoy, announced an increase in value added tax of 3% to 21%. At the time he candidly admitted, “I said I would cut taxes and I am raising them but circumstances have changed and I have to adapt to them”.
Although the crisis has not so far brought about significant deliberate tax convergence across Europe it is possible to identify certain shared trends in recent national tax policy initiatives.
Tax Increases — Especially on Property and Consumption
In recent years a number of tax experts have argued that increases in property taxation are less damaging to economic recovery than, for example, labor tax increases. In line with this academic theorising the European Council conclusions, 1-2 March 2012 (EUCO 4/1/12 REV 1), recognise the need to rebalance the burden of taxation away from labor taxes towards taxes on consumption generally and property in particular.
European revenue raising measures in the last four years have been heavily concentrated on consumption taxes. Across the EU, VAT rates were broadly static from 2002 until the economic crisis hit. In 2008 Portugal was alone in increasing its VAT rate but a further six Members States did so the following year whilst another eight countries increased their standard VAT rates in 2010 and the trend has continued since.
In the UK, the rate of stamp duty land tax which is payable on the purchase of real estate was increased by 2%, to 7%, on residential properties bought for at least £2 million. Steps have also been taken to challenge the common practice amongst non-UK residents of holding high value UK residences in corporate vehicles with a view to avoiding tax on sale.
A 15% stamp duty land tax charge now applies on the transfer to a “non-natural person”, typically a company, of UK residential property worth at least £2 million.
Also, the UK government intends to introduce an annual 2% charge on high value residential properties which are already held in corporate “envelopes” and to bring any capital gain realized on the eventual disposal of the residential property within the charge to UK tax.
The UK property tax changes mainly close down loopholes that have been available only to foreign owners of UK property; by contrast new “social charges” announced in France arguably discriminate against foreign owners of French second-homes. The new charges will raise the tax on rental income from 20% to 35.5% and the tax on sale from 19% to 34.5%. In Ireland, an annual charge of €200 has applied since 2009 on second-homes and any residential property which is not used as a principal private residence and from earlier this year even those have been subject to a €100 annual charge.
Besides the new property charges the French government’s first budget introduced an emergency increase in wealth tax designed to generate an extra €2.3 billion, a 3% tax at source on cash dividends and a reduction to €100,000 from €159,000 in the zero rate band for inheritance tax.
But the French tax change which has dominated the headlines is the introduction of 75% tax rate on income over €1 million from 2013. When the UK introduced a top rate of 50% in 2010 the threatened exodus of entrepreneurial talent failed to materialise, but so did any significant increase in tax revenues with the consequence that it is to be reduced to 45% next year. There is already some anecdotal evidence that wealthy French individuals are looking at options for leaving France but it is too soon to tell how many will actually make the move.
Financial Transaction Tax
In a number of countries there seems to be a view amongst policy makers that the crisis was caused by financial institutions so the banks should bear a significant part of the costs of recovery. In September last year the European Union published detailed proposals for a new financial transaction tax (“FTT”). Germany and France, the main proponents of tax convergence, have been pushing for EU-wide implementation from the beginning of 2014 but have made it clear that even if some Member States opt out FTT will still be introduced in the remainder. In France, President Hollande has followed his predecessor’s plans to introduce the FTT this year.
The original FTT proposals relied entirely on a “residence principle” for identifying businesses which would be liable to account for the tax. Broadly, FTT would be due if at least one party to a transaction is treated as established in the EU. However, subsequent amendments have introduced an additional “issuance principle”. This expands the FTT charge to all transactions where the securities being traded are issued by a company in a Member State that has opted for FTT even if neither of the parties to the trade has an EU establishment. So, by way of example, a trade between a U.S. and a South American bank could be subject to the EU financial transaction tax if European securities are involved.
The current EU proposal is that FTT will apply to any transaction in financial instruments excluding primary market issuance and bank loans. Share and bond transactions will be taxed at 0.1% of the higher of consideration and market value and derivatives at 0.01% of their notional amount.
Crackdown on Tax Evasion
The most obvious and uncontroversial way to increase tax revenues is to prevent tax evasion and many of the Member States have prioritised this since the crisis began. In June the EU Commission issued a communication to encourage the development of concrete ways to tackle tax evasion and fraud across the EU. The proposals include a strengthening of the EU Savings Directive, better exchange of information between national revenue authorities and improving tax compliance by, for example, introducing a single Tax Webportal and the development of a “taxpayers’ charter”.
The proposals are not limited to EU-wide initiatives but also call on individual Member States to prioritise the prevention of tax evasion and fraud in their national legislative agendas. A linked memo from the European Commission notes that, “Member States have, in some cases, almost reached the limit in the expenditure they can cut and the taxes they can increase, while honest tax-payers must carry the burden of austerity”. The size of the shadow economy is estimated to be nearly one fifth GDP on average across Member States, representing nearly 2 trillion Euros in total.
