| CCCTB - a wolf in sheep’s clothing? |
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| Brian Daly questions the stated benefits of European Commission plans to introduce one consolidated EU tax base and urges business leaders to increase their awareness of the real impact of the proposals and assist in the counter-lobby. |
Introduction
The CCCTB concept is being pushed by the Commission largely on the premise that it will simplify tax compliance obligations, thus reducing compliance costs for cross border activities within the EU. Most people who are offered an opportunity to decrease tax compliance costs would accept such an offer. Hence it is hardly a surprise that a recent survey of Financial Directors and Tax Directors of over 400 companies throughout the EU was reported as finding a high degree of support for the European Commission’s Common Consolidated Corporate Tax Base (‘CCCTB’) proposals.
However these results need to be placed in the context of a significant lack of knowledge as to what the proposals involve. It is critically important that the implications of any CCCTB proposal coming to pass are better understood. The Commission’s assertions of simplification and cost reduction are untested and highly questionable. Here I hope to explain the concept of CCCTB, outline the key issues and highlight the risk of tax harmonisation occurring by the back door.
What issues will CCCTB raise?
The CCCTB will remove one of the most important tools available to Member States to compete in attracting international business, most likely to the benefit of countries outside the EU such as Switzerland and Singapore. Implementation is likely to lead in time to the harmonisation of tax rates and the scrapping of tax treaties between EU countries and the renegotiation of treaties with non EU countries. This is serious stuff which the Commission has succeeded in getting this far by dressing it up as a cost reduction exercise. It has much broader implications.
No political decisions have been taken at this stage. The Ecofin Council has so far simply noted progress reports. However the Commission seems to be making some headway with this proposal and aims to bring forward legislative proposals in 2008.
In summary, the CCCTB will give rise to a significant number of issues and questions, including:
- When account is taken of the complexity of replacing the existing profit allocation system (i.e. tax treaties and transfer pricing) with a new formulary apportionment regime and administrative system, which will also have to interact with tax treaties across Europe and with non-EU treaty partners, it’s difficult to see that simplicity and lower costs of tax compliance will necessarily be the result.
- CCCTB would cause significant disruption and uncertainty for business in the lead up to it and for many years thereafter.
- The likelihood of it enhancing the global competitiveness of business in Europe is low.
- In the absence of a harmonised tax rate, CCCTB is unlikely to be any more successful than the current regime in ensuring that tax considerations distort as little as possible economic decisions by operators. At least the current regime has been in place for a number of years not only in Europe but across the world and is tried and tested.
- Besides all of these practical and important issues, the proposal, by virtue of removing the capacity of national governments to influence their local corporate tax environment (except for the tax rate – initially at least), will significantly erode national tax sovereignty. The CCCTB proposal focuses on only one aspect of the capacity of national governments to influence the economic environment for businesses in their country. In reality the larger States have very significant spending budgets and other intrinsic advantages which are used to influence the location of major industrial projects – these advantages are not available to smaller countries in Europe who have to date had to rely to some extent on the tax environment offered by them. Furthermore for the smaller Eurozone countries like Ireland, with no control over exchange or interest rates, tax policy is one of the few effective tools left to respond to economic shocks.
What is the CCCTB?
The CCCTB is, in principle, designed to do two things. Firstly to introduce a common base for the taxation of corporate profits across Europe i.e. in theory, taxable income would be computed in the same manner in all countries.
Secondly the reference to ‘consolidated’ base refers to an intention to aggregate the profits (calculated according to the common CCCTB set of rules) of companies operating within the same group and to create a framework for the allocation of those consolidated profits across all countries in Europe to determine how much of overall European tax base will be subject to taxation in each country (at that country’s prevailing rate of tax). The Commission intends to outline the suggested rules for calculating the common base and the mechanisms for allocation of profits in a legislative proposal in 2008.
The most recent suggestion from the Commission Services which has emerged on 13th November is for allocation by reference to a combination of a) sales by destination, b) labour, with an equal weighting of payroll costs and number of employees and c) tangible fixed assets. They specifically exclude intangible assets, mainly for what they say are practical reasons in relation to the difficulty of valuation. They also exclude financial assets and inventory because they are highly mobile although they suggest that an exception be made for financial assets in financial institutions.
Optional or mandatory?
The Commission officially insists that businesses will be able to opt in or stay out of the CCCTB framework (although word ‘optional’ is qualified by the word ‘initially’ in their 2006 Communication). Not withstanding this, the Commission put a proposal out to tender in recent months for the performance of an economic analysis on the impact of introducing the CCCTB in one of four different ways. Of the four proposals the tenderers are asked to look at, two of them are optional and two are compulsory. Indeed one of the compulsory proposals also includes a harmonised tax rate.
Sceptics will wonder how long any optional arrangement would survive. In any case, given reduction in cost and administrative burden is one of the key stated objectives of the regime, running an additional optional system alongside the 27 existing systems makes no sense in the longer term.
