Running head: POLICY ANALYSIS 1

Policy Analysis: Taxation in the EU

Kristian Moeller

MBA 546 – European Union

11-23-2015

City University of Seattle

Instructor: Larry Frazier

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Policy Analysis: Taxation in the EU

Corporate Taxation

Taxation is of major importance when doing business in Europe. Since the EU isn’t

responsible for determining the corporate taxation rate for each country, you have an

environment where the taxation rate is different for each country in the EU. Since taxation can

have a big impact on a company’s profitability, tax avoidance is an important tool for

corporations to manage the different taxation rates in Europe. In the last couple of years, the EU

has been combating tax avoidance and tax evasion by introducing new legislation and many

more are planned in the near future. This will be analyzed further in another section to see what

effect it has on a multinational corporation. The EU’s role in corporate taxation is mainly to

make sure that the member countries comply with certain EU policies, such as: ensuring the free

flow of goods, services and capital around the EU, checking that all businesses have equal

ground rules and no unfair advantages, and ensuring taxes don't discriminate against consumers,

workers or businesses from other EU countries. The goal is to create fair competition but still

allow each EU country their sovereignty when it comes to taxation and how to spend it

(“Taxation”, 2015).

According to figure 1, the average corporate income tax (CIT) has decreased significantly

over the last 20 years which largely has affected the effective average tax rates (EATR). Since

2010, the EATR has been stable at around 21% for the EU-28. Some of the reasons for the

decrease has to be found in legislative changes by the EU, but also because new member

countries from the east such as Bulgaria, Latvia, Lithuania, and Slovenia all have a much lower

EATR. France and Spain continue to have some of the highest EATR with respectively 34.3%

and 33.7% in 2012.

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Figure 1 – Corporate Income Tax Rates and Average Effective Taxation Indicators, 1995-2014 (%)

Source: DG Taxation and Customs Union

Personal Income Taxation

Personal taxation also plays a significant role for corporations doing business in Europe -

both for MNE’s and small businesses. MNE’s have different approaches to international taxation

when it comes to expatriate compensation. The different personal tax rates will affect what

approaches are best suitable. This is not only time-consuming to manage but also costly since

expatriate’s compensation packages will have to be tailored depending on the country. Small

businesses are also affected since many of which file are taxed under the personal rather than the

corporate income tax. The EU is overlooking the personal taxation to make sure that it doesn’t

affect the mobility of individuals or corporations within EU in a negative direction. This is why

double-taxation treaties are in place in Europe but yet there are some types of taxes and cross-

border situations that isn’t covered by the treaties and the EU is in place to manage these

situations and resolve problems related to this (“Taxation”, 2015).

According to figure 2, The personal income tax rate in EU-28 was 39.4% in 2014. This is

a much higher level than the 2009 low of 38%. The changes in top personal income tax rate

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doesn’t provide the full picture because other factors such as at what income level they are

applied and the definition of tax base all play an important role. It still gives insight into trends

for the top personal income tax rate.

Figure 2 – Development of Top Personal Income Tax Rate, 1995-2014 (%, simple averages)

Source: Commission Services

VAT

The EU members has agreed to align their taxation rules and established minimum rates

for VAT. This is in place to ensure the free flow of goods, services and capital around the EU

and make it easier for businesses because of the standardized VAT. It also mitigates unfair

advantages between countries (“Taxation”, 2015). With that said, the differences in VAT is still

an issue for many EU countries. In Denmark for instance, the food industry is facing issues with

the difference in VAT between Germany and Denmark. The result is increased cross-border

transactions. Many Danes cross the border to buy groceries at a much cheaper rate than the same

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products in Denmark. This is an example of how the difference in VAT can make certain

industries less competitive in one country compared to others.

As seen in figure 3, Since 2009, the VAT has steadily increased from 19.5% in 2008 to

an average of 21.5% in 2014. The increase in average top personal income taxation as well as

increased average standard VAT rate contributes to the current economic stagnation in the EU

because the consumers both get taxed higher when earning money as well as spending.

Figure 3 – Development of Average Standard VAT Rate, EU-28, 2000-14 (%)

Source: Commission Services

Tax Avoidance/Planning

Tax avoidance is a common way for corporations to minimize the rate of tax paid. The

European Commission has estimated that up to €1 trillion is lost every year due to tax avoidance

and tax evasion. It’s done both legally and illegally. Most commonly through legal means but

there have been cases where corporations are declaring less than the actual income to the local

agencies responsible for tax collection and tax law enforcement. Another method is using tax

havens such as Switzerland, Luxembourg, Hong Kong, Ireland, Cayman Islands, Singapore, and

the British Virgin Islands to facilitate your money. These tax havens help corporations store

money that in many cases are unreported and untaxed. Lastly, the most common used way for

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big corporations is aggressive tax planning that seek to take advantage of every little loophole

and make full use of and derive benefit from the limits of the law (“A huge problem”, 2015). The

lack of transparency and tax obstacles in the European market has a harmful effect on growth,

both because of lost tax revenue, but also because honest businesses are losing out to

corporations heavily involved in tax planning. It also affects the internal competition between

member countries to compete about having the best tax regime in order to attract corporate tax

money.