Whereas tax evasion generally involves deliberate law breaking, successful tax avoidance relies on the legal exploitation of legislative loopholes, where sophisticated taxpayers stay within the letter of the legislation to achieve results which were not intended or foreseen by the legislature.
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But sometimes the identification of “loopholes” may be a question of perspective. One person’s legitimate tax incentive may be another person’s loophole.
The opportunity to be paid for working overtime without paying any more tax sounds like a loophole but in fact it was a tax incentive introduced by Monsieur Sarkozy in France as an aspect of his “work more, earn more” programme. By contrast, Monsieur Hollande won the presidential election in May on a “tax and spend” ticket and an early consequence of that was the scrapping of the tax-free status of overtime hours for all but the smallest businesses.
The laborious legislative task of identifying and closing loopholes may be shortcut by having a general anti-avoidance rule or “GAAR”. Worldwide more than 30 countries have already introduced GAARs including France and Germany in Europe and the UK is to introduce one in 2013 to apply to most taxes except value added tax.
A GAAR effectively augments the interpretation of the letter of the tax law by giving the tax authority and the Courts the right to consider transactions against the broader purpose of the tax legislation.
Belgium’s GAAR initially proved ineffective because it obliged the tax authority to adopt a re-characterization that was compatible with the legal effects of the original structure. However, changes announced in March 2012 are intended to address this problem by permitting the Courts to disregard steps or transactions where “tax abuse” is proven. Where the UK GAAR applies, the tax authorities will be able to counteract the planned tax avoidance by taxing the abusive arrangement on a “just and reasonable” basis. This sounds dangerously vague in the context of assessing a taxpayer’s liability to tax and it may be some time before we see how the Courts approach the problem in practice.
Ireland’s GAAR was introduced in 1989 but its application did not come before the Irish Supreme Court until last year and even then the result was somewhat equivocal. Although the facts of the case were, according to one Irish law firm, “extreme”, the application of the GAAR was only upheld on a three to two majority, and the Court rejected an invitation to adopt Canadian jurisprudence despite the Irish legislation having been modelled on the Canadian GAAR.
Tax and Morality
A striking side effect of the ongoing discussions about tax policy has been a growing debate about morality and taxation, whether there is, in effect, a moral obligation on individuals and businesses to pay tax.
In April the New York Times ran an article on the international group structuring, including the use of European-based entities, undertaken by some US technology companies to minimise their US taxable profits and state taxes. The article noted that not everyone agrees that the philanthropy and job creation of such companies justifies group structuring which enables them to avoid “their fair share” of tax in the US.
In the UK a treasury minister recently suggested that it is “morally wrong” to pay tradesmen, such as plumbers and builders, in cash so enabling them to avoid reporting the income for VAT and income tax purposes and consequently to reduce their fees. His colleagues quickly distanced themselves from this suggestion but his comments merely echoed those of the Prime Minister, David Cameron, earlier this summer when he condemned the offshore tax planning of a well-known television celebrity as being “morally wrong” at a time of national austerity.
Christine Lagarde, managing director of the International Monetary Fund, made the morality argument more subtly when she spoke about the Greek crisis to the Guardian newspaper in May. She said “as far as Athens is concerned, I also think about all those people who are trying to escape tax all the time. All these people in Greece who are trying to escape tax”. Asked about the Greek children who are suffering from austerity measures she said “Parents are responsible, right? So parents have to pay their tax”. Her comments triggered widespread condemnation which was not lessened when it emerged that as an official of an international institution she pays no tax on her annual salary and allowances of over $550,000. Is that a loophole?
The more active proponents of tax harmonization may look back on the crisis years as a missed opportunity.
Although some of the crisis initiatives mentioned above have been proposed by the EU none of them has been universally welcomed by all the Member States. The UK, for example, remains vehemently opposed to the FTT. It is not only the states which have suffered most in the crisis that have put their own finances ahead of pan-EU policy by introducing tax incentives for certain business activities or resisting pressure to increase taxes.
The UK has introduced a “patent box” incentive; Italy has proposed a domestic interest deduction to encourage investment, and Ireland has persisted with its 12.5% corporation tax rate in the face of considerable external criticism preferring, amongst other things, to increase the effective rate on individuals’ income to almost 50%.
Whatever tax edicts are issued by the EU, the reality is that in countries like Ireland, Luxembourg and, increasingly, the UK, national taxation policy is actively structured to encourage inward investment. Technological businesses, in particular, are extremely mobile, as was recognised in the New York Times article, and for as long as US CFOs ask the question, “Where is the best country in Europe for us to set up?”, the countries of Europe will, crisis permitting, continue to tweak their tax rules to get ahead of the pack.