Q&A: Europe on Offshore

IFC Review: Can tax competition benefit the economies of EU states? At what point does tax competition become ‘harmful’?

Emer Traynor: The issue of corporate tax competition and coordination has gained importance in the European Union. In a world where economies are increasingly integrated and capital increasingly mobile, the current trend of declining statutory corporate tax rates has led to fears of a race to the bottom. Tax competition is, however, a complex phenomenon that can materialise through multiple channels and the effects on real economic activity and on governments' tax revenues of which are often ambiguous.

The economic literature is divided on tax competition. On the one hand, tax competition for mobile tax bases leads to a ‘race to the bottom’ in tax rates and leaves the competing jurisdictions with too little revenue to be able to provide public services at a socially optimal level. On the other hand, other models find a useful role for tax competition in curbing the tendency of governments to overextend the size of the public sector.

In the current economic crisis context, at macroeconomic level, tax competition could be considered harmful if it was formally identified as a driver for Member States' budget deficits.

At microeconomic level, for the last 15 years the Code of Conduct group on has applied a set of criteria to identify potential harmful tax practices which are then rolled back by the respective Member State. Broadly speaking these are the following:

• an effective level of taxation which is significantly lower than the general level of taxation in the country concerned;
• tax benefits reserved for non-residents;
• tax incentives for activities which are isolated from the domestic economy and therefore have no impact on the national tax base;
• granting of tax advantages even in the absence of any real economic activity;
• the basis of profit determination for companies in a multinational group departs from internationally accepted rules, in particular those approved by the OECD;
• lack of transparency.

IFC: Can the EU clampdown on harmful tax practices thus far be considered a success?

ET: Over a period of 15 years the Code of Conduct group has reviewed more than 500 measures, more than 100 of which have been found harmful and rolled back. This is a success, looking at the context of the EU as it is now and taking into account the Commission's competencies according to the EU Treaties. Of course the Commission still faces challenges ahead such as extending the application of the code principle to neighbouring countries and trading partners.

IFC: Has the line between tax evasion and tax planning become blurred with the EU now trying to put an end to so called ‘aggressive’ tax planning?

ET: All those interested in this subject will recognise that the distinction has never been clear cut. Aggressive tax planning is not a new concept even though the degree of aggression is often subjective. For example, some Member States are very familiar with the concept of abuse of law while others are less familiar. In view of the scale of tax evasion and avoidance in the EU and globally there is a need for clarification on this issue. This is one of the reasons why the Commission will be coming forward with ideas to tackle aggressive tax planning in the EU before the end of the year.

Again, greater coordination is essential to prevent loopholes between national tax systems from being intentionally exploited. In fact, the Commission has already taken the first steps in this direction, with its work on double non-taxation. It is also working on strengthening the Code of Conduct on business taxation, and discussions have taken off with Switzerland and Liechtenstein as part of the Commission's work to have the principles of the Code applied more widely.

IFC: Promotion of good governance, including transparency, exchange of information and fair tax competition, is part of the EU strategy – how many EU states have now signed up to the exchange of information? Is an automatic exchange of information for EU member states the way forward?

ET: Exchange of information on request on tax fraud is a standard accepted by all 27 EU Member States. It derives directly from the Directive on administrative cooperation in taxation adopted by the Council in 2011. This Directive goes as far as saying that bank secrecy cannot be opposed to a request for information. In many areas of taxation, such as taxation of savings or VAT, automatic exchange of information is taking place at a large scale. For the Commission this is definitely the way forward.

IFC: The Initiative’s objective is to protect the EU against the challenges of uncooperative jurisdictions including so called ‘tax havens’ – what constitutes a tax haven?

ET: That's what the Commission is working on and the planned December Communication will help to clarify this.  

IFC: Could you expand on the ‘carrot and stick’ approach by the EU towards ‘tax havens’ and third countries?

ET: To effectively address tax havens, two things are necessary.

Firstly, a coordinated EU approach. This is essential if the Commission's measures against uncooperative jurisdictions are to have any effect. One unified stance has much more weight than 27 different and possibly contradictory approaches. The Commission has seen that collective pressure works. The OECD's work since 2009, to which the Commission is closely aligned, has already brought about considerable changes, both in the international attitude to tax havens, and the behaviour of these countries themselves. Now the Commission will push that further, by setting down a stronger EU position. The Commission must also use its shared instruments, such as trade agreements, to ensure that European good governance principles are respected by those who we do business with.

Secondly, a ‘Stick and Carrot’ approach to the havens themselves. While the Commission is still in the process of considering what the best and most effective measures could be, there are all sorts of possibilities eg, making agreements with the EU conditional on being on a ‘white’ list or conditional on respecting our standards of good governance.  

IFC: How important is the automatic exchange of information between member states?

ET: The Savings Directive is proof of the benefits of intra-EU cooperation. Around four million records are exchanged between Member States each year, representing on average €20 billion worth of savings information. This Directive creates an information exchange system for tax authorities to help identify individuals that receive savings income in a Member State other than their own. The core principle is that of automatic exchange of information. This means that Member States can collect data on the savings of non-resident individuals, and automatically provide this data to the authorities where the individual resides.

IFC: Is the aim to achieve a level tax playing field? Is this considered the most economically beneficial way forward for EU member states?

ET: Since the Treaty of Rome and more specifically during the last 15 years the Commission has been working hard at ensuring that tax competition between Member States would take place on a level playing field. Taxation is a domain where the Commission is very active at monitoring national legislation and carrying out infringements where necessary. To give just one example, the VAT reduced rate applied by FR and LU on e-books is a striking case of harmful tax competition. The infringement process enables the Commission to actively pursue Member States that don't apply their tax regimes in conformity with the fundamental freedoms and principle of non-discrimination, without undermining national sovereignty.

The success of the Code Group's work is illustrated by the abolition of over 100 harmful tax regimes in the 27 Member States and their overseas territories. Some Member States may still need to amend certain legislation – which takes time – but overall, the Code has produced very positive results. What the Commission regards as a very positive and important development, is that the Group in the past years has also taken on board more horizontal issues such as coordinating a minimum level of anti-abuse provisions for specific areas and addressing losses of tax revenues which are not caused by one single predatory regime but by a failure in the interaction between two tax systems.

Alternatives such as more fiscal integration could be envisaged, but it would require changing the Treaty.

IFC: What is your response to those who feel the EU is not going far enough to combat so called harmful tax practices?

ET: Under the existing EU Treaties, the Commission does all it can to combat harmful practices and to encourage Member states to combat these practices. It is a joint responsibility to tackle these issues and the Commission will use all its influence to ensure that the EU and its Member States put an end to these practices together.