The EC shows examples of double non-taxation cases

February 13, 2013

The EC invited interested parties to submit situations where double non-taxation is occurring, seeking to gauge the full scale of the problem and to determine where the main weaknesses lie.

This article was first published in the Ernst & Young Global Tax Policy and Controversy Briefing, Issue 11, December 2012 (pdf, 4.25 MB)

The deadline (30 May 2012) to provide contributions has expired and although the EC announced it will publish a policy response by the end of 2012, it has in the meantime published a Report summarizing the responses received.

Report details

The Report reveals that the number of contributions received was limited. Non-governmental organizations that contributed to the consultation welcomed the focus of the initiative but found it difficult to provide many factual examples of double non-taxation.

The business community, meanwhile, expressed concerns on the scope of the consultation. Many of the contributors from the business community did not provide answers to the specific questions in the public consultation note, but instead provided broader and more general comments on the issues raised.

The following points are worth highlighting:

  • Several found it important to make a clear distinction between actual double non-taxation (e.g., due to mismatches of hybrid entities and hybrid instruments) and tax competition (low taxation).
  • Most organizations stressed that direct taxation falls within the competence of the Member States’ sovereignty. Several therefore found that any measures against double non-taxation should be handled at the Member State level, while others found some level of coordination may be appropriate.
  • Many organizations felt that the issue of double non-taxation should not be addressed separately from that of double taxation.
  • Some organizations stressed that measures against double non-taxation could adversely affect European economic competitiveness.
  • Several organizations also called for coordination with other initiatives on EU and international levels that address aspects of double non-taxation, e.g., the EU Code of Conduct Group and the OECD report on Hybrid Mismatches.

Background to the current debate: EC and OECD efforts to tackle double non-taxation cases

Within just days of each other, the EC and the OECD issued papers dealing with so-called “double non-taxation” situations. On 29 February 2012, the EC launched its public consultation on factual examples of double non-taxation cases, while a week later the OECD published a report focusing on hybrid mismatch arrangements.

Both papers aim at dealing with situations where, as a result of divergent national rules, transactions between two states lead to perceived non-taxation. This may, for instance, be the case if two states define financial instruments in a different way.

The OECD paper merely summarizes tax policy issues raised by the mismatch arrangements and describes, drawing on a survey of a few countries, the policy options available to address them. But the EC invited interested parties (including tax professionals from practice, business and academics) to submit situations where double non-taxation is occurring, seeking to gauge the full scale of the problem and to determine where the main weaknesses lie, as well as to provide possible solutions.

The EC’s consultation paper is supported by the OECD report on mismatches between countries’ tax systems. This is not surprising, given that a number of key EU countries were part of the OECD working group that prepared the report.

The OECD observes, as does the EC, that market and equity distortions caused by double non-taxation are just as undesirable as distortions caused by double taxation. Both the OECD and the EU list a number of situations that they believe warrant a closer look and possible actions by policymakers.

They also note that this list is non-exhaustive. It is peculiar that the two lists of potentially aggressive cross-border situations have only two situations in common, namely hybrid entities and hybrid instruments.

Work undertaken by the EU Code Group

Within the EU, the debate on double non-taxation is closely connected to the work of the EU Code of Conduct Group (the Group).  In 2009, the Group determined that double non-taxation caused by mismatches is a problem that has to be addressed.

So far the Group’s work in this area particularly focused on mismatches between national law characterizations of payments made under hybrid loan arrangements.

Two broad and rather obvious approaches have been identified:

  1. Either the payer Member State follows the characterization in the recipient Member State (denial of deduction of the interest payment in the source Member State)
    or
  2. The inverse (denial of exemption of the interest payment received).

The Group is currently debating how the “agreed solution” should be implemented (hard law or soft law). In its most recent June 2012 Progress Report, the Group also announced that it started its work on other mismatches, specifically in the area of hybrid entities and permanent establishments.

