In January, the European Commission presented new measures designed to prevent and combat corporate tax avoidance ("the Proposal"). The Proposal is a coordinated EU-wide response to corporate tax avoidance, following global standards developed by the OECD last autumn. New rules are deemed necessary to align the tax laws of all 28 EU member states in order to fight aggressive tax practices by large companies. This article briefly outlines the content of the Proposal and points out the practices which will be disallowed in the (near) future.
Defining what constitutes fair taxation has always proven to be a challenging endeavour. For companies, taxes are a cost which, like other expenses, should be reduced in order to optimise profits. No one blames (multinational) companies when they try to decrease their tax exposure, provided they pay their "fair share" of tax.
Key features of the Proposal include: (i) legally binding measures to block the most common methods used by companies to avoid paying tax; (ii) a recommendation on how to prevent tax treaty abuse; (iii) a proposal to share tax-related information on multinationals operating in the EU through administrative cooperation; (iv) actions to promote good tax governance on the international scene; and (vi) a new EU process for black-listing third countries that refuse to play fair. The purpose of the Proposal is threefold: hamper aggressive tax planning, boost transparency between Member states, and ensure fairer competition for all businesses in the Single Market. In this way, a level playing field will be created for all businesses, to ensure fair and effective taxation. Below we briefly set out the changes liable to have the greatest impact on your business.
New measures to fight tax avoidance
Effective taxation implies that companies generating profits in the EU should pay their fair share of tax. In practice, multinationals tend to use tax planning to take advantage of mismatches between the tax laws of the member states. The six most common methods listed by the Commission and the proposed methods to tackle them are:
- the classic profit shift to group companies in low-tax jurisdictions, thereby reducing taxable profits in the EU: Controlled Foreign Corporation (CFC) rules will be introduced to tax all profits in the EU;
- paying interest to a group company in a low-tax jurisdiction, thereby generating a tax deduction: interest limitation rules will be introduced to cap the amount of interest a company can deduct;
- hybrid mismatches, e.g. a member state treats a payment as interest while another considers it to be a dividend and both allow a tax deduction: hybrid rules will be introduced to eliminate mismatches, ensuring effective taxation;
- the "switchover", by which member states often treat dividends received by EU-based companies as if they had already been properly tax at source (tax exemption for incoming dividends): under the new rules, member states will be able to tax incoming dividends that have not yet been properly taxed;
- the "patent flight" by which European companies transfer their IP rights to no-tax countries just before they are finalised: new exit tax rules will ensure that member states can tax IP before it is transferred out of the EU;
- a "safety net" or General Anti-Abuse Rule ("GAAR") will be introduced to tackle artificial tax arrangements not covered by specific rules when companies engage in aggressive tax planning to bypass rules and find loopholes in new tax laws.
Prevention of tax treaty abuse
Tax treaties are designed to prevent income linked to more than one country from being taxed twice. In practice, however, such treaties may, under certain circumstances, give raise to non-taxation. The Proposal contains recommendations to shut down treaty shopping. In future, if a group company does not carry out a genuine economic activity, the tax treaty (granting relief from taxation and power to tax) will not be applicable, thus ensuring that it is not abused and that the taxes due are effectively paid in the other country.
Improved tax transparency through administrative cooperation
Several initiatives have recently been enacted to increase the (international) exchange of information. Transparency is crucial to identify aggressive tax planning practices. Under the revised Administrative Cooperation Directive, key tax-related information on multinationals operating in the EU will be exchanged between the national tax authorities, mainly through country-by-country reporting. In brief, the parent company of a multinational group that receives tax-related information for all of its subsidiaries must file a report with the tax administration of the place where it resides. That authority will then share the report with all tax authorities of other states where the group companies are resident. Even though the principle appears straightforward, the exchange of information could prove difficult in practice due to information overlap, language issues, different approaches, etc.
Low-tax or no-tax countries
Relations with low-tax and no-tax countries currently vary from one EU member state to another. The Proposal offers updated tax good governance criteria. After the establishment of a list of countries to be screened using neutral indicators, dialogue should take place with these countries on measures they can take. At the Commission's recommendation, the member states can decide to blacklist a country, which will be removed from the list once it meets the agreed standards.
What to expect in 2016 and 2017
The most discussed measure is the new proposal for a Common Consolidated Corporate Tax Base ("CCCTB"), a single set of rules which companies operating within the EU can use to calculate their taxable profits. In other words, a company will have to comply with a single EU system to determine its taxable income, rather than different rules in each member state in which it operates. However, given that the allocation of taxation rights between the member states is a highly sensitive issue, it is unlikely that a compromise will be reached soon. Other measures which may be expected include a new proposal on enhanced transparency measures, a first common EU list of no-tax/low-tax countries, proposals on transfer pricing and patent box rules and, last but not least, the entry into force of the new EU rules on the exchange of information for tax matters.