Survey findings
A recent survey of Finance and Tax Directors firstly asked whether the respondents were aware of the forthcoming CCCTB proposals. Overall, half of respondents were aware and half unaware. Levels of awareness varied dramatically between different countries. The Irish respondents had the second highest levels of awareness at 70%, which still reveals a significant lack of awareness i.e. 30% which is perhaps surprising.
In many countries, less than 30% of respondents were aware of the proposals. Overall 78% of respondents claimed to be in favour of proposals for a harmonised base. However this average comprises significant majorities in some of those Member States who were largely unaware of the proposals prior to the survey. Despite the lack of awareness, many of these same respondents specifically supported the even bigger move to a consolidated tax base.
There are widely divergent views on what is the preferred allocation basis which demonstrates that any existing support for the concept is likely to be predicated on an assumption that the allocation basis will make sense for the group involved - an assumption which will not be true in all cases. Indeed in 12 out of the 27 countries surveyed, support for the allocation basis most recently suggested was less than 30%, and in many cases significantly less than that.
83% expected CCCTB would either simplify their tax compliance or reduce their compliance costs but only a minority of 36% thought it would improve their company’s global competitiveness. In addition 69% of respondents said they were in favour of a common corporate tax rate across Europe though that does not form part of current proposals.
The survey was only a snapshot of views, interviewing only 10 respondents in many countries. It does however provide a wakeup call for business to gain a better understanding of the proposals. Given the lack of awareness of the underlying concept, it seems that many statements of support may be founded on an automatic assumption that CCCTB will succeed in achieving its stated aims in a cost efficient manner. So, what does the Commission say it wants CCCTB to achieve?
Aims of CCCTB
Many reports of the Commission have set out in detail the objectives of CCCTB. Broadly they can be summed up as improving competitiveness of European businesses, decreasing tax compliance costs and tax obstacles to cross border activity such as transfer pricing difficulties and group loss compensation.
Can the CCCTB achieve the Commission’s stated objectives?
Impact on Compliance Costs
I would suggest that it is unlikely that the CCCTB proposal will produce a system which is simpler for businesses to comply with. The current system used commonly across the globe for the allocation of group profits between taxing jurisdictions is the framework of tax treaties and transfer pricing rules which have been built up over the years and which have been set down in the widely respected OECD Guidelines.
Transfer pricing rules refer to the arms length pricing of cross border transactions within multinational groups. The rules have become much more sophisticated and better understood and applied as years have gone by. Yet there seems to be an underlying assumption amongst CCCTB proponents that transfer pricing rules represent a major problem to be overcome.
Before even considering profit allocation, the Commission faces difficulties in agreeing a common starting point in the calculation of tax base given the CCCTB is not intended to be directly linked to either domestic accounting rules or IAS/IFRS. Given the wide divergence of treatment that exists, the Commission will need to agree the most basic elements of what constitutes taxable profits. For example, what interest expense is deductible? What capital expenditure is allowable? Over what periods can assets be depreciated? When is income to be recognised? How are losses treated? The Commission has made suggestions on some of these. How will other complex areas be dealt with such as thin capitalisation, controlled foreign corporation legislation for investment outside the EU, R&D activity, securitisation vehicles, catastrophic reserves in the insurance area and the complexities of life insurance taxation?
And that is only the starting point. More problems arise with consolidation. The difficulties with transfer pricing normally arise from differences in approach to allocation of profits, and therefore tax take, between tax authorities, not because transfer pricing as a concept is fundamentally flawed. Surely this all boils down to the same question - which jurisdiction gets a slice of the revenue? If we have difficulty resolving such issues bilaterally, what is the likelihood of reaching unanimity on the method of allocation across all Member States? Yet, the 13 November document suggests that political agreement will be needed on the weighting of importance of labour, sales and tangible fixed assets allocation factors.
These factors suit ‘old’ rather than ‘new’ types of industry and reflect a line of thinking which is not consistent with the Lisbon Strategy, which aims to make Europe the most competitive and knowledge based economy by 2010. They are also inappropriate for any industry, e.g. high tech, where intangibles are critical.
Moreover even with CCCTB, companies would still have transfer pricing compliance obligations in relation to transactions with associated companies outside of the CCCTB area.
To promote simplicity it was suggested that CCCTB should allow for single compliance, i.e. one consolidated tax return in a single location, such as head office location. A whole range of questions would need to be addressed as to who would have audit powers etc . The 13 November paper sets out some initial suggestions in this regard but it is questionable how tax authorities in small States like Ireland could safeguard their position when they will, in so many cases, not constitute the ‘home state’.
Complexities will arise with issues such as defining groups, dealing with companies leaving a CCCTB group, handling corporate tax and VAT offsets which can currently be done in certain countries, treatment of trade taxes etc.
