Communications on a comprehensive strategy to promote tax co-ordination in the EU– Frequently Asked Questions
European Commission - MEMO/06/499 19/12/2006
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Brussels, 19 December 2006
Communications on a comprehensive strategy to promote tax co-ordination in the EU– Frequently Asked Questions
Co-ordination in the direct tax area in general
What is co-ordination?
Co-ordination builds on national tax systems to render them compatible with the Treaty and with each other. The aim is not to replace existing tax systems by a uniform Community system (harmonisation), but to ensure that such non-harmonised tax systems can better work together. The Commission proposes a constructive and co-operative approach with MS and other stakeholders with a view to finding common solutions.
What are the objectives of coordination of tax systems?
The objective of a co-ordinated approach at EU level is to improve the performance of existing national direct tax systems, and to remove tax obstacles to cross-border activities and investment, so as to allow taxpayers to take full advantage of the Internal Market.
Specifically, the objectives of such a co-ordinated approach are:
How will co-ordination be implemented? Which areas need better co-ordination?
The Commission will work together with Member States and, where appropriate, with other stakeholders. Specific initiatives will be proposed by the Commission to Member States.
For instance, two first areas where there is a need for a co-ordinated approach are exit taxes (see page 3), and the tax treatment of losses in cross-border situations (see page 5).
Other areas will be considered in the next future, such as anti-abuse rules, withholding taxes on cross-border income, or inheritance taxes. The Commission considers there is also a need for a general mechanism for preventing double taxation of taxpayers subject to the jurisdiction of two or more Member States.
Is this instead of the Common Consolidated Corporate Tax Base (CCCTB)?
No. This initiative complements our work on the CCCTB.
The CCCTB constitutes a long-term solution to remove the underlying tax obstacles which exist for corporate taxpayers operating in more than one Member State.
However there also continues to be a need for more targeted measures to address the most urgent problems in the short to medium term. The co-ordination package is designed to give fresh impetus to targeted measures already undertaken, such as the Joint Transfer Pricing Forum. It is designed to provide an immediate response to the problems of co-ordinating unharmonised systems.
There are issues which will remain even after a CCCTB has been introduced: the CCCTB will be optional and will not necessarily apply to all companies investing across borders (e.g. only companies which meet certain holding percentages will be able to be included in a CCCTB group).
Moreover, the co-ordination initiative will also deal with discrimination and double taxation in relation to individual taxpayers not covered by the CCCTB.
Why does the Commission not just litigate?
The number of infringement proceedings begun by the Commission has increased in the last few years. It is not always necessary for such cases to go to Court because often Member States respond by removing the unlawful restriction.
But in the Commission's view something more is needed. We should not simply rely on infringement proceedings to secure compliance with Community law. It is better to work in parallel at a political level to try to resolve problems, particularly where they are common to a number of Member States. Moreover, even where a ruling forces a number of Member States to introduce new tax rules, they often do so in vastly different ways, adding to existing complexity.
Why is the Commission doing this now?
Work at EU level has been successful with a number of targeted initiatives such as amendments to the directives and the Joint Transfer Pricing Forum. However, the increased litigation brought by taxpayers over the last few years has demonstrated that tax barriers to cross-border movement and investment remain common place. There is a need to give further impetus to such initiatives and provide for a more comprehensive strategy, and this is the start of that. Moreover in recent years the Commission services have tried on a number of subjects to obtain cooperation of Member States for certain solutions without any success. Now it is the time to bring such ideas to the political level of the Ministers.
Co-ordination in the exit taxation area
What are exit taxes?
Exit taxes are taxes which Member States levy on accrued but as yet unrealised capital gains when individual or corporate taxpayers transfer their residence to another State or when corporate taxpayers transfer individual assets from their head office to a permanent establishment situated in an another State (or vice versa).
Why do Member States levy exit taxes?
Member States have different reasons for levying exit taxes. Some Member States levy them to counteract specific types of tax avoidance and tax-induced (temporary) emigrations. For other Member States exit taxes are a means of ensuring that they are able to tax any income which has accrued while taxpayers were resident in their territory. Frequently, national exit tax provisions are also based on a combination of these reasons.
Is there no scope for immediate taxation at the moment of exit?
The European Court of Justice has ruled that immediate taxation at the moment of exit of accrued but as yet unrealised capital gains is not possible if there would be no similar taxation in comparable domestic situations. It follows from ECJ case-law that Member States will have to defer collection of their taxes until the moment of actual realisation of the capital gains, and that such deferral may not be subject to restrictive conditions such as the requirement of a bank guarantee or the appointment of a fiscal representative.
Member States may, however, provide taxpayers with the option to renounce the deferred collection of tax and to choose to pay the tax at the moment of transfer. Such an option must however be truly voluntary and even-handed.
Can you give some examples of existing mismatches between different national rules and proposed co-ordinated solutions?
