This article comes from a webinar held on 13 May 2020 on the EU Tax Agenda organised by Deloitte EU Policy Center
On 13 May 2020 we held a Webinar on the EU Tax Agenda. Gianmarco Monsellato, Deloitte EU Tax Public Policy Leader, led this webinar. Gianmarco elaborated on the EU Tax Agenda for the coming months and years: what could be the future of tax within the EU and why the future of tax is relevant for the future of the EU at large.
We have summarized the topics that were discussed in this document.
Is the EU tax system fit for purpose?
Tax has become a political topic over the past 10 years. There are concerns about fairness in taxation, while in the past, tax was only supposed to be efficient. Tax has crystallised the nexus of challenges and opportunities that the EU is facing for the future and notably the next five years of the mandate of the EC and the EP.
EU taxation is composed of two dimensions. On the one hand, VAT or indirect tax is by definition an EU tax. It is well mastered by the EU and the way ahead is clear, i.e. the EU is going to focus on anti-fraud provisions, as well as on digitalisation of VAT collection and on the other hand, direct tax.
The international tax system is experiencing a significant tax reset. The question of whether the EU tax system is fit for purpose, specially post Covid-19, and whether it is fair is complex. The world has entered into tax protectionism since 2016. Custom duties were the protectionist tool of the 19th century, while tax policy has become the one of today. The tax systems of China since 2008 and of the US since 2016 are designed as an incentive to invest in those markets, to have assets located in those territories with strong incentives to stay put. With US tax reform for example, IP assets located in the US can be eligible for a very low tax rate of ~13% – similar to the corporate tax rate in Ireland – while the tax rate on income from intangible assets located outside the US, but used in the US, can go up to ~25%. Provisions following a similar spirit exist in China as well. The fact is that some form of tax protectionism is happening even within Europe.
The EU is caught in the middle of that protectionism 2.0. There is currently no EU direct tax system as tax is still a matter of Member State sovereignty… However, Member States are each very small on their own on the international scene compared to the US or China and it is unlikely that they would be able to compete on their own with such giants. It would be a mistake for Member States to believe that they would be able to protect their tax sovereignty or even to believe that the said tax sovereignty actually still exists in this international world.
The EU can be part of a possible answer to that equation. The European Commission is advocating for a corporate tax consolidation or at least a harmonisation with a consolidated common corporate tax base with one tax basis within the EU for all the Member States, and different tax rates. This would be a very significant first step towards European corporate tax integration if the resistance from several Member States would be overcome, which would normally require unanimity to move ahead. A switch from unanimity to qualified majority voting for tax matters at EU level should be possible from a legal perspective, notably if the integrity of the internal market is threatened. One could argue that having different tax systems in each of the Member States is threatening the internal market, particularly after the Covid-19 crisis. Achieving such a switch is rather a political question. The previous European Commission has used State aid procedures pretty aggressively to send a message to Member States that if they wanted to retain their tax sovereignty, they would have to deal with heavy ex post supervision and possible challenges. The new European Commission from President von der Leyen could try the same. There is currently no political consensus, but the Covid-19 crisis might change things. In any case, the European Commission will be able to achieve a lot of unanimity in tax by using smart political leverage.
Challenges from the Covid-19 crisis and from double taxation
The post Covid-19 challenge for Member States would be to find the sufficient tax revenues and government budgets to repay the enormous debts contracted during the crisis to support their economies. In most countries, it would be very difficult to raise significant new tax revenue on individuals, as most are already heavily taxed. In this case, Member States would have to understand if their corporate tax system is fit for purpose. As tax rates are already high in many countries, it would be challenging to increase corporate tax rates further given the Covid-19 crisis. There are two ways to raise taxes. The smartest way to raise taxes would be to have a neutral taxation with moderate tax rates and a wide or large taxable basis. This is fair, transparent and does not trigger negative incentives for investors. With high rates, corporate taxpayers would rather prefer to have losses than big profits in order to have a significant tax asset in the balance sheet, which is absurd. The less smart way to raise taxes would be to rely on high tax rates with a narrow tax basis, which is not efficient. To be sustainable, the tax policy of the future needs to have a tax that is as neutral as possible with a wide taxable basis, combined with direct public subsidies to deal with social fairness.
