In late 2012 the EU Commission presented an action plan for tackling tax fraud and tax evasion, in an interview with the IFC Economic Report, the Directorate General for Taxation & Customs, Philip Kermode, discusses the issues of tax planning, tax avoidance and tax evasion in the EU.
IFC REVIEW - How big a problem is tax fraud and evasion within the EU?
Phillip Kermode: We do not have a precise estimate, but the problem is very significant. According to some estimates it could be as much as a € 1 trillion per year although further work is needed in the area of quantifying potential losses.
IFC: How significant has it been in contributing to the EU’s current economic problems?
PK: Tax receipts are an essential part of the revenue sources of EU Member States so the extent to which taxes are not collected in line with the intentions of the legislators puts pressure on Member State finances. This can lead to an unfair sharing of the burden of paying for public services and an increase in sovereign debt. In this sense tax fraud and evasion undermine Member States' ability to finance solutions to deal with the current economic problems. Dealing effectively with this problem is therefore part of the solution.
IFC: How important is it that action is taken on a Europe-wide level to tackle the problem of tax evasion?
PK: It is crucial. Globalisation is a tangible reality for businesses but also for tax evaders. Tax administrations must be able to react and this can only be done through co-operation. The EUs Internal Market is built on the Treaty freedoms but the benefits that they bring must not be undermined by a possibility for tax evaders to escape attention because of the lack of co-ordinated, co-operative action by Member States. So the solution must ensure individual Member State action is supported by high levels of co-operation and where possible this must be extended beyond the EU.
IFC: Is if feasible to expect a unified approach to the problem?
PK: It is needed. It is the meaning of our action plan of last December. In this action plan we have put forward 34 measures, consisting of a mix of ideas for both legislative and non-legislative action, to ensure that many of the different elements that make tax fraud and evasion possible are addressed at the appropriate level and that tax administrations in the EU have the appropriate tools to deal with the problems. In a context where decisions are taken by unanimity, the feasibility of legislative actions will depend on the commitment of Member States to take decisive action. EU leaders at the European Summit on 22 May positively confirmed and recognised the need for action.
IFC: To what extent can these problems (tax evasion, lack of common standard re tax) be blamed for Cyprus’ implosion as an international finance centre?
PK: Tax evasion and mismatches in Member States' tax legislation affect all Member States. While not directly responsible for the difficulties in the Cyprus financial system, these issues represent an overall weakness in the system in that lack of transparency and sound rules can create an unsound environment.
IFC: There has been increased attention on corporate tax planning – should individual corporations or the governments bear responsibility for the tax or lack of tax being paid by international corporations such as Google, Starbucks etc?
PK: The Commission has addressed the issue of corporate tax planning, or to be more precise aggressive tax planning, in one of the recommendations that it issued with its Action plan last December. The situation in the world at large is complex. The rules that have guided international taxation for decades are showing their age and in particular the fact that they are not adapted to deal with the complex modern business world which includes multinational group structures, unlike the models used in the past. These rules need to be modernised. This is where governments and international organisations need to act. But companies also have to respect the fact that significant reputational damage can be done where they are seen to be avoiding their social responsibilities. Manipulation of tax systems of different jurisdictions in the international environment is just not acceptable. In short everyone needs to act now.
IFC: One of the recommendations in the EU Action Plan includes the blacklisting of third countries not meeting minimum standards of good governance in tax matters – what constitutes the minimum standard of good governance?
PK: We are taking an ambitious approach. In recent years the OECD has been promoting, with considerable success, the two pillars of transparency and information exchange. What we propose is to give equal emphasis to an important third pillar: Fair tax competition. In the EU, Member States apply the principles of fair tax competition set out in our Code of Conduct on business taxation, and we have seen some considerable achievements in this area as a result. The Commission believes that using these principles as a basis for assessing third countries' tax regimes is a fair and effective way to establish a common EU approach to tax havens.