In 2012, The European Commission presented an action plan to fight this problem area.

So far over 30 actions are planned to be introduced that will help mitigate this problem. The

current system is outdated and hasn’t kept up with the modern globalized world. It allows

corporations who make tons of money in the EU to pay little or no taxes in the EU because of

advanced tax-planning schemes. It’s bad for the Single Market which goal is harmonized laws.

The heavy tax planning works against this because the member countries compete to attract

corporation’s taxable profits. It’s a bad spiral that only creates obstacles in the European market.

The lack of coordination of corporate taxation between member countries is causing multiple

problems undermining EU’s goal of growth and competitiveness (“Q&A for the Action Plan…”,

2015).

The proposed action plan will aim at improving the old tax system and adjust it to the

modern world. To succeed, the member countries need to work more closely on corporate

taxation to achieve the outcomes of the action plan, which are as follows (“Q&A for the Action

Plan…”, 2015):

• Companies should pay tax where they generate profits.

• Taxation should be more growth-friendly, and this should not be compromised by

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competition for mobile tax bases.

• One country's preferential regime should not lead to revenue losses for other countries.

• Honest businesses should not lose out to tax-avoiding competitors.

• Third countries should not be able to entice companies to shift profits out of the EU.

We can see that the focus is having companies pay taxes in the countries where they generate

profit and to make sure that the action plan is promoting sustainable growth along with lowering

competition between countries to compete for corporate taxes. This will ensure a more

competitive business environment with less obstacles. To make this happen there are five main

elements of the EU’s action plan to fight tax avoidance and tax evasion.

The first one is re-launching the Common Consolidated Corporate Tax Base (CCCTB), a

single set of rules that companies operating within the EU could use to calculate their taxable

profits. CCCTB was first proposed in 2011 and since the EU-28 hasn’t been able to come to an

agreement. This lead to a new proposal on the CCCTB, a less ambiguous one, but still very

effective. Another area on the agenda is making sure that corporations pay the taxes where

profits are generated. Various means are being researched as to how to shut off opportunities for

profit shifting, which is a big issue for many members. The plan aims at improving the transfer

pricing system and limiting preferential tax regimes and tax havens. Next, the EU wants to create

a better business environment with less tax obstacles, more stability, and more cross-border

trade. This in return will help attract businesses and investments, which will help sustain

economic growth. To tackle tax avoidance, increased transparency is needed and the EU already

has its first initiatives ready; a transparency package that aims to improve cooperation between

member countries in terms on their cross-border tax rulings. A public consultation has also been

launched to see whether requiring corporations to disclose more tax information could help

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tackle tax avoidance. For instance, companies could be required to disclose the taxes they pay, in

every country where they operate. Lastly, the EU needs to increase their cooperation and the

Commission has already extended the work of a platform for tax good governance to monitor EU

countries’ progress in tackling aggressive tax planning and tax heavens (“Q&A for the Action

Plan…”, 2015).

How Corporations React to the Current Corporate Taxation

The current tax laws applicable in the EU date all the way back to the 1930s. Since then

they haven’t evolved over time. The globalization has created a big need for new laws and the

current laws allow companies to take advantage of the European taxation regime. Corporations

that does cross-border trading in multiple EU countries pay on average 30% less taxes than

corporations who only does business in one EU country. The reason for this is because

multinational corporations are able take advantage of profit shifting. In 70% of the cases this is

done through transfer pricing between the different parts of a company and the intellectual

property being located in tax havens (“Action Plan on…”, 2015).

As mentioned earlier in the paper, multiple countries right now have preferential tax

regimes and is considered a tax haven. Luxembourg is one of the big players and in 2012 alone,

U.S. corporations moved $95 billion into the country. In comparison, direct investments from the

U.S. into Luxembourg amounted to $416 billion. This is a huge amount of money for a little

country with only $60.14 billion in GDP and they are widely criticized for its tax advantages.

Companies like Amazon, FedEx, and Verizon all use Luxembourg as a tax haven to avoid high

tax rates. While officially having a corporate tax rate of 29.22%, many corporations end up

paying little to none because they get a preapproved tax status by first consulting with tax

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ministers in Luxembourg to get a tax ruling approved. This allows corporations to arrange a

structure that allows for the least possible amount of taxes. It’s done by setting up a subsidiary

that are taxable under Luxembourg law. The subsidiary can act as a holding company for

European or other subsidiaries. The parent company is then allowed to lend money to itself and

is not subject to a tax on the interest payment, thereby lowering its overall tax burden through

large deductibles (Gusovsky, 2014).