The cost of doing business internationally is going up very significantly because of double taxation, which appears when carrying out cross border business within or outside the EU. The same income would indeed be taxed twice by two countries and companies would end up sometimes paying even more than 100% of the net income in taxes instead of approximately 25%. This would happen if country A would claim that the tax basis determined based on transfer pricing cross-border flows should be higher in country A than in country B, ending up in a double taxation situation with potentially 100% of the income paid in taxes taking into account penalties, e.g. Chrysler had USD 1bn of double taxation between Canada and the US, which was one of the reasons for its bankruptcy. EU corporates face the risk of double taxation with non-EU trading partners such as the US, China, India, Japan, etc., but also within the EU with other Member States. According to Eurostat, 94% of EU companies have already suffered double taxation once. In France and Germany, tax authorities are dealing with significant numbers of cases of double taxation, e.g. approximately 1,000 cases between France and Germany and approximately 800 cases between France and Italy. These Member States cannot be considered as tax havens and this situation is purely the result of intra-EU tax competition. Double taxation has significant impacts on the economy of the EU Member States. European businesses are suffering from the costs of double taxation as it makes international business is costly and risky. This is limiting the ability of EU players to invest, to export or to grow, as well as to create jobs and to achieve the inclusive economic growth that is needed for the future of the EU post Covid-19.
Since, the Council Directive 2017/1852 of 10 October 2017 on Tax Dispute Resolution Mechanisms in the EU, tax authorities in the EU are compelled to resolve double taxation and ensure that the taxpayers pay tax only once. This is of course a welcome development, even if it is not perfect yet as it is giving too much latitude to the tax authorities. Taxpayers are indeed not eligible for this procedure if a tax administration would impose tax penalties. Tax administrations are thus using this as a strategy to avoid taxpayers relying on this procedure. In addition, it is a complex procedure that happens only after the whole tax assessment procedure, which makes it is very costly for companies. One step further could be that, except for obvious fraud mechanisms, there would be no transfer pricing assessment within EU. This would provide more certainty to EU businesses and would be a big boost to the EU economy.
Covid-19 is raising the question of the need to relocate business to Europe. The related issue is the cost to relocate to Europe as such a move may trigger exit taxation in the country that would be left by the business relocating to Europe. Member State have to adapt their tax policies to ensure tax neutrality, notably for relocation (through a possible deduction of the exit tax in the country of relocation), and that companies that are going to invest in Europe are not penalised. The European Commission could play a very significant role in building doctrine on tax neutrality for relocation.
Today, everyone, but the EU, is doing their “country first programme”, as Member States in favour of protectionism, and the EU is rather focused on avoiding tax competition than on ensuring “Europe first”. An EU first tax programme is needed to restart the economy post Covid-19, but it is subject to tax harmonisation within the EU. If each Member State would set up its own “country first” programme, they would be competing against each other, which would be detrimental to the EU economy as it would achieve the opposite effect from the one sought. Increased tax integration in the EU would be necessary if one day the EU, in the same fashion as US or China, provides tax incentives to investors willing to locate their assets in the EU and willing to create jobs in the EU. Doing this at the EU level would be sustainable, which would not be the case if all Member States continue to compete with each other to attract the same investments. The Covid-19 crisis may create the necessary political consensus towards the harmonisation of the EU tax system to compete at the international level. France is now willing to follow this route and the question is now what Germany will do.
The EU is aiming to use tax as leverage to accelerate the shift to a green economy, as tax is known to be an effective tool to impact behaviour. The risk of such tax policy would be that green taxation would not be a sustainable tax policy in the medium or long run. Indeed, if such policy would be successful in changing behaviour, polluting activities would disappear with the related tax revenue drying up, which would negatively impact government budgets. In the opposite case, if tax revenue from polluting activities continues to fund fiscal budgets, this would mean that this policy was not successful and that the EU would be still polluting as behaviour would not have changed. This plan to use tax to accelerate the shift towards the green economy can be an efficient tool to accelerate the green transition, but it would not be addressing the funding needs of the EU Member States, in particular post Covid-19.