With respect to individual taxpayers, a mismatch between different national provisions for example arises if the exit State calculates the capital gain at the moment of exit, and collects the tax at the moment of actual disposal, and the new State of residence taxes the whole capital gain from acquisition up to the actual disposal. This causes double taxation of the value increase from acquisition to the moment of exit. The Communication suggests that such double taxation can be eliminated either by crediting taxes levied in the other Member State or by dividing the taxing rights on the relevant assets according to the period that the taxpayer was resident in each of the Member States.
With respect to corporate taxpayers mismatches arise from differences in valuation methods as regards transferred assets. A number of EU Member States allow assets to be transferred to a permanent establishment in another EU Member State at book value. These EU Member States choose not to exercise their taxing rights on the difference between the book value and the market value of the assets at the time of transfer. Generally, these EU Member States also value assets transferred to a permanent establishment in their country at book value. Other EU Member States seek to exercise their taxing rights on the difference between the book value and the market value of the assets at the moment of transfer. In practice, these differences between valuation at book value and market value can result in double taxation or unintended non-taxation of capital gains. The Communication examines different options to overcome such obstacles, ranging from a transfer at market value with a step-up in the receiving Member State to an approach based on book value continuation.
How will these proposals affect Member States' tax revenues?
An unconditional deferral of tax collection until the moment of actual realisation will not in itself ensure that the exit State is able to effectively collect its taxes in due course. The proposals in this Communication provide for appropriate administrative co-operation (exchange of information and assistance in collection), as well as co-ordinated solutions (see above) to resolve the mismatches between different national provisions.
When implemented properly, these will allow Member States to effectively safeguard their tax claims. The overall effect on Member States' tax revenues should therefore be positive.
How will taxpayers benefit from these proposals?
The proposed co-ordinated solutions are aimed at avoiding discrimination and double taxation. These proposals ensure that individual and corporate taxpayers that exercise their right to transfer their residence or individual assets to another Member State are treated equally in comparison with taxpayers in comparable domestic situations and do not suffer any double taxation as a result. The proposals therefore help to remove remaining tax obstacles to cross-border activity.
How will this initiative help the Internal Market?
Discriminatory tax practices and double taxation are inefficient and tend to partition the Internal Market. They act as a disincentive to cross-border activity and investment just as much as other regulatory restrictions.
At the same time, the scope for inadvertent non-taxation and tax abuse offered by the current mismatches between different national provisions leads to market inefficiencies and may force Member States to increase the tax burden on other taxpayers or products. This is equally detrimental to the Internal Market.
The co-ordinated solutions proposed in this Communication aim at removing discrimination and double taxation, while at the same time eliminating unintentional non-taxation and abuse. When implemented properly, this will provide a significant contribution to Internal Market.
Why is this initiative presented in the form of a Communication and not for example a Directive?
The Communication is designed in part to provide guidance on the principles flowing from the case-law on exit taxes and prompting discussion on ways in which Member States can comply with their obligations. Member States are obliged to take action – the idea is to facilitate and co-ordinate such action.
But the Communication also suggests that there is a need to address the mismatches between different national rules in order to ensure that they interact coherently with each other. This requires a flexible approach for which a Communication is particularly suited.
Co-ordination of cross-border loss relief schemes
What are losses?
The term "losses" can broadly be defined as the excess of expenses over revenues for a given period. Losses lead to a reduction of the capital of a company and will finally result in the insolvency of the company where the activities do not become profitable (and no assistance is provided by shareholders or other investors). Losses may occur in particular where a new business is formed or a new investment is made (so called "start-up losses").
How are losses treated for income tax purposes?
Income taxes are levied on income generated during the tax year.
However, as taxes are generally levied in order to finance public expenditure; losses as "negative" income do not normally entitle the taxpayer to a refund.
Most income systems do provide for some form of loss relief, either by carrying over the loss to offset it against profits of previous years (carry-back) or in future years (carry-forward) or by setting off the loss against other income of the same tax payer in the year in which the loss was incurred (see Annex VII in the Technical Annex of the Communication SEC(2006) 1690).
Furthermore, most corporate tax systems also provide some form of group taxation (for instance consolidation, group contribution or group relief) allowing profits and losses of a group of companies to be treated as if they were aggregated results of a single enterprise (see Annex VIII in the Technical Annex of the Communication SEC(2006) 1690).
Why does a lack of relief of losses result in "overtaxation"?
The issue of "overtaxation" may be illustrated by the following example: A parent company has a profit of 200 and a subsidiary incurs a loss of (100). Where the loss of the subsidiary cannot be relieved, the parent company will be taxed on its profits of 200, although the aggregated profit of the group for the taxable period only amounts to 100. The losses of the subsidiary may be taken into account in future tax years as a loss carry-forward provided that it returns to profit.
An immediate taking into account of the loss avoids cash-flow disadvantages resulting from the time lag in the taking into account of the loss, i.e. as a loss carry-forward and a set-off against future profits, in comparison with an immediate set-off against another positive tax base.