Each corporation has a different tax structure and strategy for avoiding taxes. To illustrate

how effective these tax structures can be let’s take a look at Amazon who is just one of the many

major global companies using Luxembourg as a tax haven. According to Gusovsky (2014),

CNBC, in partnership with the International Consortium of Investigative Journalists, was able to

access nearly 550 tax rulings from about 340 companies, giving them access to many global

companies using tax havens to save billions of dollars. Gusovsky (2014) found that “Amazon has

formed a Luxembourg intangible holding partnership that owns various European patents. It also

charges royalties to Amazon EU, a Luxembourg corporation, for the use of those intangibles. In

turn, Amazon EU appears to sublicense the right to use those intangibles to European affiliates,

which pay the entity royalties, according to international tax expert Steven Plotnick. The effect

of this in 2010 was that European affiliates paid 286 million euros to Amazon EU, which

Plotnick said was presumably deductible in Luxembourg. Amazon EU then paid to the parent

company 519 million euros, leaving the Luxembourg corporation with a tax bill of 4 million

euros, or only 0.77 percent.” These taxation schemes are very effective but the EU’s action plan

to prevent tax avoidance and tax evasion will change the corporate taxation landscape, which

will have big impact on how companies operate in the EU.

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The Effect of EU’s Action Plan on Corporate Taxation

In Appendix A, there’s a timeline for the action plan that shows how it’s going to play

out over the next 3 years and in the future. This gives us insight into when the different items of

the action plan take effect. It’s no doubt that companies will have to pay more taxes in the future.

Margrethe Vestager, Europe’s competition commissioner, has already been targeting major

global companies and recently ordered Fiat and Starbucks to pay up tens of millions of euros in

unpaid taxes, and she’s going after Apple and Amazon next (Hirst, 2015). Multinationals

sophisticated tax schemes could be coming to an end in the near future when the action plan is

fully implemented. This section will focus on how it will affect businesses operating in Europe.

Probably the most important part of the action plan is the Common Consolidated

Corporate Tax Base (CCCTB). It allows corporations to file a single tax return for all their

activities within the EU rather than filing a tax return for each country, in which they are doing

business, making things less complicated and cross-border trading easier. It would also allow

corporations to offset losses in one EU country against profits in another, which would create a

stronger Single Market. The CCCTB would also mitigate risks associated with different legal

factors between the member countries because they only have to operate under one set of tax

laws rather than potentially all EU-28. This will have a huge effect on the transparency of EU’s

taxation regime and make it less costly to manage. The CCCTB would also benefit tax avoidance

since countries will have to apply the same rules for calculating the taxable profits of cross-

border corporations. It has many benefits that all work against tax avoidance since consolidating

the tax base would remove the possibility of taking advantage of loopholes between countries. It

would also eliminate the reason for having complex transfer pricing systems – the major way for

tax avoidance under the current tax laws (“Q&A on the CCCTB…”, 2015).

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A EU wide implementation of the CCCTB would have significant effects on the way

MNE’s operate in the EU since it takes away the reasoning for complex transfer pricing. Over

time it would make subsidiaries currently established in tax havens like Luxembourg, Ireland and

Switzerland unnecessary and a restructuring of the organization would be needed to operate

within the EU.

The action plan also sets out to ensure that taxes are paid where profits are generated. The

EU doesn’t have any plans to harmonize the corporate tax rate but rather achieve the same goal

by closing loopholes, improving the transfer pricing system and implementing stricter rules for

preferential tax regimes such as Luxembourg.

Boosting the transparency and cooperation between Member States will help reduce tax

avoidance. EU recently presented a Tax Transparency Package that aims equipping member

countries with the information they need to protect their tax bases and effectively target

companies that try to escape paying their fair share of taxes (“Combatting corporate tax…”,

2015).

EU’s action plan to combat tax avoidance and make the Single Market a better business

environment is going to affect all businesses operating in the EU. It’s only a matter of time

before it will be implemented and corporations should start looking for ways to operate

efficiently and competitively under the new tax laws so they are prepared for how to restructure

their organization to comply with the new laws.

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Appendixes

Appendix A

Source: European Commission

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Resources

Action Plan on Corporate Taxation. (2015). European Commission. Retrieved from

http://ec.europa.eu/taxation_customs/taxation/company_tax/fairer_corporate_taxation/ind

ex_en.htm

A huge problem. (2015). European Commission. Retrieved from

http://ec.europa.eu/taxation_customs/taxation/tax_fraud_evasion/a_huge_problem/index_

en.htm

Combatting corporate tax avoidance: Commission presents Tax Transparency Package. (2015).

European Commission. Retrieved from http://europa.eu/rapid/press-release_IP-15-

4610_en.htm

Gusovsky, Dina. (2014). Taxes, multinational firms & Luxembourg—revealed. CNBC.

Retrieved from http://www.cnbc.com/2014/11/06/taxes-multinational-firms-

luxembourgrevealed.html

Hirst, Nicholas. (2015). The Danish tax reaper cometh. Politico. Retrieved from

http://www.politico.eu/article/danish-tax-reaper-fiat-starbucks-ruling-competition-

commissioner/

Q&A on the Action Plan for Fair and Efficient Corporate Taxation in the EU. (2015). European

Commission. Retrieved from http://europa.eu/rapid/press-release_MEMO-15-

5175_en.htm

Q&A on the CCCTB re-launch. (2015). European Commission. Retrieved from

http://europa.eu/rapid/press-release_MEMO-15-5174_en.htm

Taxation. (2015). European Union. Retrieved from http://europa.eu/pol/tax/index_en.htm