It is unlikely the OECD will deliver and reach consensus on taxation of the digital economy by the end of 2020 given the current Covid-19 context. Some countries such as France are going to implement a digital tax in the absence of consensus at the OECD level, but for the time being there seems to be no consensus at the EU level to bring in a digital tax. However, implementing a tax for a small number of digital players is not fair and not effective. According to the French tax authorities, a digital tax would bring EUR 500m of tax revenue, which compared with the French budget is irrelevant. France is a good example, showing that digital tax is a tax for which there is a lot of political appetite, but is not efficient from a public spending perspective. The way it is structured also hurts SMEs selling on digital platforms, which are going to pay the tax as the digital platforms are going to transfer the tax to their business partners. Ultimately, the digital tax will be supported by the end consumers, impacting negatively their consumption ability. Digital tax is a tax designed to target a limited number of players, while any tax to be efficient has to be general in order to have a scope encompassing the whole economy. Many tax administrations do not support digital tax as the whole economy is going digital. France is pushing for a digital tax for political reasons, to send a message to the retail industry, which is suffering even more with the Covid-19, that it is taking care of them and trying to balance the competition with the digital companies. This is a meaningful and legitimate communication, but it is not efficient tax-wise. In addition, more tax basis allocated to the consumer market will not benefit the EU, e.g. Iceland will lose a lot as it is a small market with a lot of innovation but low consumption.
The discussion about digital tax is about the economy of the future and how to tax it fairly and efficiently. If the EU speaks as one voice it can influence discussions at the OECD level. If Member States each speak on their own, they will not have a say on taxation in the digital world.
Wealth tax has been part of French history and is a political totem. It is not a tax that brings significant tax revenues, while it triggers expatriation of wealthy taxpayers to neighbouring countries. With the Covid-19 crisis, it is possible that governments would introduce a wealth tax to send a strong political message to citizens; most charities and non-profit organisations are lobbying for its return because it operated as powerful leverage to make wealth individuals donate to charities and associations. Donations went indeed down with the repeal of wealth tax in France. There is political momentum to reintroduce wealth tax. The French government does not seem to be very keen to do so, knowing that economically and technically, wealth tax would not solve the funding needs of France and is likely to trigger another expatriation of investors. In addition, the message sent to the international community would be negative.
A wealth tax at the European level is unlikely, as Member States have very different cultures in relation to tax. Interestingly, even the US is currently discussing the introduction of a wealth tax, which was unexpected. If the US does introduce such a wealth tax, this would change the momentum.
The future of tax in the EU – Can we build one single market with one single currency and with many different tax systems?
Never in history has there been one single market with one single currency and different tax systems and budget policies. This has never happened before. The tensions it creates are already noticeable within the internal market. Italian media are for example carrying out a campaign against the Netherlands which is allegedly attracting Italian companies with their tax system and are hurting the Italian economy and companies. Considering the US and China have changed their tax policies to strongly encourage international investment in their territory to create more jobs, if the EU does not act, the Member States would face very difficult times in a couple of years when it will be time to face the huge deficits left after the Covid-19 crisis. This could create a fragmentation of the EU post Brexit.
We believe that there would be three possible ways forward for the EU on tax:
- The European Commission would be successful in achieving a full tax integration with the CCCTB (i.e. one single tax system in the EU with one tax basis, but different tax rates). As a result, there would be no more double taxation within the EU. That would be the most easiest and most efficient solution. There is no political agreement for the time being for this, but the Covid-19 crisis may change perspectives.
- A limited harmonisation of the tax rules within the EU. This is already happening, but probably not enough, as harmonising will not take away double taxation and tax competition within the EU. It would be difficult for companies to be exposed to one internal market where there is competition and be still competing with other markets at international level. This would just be a delay in the integration process and would not solve the main issues.
- The third way, which can be very efficient, would be a small step forward with a limited transfer of tax sovereignty to the EU, not for the whole tax, but only for transfer pricing, i.e. tax on cross-border flows. In such a case, if e.g. Germany wants to challenge the allocation of tax basis with France, it would only be possible to do it with a discussion between the Member States and the European Commission. The taxpayer should be neutral in this process and not even be a part of the discussion. The authority to negotiate resolution of double tax issues with other non EU countries should also be transferred to the European Commission as it would have a better negotiating position than Member States themselves to negotiate with counter parts such as the US or China. It would be easier for everyone and much more efficient. Such transfer of sovereignty would just be a pool of resources of the EU tax administrations as has already been done for VAT. This may achieve a lot without changing the political balance within the EU too much.
Whatever the decisions and actions taken by the EU on tax in the next 5 years, these will be precursors of the evolution of the EU at large, as this will raise questions about whether the EU wants more integration or not, or whether Member States only want to have a single market without custom duties. The tax discussion is going to be very technical, as always.
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