Given such complexities, it is questionable whether the CCCTB will deliver any simplification of tax compliance administration and reduction in compliance costs. The necessity to develop a new set of rules and definitions for the CCCTB will add to the administrative complexity and require a new dispute resolution system. Much of the current reporting requirements in relation to transfer pricing and group accounting will continue to be necessary for statutory and business planning reasons. Disputes over the base and interpretation of the formulary approach may well replace transfer pricing disputes.
Impact on Tax Treaties:
There is also the unresolved practical question as to how the CCCTB proposal would interact with the bi-lateral tax treaties between European countries which preclude countries taxing business profits of enterprises from other countries unless those enterprises have permanent establishments in the local countries. Would non EU income be allocated across the EU group on the basis of the CCCTB profit allocation mechanism? Would this result in all treaties between the non EU country and each EU country, in which the group has operations, being invoked? Or would income have to be tracked under old principles for treaty purposes again resulting in a parallel system? On the face of it, a potential implication is the scrapping of existing treaties between EU countries and perhaps renegotiation of those with non-EU countries.
Impact on Competitiveness:
As we know, the competition for location of commercial activity across the world is ever-present. In the event that an eventual compulsory CCCTB results in the removal of incentives and a lack of flexibility to respond to changes such as the development of innovative products etc, certain activities may move outside Europe. Not only will Europe lose from a jobs point of view, but will also lose from an Exchequer point of view as it will no longer have the benefit of the Exchequer revenues generated from these activities.
It is fair to say that most businesses see competition as being a good thing. Tax is a cost of business, and like any other cost of business, it is something which governments should be incentivised to keep at the lowest possible level whilst providing an appropriate infrastructure for society generally. A lack of competition in this area is only likely to allow governments not to focus on gaining efficiencies in the manner in which taxation revenues are spent.
Impact on EU Social Model
One of the key elements of the European social model is the ability to develop an economy which is spread widely across a diverse cultural, demographic and economic environment.
The removal or watering down of the existing framework within each country whereby locally elected governments can incentivise and drive economic activity in their local environments is, in my view, more likely rather than less likely to lead to a centralisation of economic activity within the large European states. This is not necessarily a good model for the development of the European Union.
Jurisprudence
There will undoubtedly be different interpretations of CCCTB rules by different States given the different starting points in tax framework which will surely result in more litigation to ensure common interpretation. Will there be a central court of appeal from each State? The vast bulk of ECJ tax cases currently come from the existing harmonised taxes e.g.VAT. Another harmonised set of rules implies a new flood of cases for years to come.
Enhanced Cooperation?
The Nice Treaty provides for what is called the ‘Enhanced Cooperation Option’ whereby a project having gone through the whole process fails to be adopted it can be taken up by a number of Member States who can go it alone. If this happens, CCCTB will be available as an optional system, for now at least, for companies located in the countries which opt for it. It could be a gamble for Ireland to opt out of the process and remain in what would be perceived to be the second tier of a two-tier system. In time it is possible that we would come under pressure to join by multinational companies who wish to opt to apply CCCTB across their European operations. It is possible that Ireland and other smaller States would ultimately be forced to enter into a new regime by being ‘leant on’ elsewhere.
Conclusion
In many ways, the CCCTB proposal is a big solution looking for a big problem. Whether there is a big problem or not depends on whether one thinks that the existing system of allocating profits across Europe i.e. via tax treaties and transfer pricing, is so sufficiently deficient that it should be replaced with a new system which is itself going to be complex and costly to implement. The reduction of cross border obstacles could be equally effectively tackled via less costly targeted solutions, through the continued development of directives along the lines of the Mergers and Parent/Subsidiaries Directives. For example, the cross border loss relief issues raised by the Marks and Spencer case could have been dealt with in this way.
A broader question is whether corporate tax compliance is such a significant cost to warrant such focus in isolation? Surely if compliance cost reduction is the real objective here, our focus should be on withholding tax, VAT, payroll taxes etc which often impose significant burdens on business. Is the Commission using a sledgehammer to crack a nut or does this simply betray the true intention of the proposal - to harmonise corporate taxes?
I hope that when better informed and familiar with the likely complexities of the CCCTB system, businesses across Europe will realise that the current system, whilst not perfect, is probably the best one available and the cost and disruption of changing from it would outweigh any perceived benefits that might arise - it is a bit like democracy which Churchill once said was the worst form of government except for all those other forms.
To date the Irish Government is taking the right approach, voicing its opposition at Commission and Ministerial level and engaging in technical discussions at the appropriate levels.
Collectively, the government, the Irish tax profession and representatives from Irish industry now need to increase focus on the conceptual and technical arguments and do our best to raise awareness in relation to the pitfalls before a legislative proposal is issued in 2008. To support the efforts of Government I believe a proper lobbying campaign needs to be undertaken by internationally focused businesses based in Ireland. |
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| Article appeared in the November 2007 issue.
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