IFC: Will this be tackled within the EU before tackling third countries?
PK: These principles are already in force in the European Union and have produced good results. The process has led to the dismantlement of more than a hundred harmful tax regimes in EU Member States, and the action continues today with a process of constant monitoring and examination of potentially harmful new regimes. The Commission believes that further strengthening of this process will contribute to ensuring fair competition not only within the EU but that it can also act to support similar actions at a wider international level.
IFC: Member state tax legislation is in part designed to entice business into the country - is it not to be expected that governments will compete to attract business and therefore jobs and ultimately growth into their economy?
PK: Tax competition is a difficult and politically sensitive subject. The basis of the work under the Code of Conduct is that a degree of tax competition is acceptable as long as it is fair. What is not acceptable is trying to attract a tax base into a country with no associated economic substance. Regimes that are reserved for non-residents or ring-fenced from the domestic economy for example are also unacceptable. In addition to these elements of the Code work, the exploitation of mismatches in tax regimes which results in double non-taxation has to be tackled.
IFC: How can the EU eradicate so called ‘undercutting’ between jurisdictions? Do you, for example, expect member states to have a single corporate tax rate?
PK: It is not realistic to think that Member States would agree to a single corporate tax rate. In addition the question of comparing different corporate tax regimes to establish so-called ‘undercutting’ is complicated by the fact that there are also differences in the tax bases used by Member States. What is most important is that Member States implement efficient, effective tax regimes that do not unfairly attract business or provide profit-shifting possibilities and that minimise the burden on responsible companies.
IFC: Within the Action Plan there is reference to ‘aggressive’ tax planning and ‘abusive’ tax planning – how is it determined at what point tax planning becomes aggressive or abusive?
PK: Aggressive tax planning consists of taking advantage of the technicalities of a tax system or of mismatches between two or more tax systems for the purpose of reducing tax liability. I think that this gives a pretty clear indication of what we are targeting.
IFC: Is it inevitable that tax planning in and of itself will become if not illegal, at the very least counter to corporate social responsibility?
PK: We have to distinguish between legitimate planning of one's affairs and the abuse of the rules in place. I think that there is considerable pressure on companies to act responsibly and to be seen to do so. Reputation is a fragile thing and yet it is of vital importance to worldwide companies and groups. So I would see this in terms of respecting corporate social responsibility.
IFC: The Action Plan mentions the use of sanctions against those who facilitate evaders – ie tax planners and lawyers. Is it expected that such sanctions may be used against those who facilitate aggressive tax planning?
PK: The issue of sanctions is essentially one for Member States in the context of their national legal provisions. What the Commission has said is that it will study the opportunity and feasibility to align the definition of certain types of tax offences, including administrative and criminal sanctions for all types of taxes.
IFC: How are international corporations to pit a corporate social responsibility against their responsibility to their shareholders to maximise profits (assuming that tax planning is part of their profit maximising efforts)?
PK: The interests of shareholders include those of wider society of which such shareholders are a part. If society expects international corporations to adhere to certain standards then I would expect shareholders to support this view. The answer to this question cannot therefore be that maximising profits has to be seen as separate from the social environment and ethical standards that exist.
IFC: How important is the automatic exchange of information within Europe?
PK: Automatic exchange of information in the EU is carried out on a large scale and has been for a long time. Since 1993 we have the VAT Information Exchange System in place through which transfers take place on a quarterly basis on all cross border sales taking place in the EU. This helps to support the VAT systems of Member States which are based on EU legislation. Since 2005 Member States have been exchanging information on cross-border savings income of up to €10 billion per year. This exchange of savings information helps to ensure effective taxation in the Member States of their residents' foreign savings income. Recent international developments suggest that we will now be able to go forward quickly on extending the scope and usefulness of these provisions and to negotiate strong agreements with some of our EU neighbours, including Switzerland. This will help not only to strengthen revenue collection but also to ensure fairness.