Comments on the outcome of the consultation

As stated above, the EC stresses that the total number of 25 contributions could be perceived as limited.  It states the main reasons as being the fact that the public consultation relates only to direct taxation (and not to taxation of individuals) and that the subject matter is quite complex. However, there may be another reason.

The examples of double non-taxation, listed in the Commission’s consultation document, occur frequently within the EU and are often confirmed by the courts and tax authorities. They are in many cases an integral part of a country’s taxation system and, as with the reduction of corporate tax rates and Europe’s wholesale move to dividend exemption, a part of building a sustainable fiscal climate by the different territories.

This might explain the lack of response to the Commission’s call for comments, particularly the request for details on any additional specific cases that may lead to double non-taxation. In this context, it is also not unexpected that most of the preferred solutions suggested by the business community were based on the premise that direct taxation falls within the competence of the Member States’ sovereignty.

Only a few business community contributors found coordination or harmonization efforts at the EU level appropriate (for example, the Commission’s Common Consolidated Corporate Tax Base (CCCTB) proposal) as a means to tackle double non-taxation. Finally, several contributors called for avoidance of duplication of work already undertaken at the EU and OECD level.

The way forward: is the focus of the current debate holistic enough?

The EC’s Report summarizing the outcome of the public consultation is of course very welcome. However, far more interesting is that the EC is currently further analyzing the received contributions in order to identify and develop “appropriate policy responses.”

The received contributions will be used as input for the EC’s communication on strengthening good governance in the tax area (“tax havens, uncooperative jurisdictions, and aggressive tax planning”), which it intends to publish at the end of 2012. With a view to possible policy responses, it is notable to take into account that, as the EC implies in its consultation paper, it does not seek harmonization of taxation systems for purposes of combating mismatches. Instead, the EC seems to favor a more pragmatic legislative approach to be undertaken at different levels.

Apart from the traditional EU legislative approach (adoption of a directive at the EU level to be implemented by the Member States), the consultation paper mentions unilateral legislation in individual Member States, as well as bilaterally between Member States.

The EC further suggested increased exchange of taxpayer information, especially mandatory advance disclosure of certain national tax planning schemes and also good governance as potentially very powerful tools; the latter, for example, could result in soft law agreements between Member States or in the sharing of leading practices.

The EC’s progress in this area is obviously deeply connected to the progress on the EC’s CCCTB proposal, which is still on the Council’s table and not yet finding consensus. Any solution on the CCCTB proposal would obviate the need for any legislation on mismatches, as would a further convergence of tax systems, such as that being proposed (and to some degree enacted) by Germany and France.

One of the remaining questions is how eager the various EU Member States will be to implement what might be seen as a further restriction on the ability to use tax as a national policy tool. Consider for example the Belgian Notional Interest Deduction and the recently introduced Italian Allowance for Corporate Equity.

How do these Brussels-condoned measures stack up against this mismatch initiative? The same could be asked about the intellectual property regimes in various EU countries: clearly embraced by Brussels and clearly intended to attract business through a mismatch?

Another interesting question to ask is whether countries are becoming wary of the increasing complexity of their tax rules and the pressure it puts on their tax administrations and judicial systems. Certainly, many countries have established programs designed to simplify their tax code.

However, the growing collaboration by the EU Member States continues to put this drive toward simplification under pressure. Of course, the effect of this complexity on companies where each tax change now means intricate IT changes and increased compliance costs has an even larger impact on companies themselves; migration of corporations or functions within companies may not be a new phenomenon, but it is becoming more common, especially by those corporations that feel overburdened by regulatory and administrative systems.

What therefore might be missing in the current debate is a thorough and detailed study of the various solutions and their form on the potential impact on taxpayers themselves. Currently, the vast majority of focus seems to be on the perceived income the potential EU policy responses could generate for government and the compliance cost to the Member States implementing them, not to the companies that have to deal with them and, most importantly of all, the impact the changes in tax law and the increased compliance burden may have on global trade.

As pointed out, the impact of (potential) policy responses on the ability of EU multinationals to remain competitive should be closely monitored and compared with multinationals with head offices in third countries, particularly those in OECD non-EU countries.

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