Tax Law in the European Union: The Current State of Play [OCTOBER 2004]
1st November 2004
Introduction
The European Union (the "EU") now has 25 Member States. As a result, EU tax law now affects more than 454 million people. This may be a good time to review the current state of EU tax law, which has been evolving rapidly.
There has been a heated debate about tax issues in the EU for some time. European developments have prompted many recent changes to national tax systems. This is true both in the UK and in other member states.
Indirect taxes (e.g. VAT and customs duties)
VAT is a European tax, governed chiefly by directives.[1] Directives are binding, as to the result to be achieved, on Member States. The national authorities are free, however, to choose the form and methods by which they achieve the result.[2] VAT advice may therefore involve a review of European law, national (e.g. UK) law and the actual practice of the tax authorities.
Customs Duties are governed by regulations.[3] A European regulation is binding in its entirety and is directly applicable in all Member States.[4] It is a type of primary legislation, which should not be confused with statutory instruments passed pursuant to UK Acts of Parliament. In principle, therefore the customs treatment of goods is identical regardless of where goods enter the EU.
Direct taxes (e.g. income tax, capital gains tax, corporation tax)
Direct taxes are still meant to be matters for Member States, not for the EU. There are, however, a growing number of exceptions. These are outlined below.
Legislation and other initiatives of national governments
Until recently there have only been a few European directives in the field of direct taxes. There has been rather more activity of late. The following is a summary of the present position. There are now three directives aiming to avoid tax problems arising from cross-border business activities. They cover:
- cross-border dividends and distributions of profits[5];
- cross-border payments of interest and royalties[6]; and
- cross-border mergers and reorganisations[7].
An Arbitration Convention[8], designed to resolve double taxation disputes within the EU, is currently in abeyance. All 15 of the "old" Member States have now ratified a protocol extending the life of the Arbitration Convention and the protocol is likely to take effect-as between those States-shortly.
There are also three directives essentially dealing with cross-border enforcement of tax liabilities. They cover:
- individual savings[9];
- mutual exchange of information between Member States[10]; and
- mutual assistance between Member States with the recovery of tax liabilities[11].
Tax is likely to be charged at source under the Savings Directive from 1st July 2005. There have recently been several extensions to the scope of the directives dealing with mutual assistance.
On 1st December 1997, Member States agreed on a Code of Conduct, which was designed to curb harmful tax competition between Member States. In 1999, the Primarolo Committee, which was formed under the Code of Conduct, listed harmful measures that affected, or might affect, the location of business activity in the EC.[12] Since then the European Commission has investigated a number of these regimes. In most cases, it has decided that the regimes concerned constituted illegal state aid.[13]
Court decisions based on the EC Treaty
The European Court of Justice (the "ECJ") has taken a more and more radical line in the field of direct taxation, and has mostly found in favour of taxpayers. The ECJ's decisions are based on freedoms enshrined in the EC Treaty: free movement of workers[14]; freedom of establishment[15]; free provision of services[16]; and free movement of capital and payments[17]. Many important decisions are based on freedom of establishment.
While accepting that Member States still control their direct tax systems, the ECJ has held that Member States must exercise their powers in accordance with the Treaty. In practice, if a feature of a tax system amounts to a barrier to cross-border economic activities, the ECJ has often held that the feature conflicts with the EC Treaty.
For example:
- If an individual who lives in one Member State works in another state, from which he and his household derive most of their income, the state where he works must give him tax allowances as if he were a resident.[18]
- If a company formed in Member State A has a branch in Member State B, Member State B must give the branch tax reliefs equivalent to those to which a company formed in Member State B would have been entitled under double tax treaties to which Member State B is a party.[19]
- "Thin capitalisation" rules (restricting the use of debt to fund subsidiaries) appear not to be valid within the EU.[20]
- If a Member State would give relief to a parent company for the cost of funding its investment in a subsidiary in the same Member State, it must also give relief in respect of a subsidiary in another Member State. This applies even if it does not tax the profits of the latter subsidiary.[21]
There are pending cases questioning (among other things):
- whether a Member State, which gives relief to a parent company for losses incurred by a subsidiary in the same Member State, must also give such relief where the subsidiary is in a different Member State-even though the Member State of the parent company does not tax the profits of the subsidiary;[22] and
- whether controlled foreign company legislation, under which the Member State of a parent company taxes the parent company on the profits of a subsidiary in another Member State even if the subsidiary has not distributed those profits to the parent company, is legal within the EU.[23]
Very few defences are available to Member States.
- The defence of cohesion (protecting the coherence of a national tax system) seems to be so limited as to be useless in most circumstances.[24]
- Steps guarding against illegal tax evasion-but not steps countering legal tax avoidance- are acceptable so long as they are proportionate.[25]
How long can this go on?
The decisions of the ECJ do seem to favour taxpayers. A tax regime might discriminate in favour of a taxpayer in certain respects. The ECJ tends to ignore that if, in a given situation, the regime has an unfavourable effect.[26] There may be a risk that, in eliminating one type of discrimination, a Member State creates another. That could open the way for a new challenge. Member States dislike the trend of ECJ decisions but have not, so far, reached agreement on how to respond.
Summary
European directives and rulings of the ECJ have prompted many recent changes in the tax law of Member States. Real opportunities have arisen for taxpayers, but things still seem to be changing fast. It is vital to keep a close eye on these aspects when analysing international tax issues.
Robert Newey
October 2004
Important: These notes are necessarily simplified and tax law can change rapidly. Always take detailed, specific advice before taking, or deciding not to take, action.
REFERENCES
[1] Especially the Sixth VAT Directive: Council Directive 77/388/EC.
[2] EC Treaty, article 249.
[3] Especially Council Regulation (EEC) No 2913/92 of 12 October 1992 establishing the Community Customs Code.
[4] EC Treaty, article 249.
[5] Council Directive 90/435/EEC of 23 July 1990 (the "Parent/Subsidiary Directive").
[6] Council Directive 2003/49/EC of 3 June 2003.
[7] Council Directive 90/434/EEC of 23rd July 1990 (the "Mergers Directive").
[8] Convention 90/436 of 23rd July 1990.
[9] Council Directive 2003/48/EC of 3 June 2003 on taxation of savings income in the form of interest payments.
[10] Council Directive 77/799/EEC of 19 December 1977, amended by Council Directive 2003/93/EC of 7 October 2003.
[11] Council Directive of 15 March 1976 on mutual assistance for the recovery of claims relating to certain levies, duties, taxes and other measures (76/308/EEC), amended by Council Directive 2001/44/EC of 15 June 2001.
[12] Report from the Code of Conduct Group (Business Taxation) to the ECOFIN Council on 29 November 1999.
[13] Infringing Article 87 EC.
[14] Article 39 EC.
[15] Articles 43 and 48 EC
[16] Article 49 EC.
[17] Article 56 EC.
[18] Case C-279/93 Schumacker.
[19] Case C-307/97 Saint-Gobain.
[20] Case C-324/00 Lankhorst-Hohorst.
[21] Case C-168/01 Bosal.
[22] Pending Case C-446/03, Marks & Spencer.
[23] UK Special Commissioners' Decision SpC 415 Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v IRC, June 2004.
[24] See Case C-204/90 Bachmann and see especially Case C-168/01 Bosal.
[25] See, for example, Case C-9/02 de Lasteyrie.
[26] See, for example, Case C-330/91 Commerzbank; Case C-250/95 Futura; Case C-141/99 AMID; Case C-168/01 Bosal.