What is the objective of the communication?
The objective of the Communication is to explore ways of eliminating the tax obstacle caused by the lack of cross-border loss relief (i) within a company, (ii) within a group of companies. The document therefore first explains the basic principles and problems regarding cross-border loss relief, but also suggests ways in which Member States may allow such cross-border relief of losses.
What is the difference of treatment between losses incurred in a branch or in a subsidiary in domestic situations?
In all Member States, companies are treated as separate taxpayers for income tax purposes. Although a branch may operate as a separate unit, for company law and tax purposes it remains a part of the company. Therefore, the profits and losses of all domestic branches of a company are aggregated. This leads to an immediate taking into account of losses within a company.
An incorporated subsidiary has legal personality. This means, it is a separate entity with its own management and its own resources, which, for example, also may conclude a contract with its own shareholders. From a tax point of view, such a subsidiary is a separate taxpayer. Normally, a subsidiary only distributes profits and reserves, if the shareholders' meeting decides to do so.
Where a subsidiary has a loss, normally such a loss is blocked at the level of the subsidiary, i.e. it may not be "distributed" to the shareholders.
For this reason, many Member States have introduced special tax rules in order to have a domestic group of companies treated as a single economic entity. 19 of the 27 Member States have introduced such a rule.
How many Member States provide for a relief of losses within one company in cross-border situations?
An immediate taking into account of losses is not automatic, since in cross-border situations 2 tax jurisdictions are involved. At present, most Member States grant cross-border relief of losses incurred in a foreign permanent establishment. Only 9 (of 27 Member States) do not provide for such relief (see Annex III in the Technical Annex of the Communication SEC(2006) 1690).
How many Member States provide for a relief of losses within a group of companies in cross-border situations?
Already in domestic situations, the taking into account of losses of a subsidiary or a group member is not automatic but has to be explicitly provided for by the tax legislation. 8 Member States (of 27) have not introduced such a provision (see Annex IV in the Technical Annex of the Communication SEC(2006) 1690).
Of the 19 Member States which currently have domestic group taxation schemes only 4 Member States have measures in place for cross-border situations.
Why does the lack of cross-border loss relief represent an obstacle to the internal market?
Where a relief of losses is possible in domestic, but not in cross-border situations, this will lead to a distortion of business decisions within the internal market. In particular, SMEs may refrain from investing abroad due to the fact that the expected start-up losses may not be (fully) set-off against profits of the head office or parent company. Also, business decisions are distorted because companies may choose, purely for tax reasons, to establish a business in the form of a permanent establishment, whereas non-tax reasons would have been in favour of a subsidiary.
What is the relation of the Communication to the project of a CCCTB?
The Communication represents a targeted measure which addresses the urgent problem of the lack of cross-border loss relief, within the short- and midterm.
A CCCTB represents a comprehensive solution which provides a systematic and longer term solution. Introducing cross-border loss-relief therefore represents an intermediate solution pending the adoption of a CCCTB. Once a CCCTB is established, a targeted measure would be complementary for situations which are not covered by a CCCTB.
What is the impact of the decision of the European Court of Justice (ECJ) in the Marks & Spencer case?
The Communication on the tax treatment of losses in cross-border situations builds on recent case law of the European Court of Justice, in particular the judgment in the Marks & Spencer case of 13 December 2005.
It was claimed that the refusal to allow the UK parent company to set off against its profits the losses of its foreign EU subsidiaries which did not carry on business in the UK infringed the freedom of establishment provided for by the EC Treaty. Had the loss been incurred by a UK subsidiary, it would have been taken into account.
The Court held that this difference in treatment posed a restriction on the freedom of establishment but that such a restriction was permissible in the light of the following 3 justifications, taken together: (a) the need for a balanced allocation of taxing powers between the Member States, (b) the need to prevent losses from being taken into account twice, and (c) the risk of tax avoidance.
The Court, however, ruled that the UK rules at issue were disproportionate in so far as they also denied loss relief where the non-resident subsidiary had exhausted all possibilities for current and future relief in its state of establishment.
In its decision the Court obliged, under certain conditions, the Member State of a parent company to grant relief for definitive losses of a subsidiary established in another Member State.
However, the Commission considers that applying these principles to other cases could lead to the situation that for instance start-up losses from SMEs might not benefit from cross-border loss relief and that SMEs would therefore suffer a cash-flow disadvantage in such a situation.
The Communication recommends as a minimum standard a “vertical upward” cross-border relief of losses which should meet the justified concerns of Member States with regard to the risk of abuse, while at the same time avoiding unnecessary cash-flow disadvantages for business.
Does the implementation of the solutions presented in the Communication require harmonisation?
All solutions presented in the Communication could be applied on the basis of the existing tax systems and tax bases of the Member States. Therefore, they do not require any harmonisation of tax systems or the tax base. Nevertheless, coordinated action by the home country and the foreign investment country would be the most appropriate approach.