Direct tax co-ordination


Peter Schonewille



The Commission does not seek fiscal harmonisation for harmonisationís sake. It sees its role as limited to the co-ordination of national tax policies to the extent necessary for the smooth functioning of the Single Market, taking full account of the principles of subsidiarity and proportionality. It favours a pragmatic and realistic approach aimed at providing a more effective defence against the loss of national fiscal sovereignty in favour of the markets which is currently being experienced by Member States. This contribution takes stock of developments on the direct taxation front.

The Single Market with its four freedoms - the free movement of goods, persons, services and capital - is the cornerstone of European integration. The steps which have already been taken towards its completion have had positive effects in terms of growth, employment, trade and competitiveness. The next step is the introduction of the Euro in less than a yearís time. The introduction of a single currency implies that there will be no exchange rate risks for economic agents trading or investing in other countries which have also introduced the new currency. Cross-border transparency will increase and eventually there will be a real integrated market for consumers, producers and investors.

The introduction of a single currency will increase the risk of harmful tax competition. Fair competition is, of course, a cornerstone of the Single Market. Tax competition can have beneficial effects by forcing Governments to avoid overspending. At the same time, the boundary between "fair" and "unfair" tax competition is often unclear. It is when tax competition leads to an erosion of Member Statesí tax revenues, when taxable bases are relocated to other countries purely for tax reasons, that tax competition becomes a problem. Tax competition can also force Member States to shift taxation to less mobile production factors such as labour, with detrimental results for employment.


Developments in the tax field on an EU-wide basis have up to now been strongly influenced by the requirement for unanimity in the Council. In practice this has made it very difficult to reach agreement on new measures. It was because of this lack of progress that the Commission presented a new and comprehensive approach to tax issues to the informal ECOFIN Council in Verona in April 1996. This approach involved placing tax issues in the framework of wider European objectives, such as the promotion of employment and the completion and smooth functioning of the Single Market, including EMU, rather than focusing on taxation proposals in isolation.

This new approach had its first result in the historic decision reached by ECOFIN Ministers on 1 December 1997. On that day, EU Finance Ministers unanimously adopted a package to tackle harmful tax competition, including a code of conduct for business taxation, key elements on the taxation of savings and agreement on the principle of the need to eliminate withholding taxes on cross-border interest and royalty payments between companies.

The agreement of the Council is historic firstly because it is the first time in more than seven years that the Council has agreed unanimously on direct taxation measures. The last such time was in July 1990, when the parent/subsidiary and merger directives were adopted, and the arbitration convention was signed. And that was, in the case of the two directives, after twenty-one long years of Council negotiations.

One of the reasons for the success of the package is that it focuses on reaching a political agreement first, before trying to reach agreement on legislative proposals. Another reason is that by combining a number of measures, it allows to maintain a balance between the different interests of the Member States.

The December tax package is a targeted effort to tackle harmful tax competition and eliminate some distortions in the Single Market; it is not intended to raise taxes, which would damage the international competitiveness of the Union, nor is it intended to be the start of a process of wholesale tax harmonisation, which would be incompatible with the subsidiarity principle.

It has been argued that co-ordinated action at a Community level against tax competition will damage the competitiveness of the EU vis-à-vis the rest of the world. However, the elimination of the extra costs of doing business in other Member States which will come with EMU will correspondingly mean that there will be a greater difference between the costs of investing within the single currency area and outside. This suggests that a certain amount of co-ordination of taxation between Member States will be possible without causing migrations of companies or outflows of income outside the Euro area. Furthermore, co-ordinated action within the Union might stimulate third countries to follow the same approach. The level of economic integration within the Union is another reason not to wait for the rest of the world before taking action.


The first element of the package is the Resolution on a code of conduct for business taxation. The Resolution includes a precise definition of potentially harmful measures, starting with those tax measures which provide for a significantly lower effective level of taxation, including zero taxation, than those which generally apply in the Member State in question. It then provides for a review process, and it is this process that will determine which potentially harmful measures are actually harmful, and thus require to be rolled back or covered by the standstill clause. The review will be carried out by a Council group, consisting of high-level representatives of the Member States and of the Commission, and the outcome will be reported to the Council. It will be for the Council to consider the reports of the Group, and to decide whether to publish them. The ECOFIN Council of 9 March established the new Group, which is now formally called the "Code of Conduct Group", which will shortly commence the review process.

A crucial point, of course, is the time frame in which harmful measures should be rolled back. The code says "as soon as possible, taking into account the Councilís discussions following the review process". Indeed it is clear that Member States should already be considering their own laws and practices in the light of their commitment to the principles of the Code of Conduct. A number of Member States did seek to mitigate the impact of the code on their specific national situations, but nevertheless it was agreed, in the interests of all Member States, to set an overall limit for the rollback period, in principle, of five years. In this context, it should be noted that the Code also contains a standstill clause, which is a major step forward in itself.

The Resolution also clearly confirms the Commissionís commitment in relation to the state aid rules of Articles 92 to 94 of the EC treaty. The Commission will publish guidelines on the application of state aid rules to measures relating to business taxation later this year, after discussing them with the Member States. In the Resolution the Commission also commits itself to the rigorous application of these rules, taking into account the negative effects of aid that are brought to light in the review process.

It is clear that the review process by the Group under the code of conduct and the application of the state aid rules by the Commission are two separate processes. Nonetheless, it is expected that a positive synergy between these two processes will develop. The code of conduct cannot alter the provisions of the treaty in relation to state aid, and the Commission does not have the power to renounce its exclusive competence in that matter. However, the many hours of negotiations, culminating in the adoption of the code last December, will already have had a positive effect in raising awareness within the Commission of the particular role state aids play in tax competition. This is in itself an achievement, and it is likely that future decisions by the Commission in relation to fiscal state aid will be informed by the discipline introduced by the code.

The OECD is currently also working on a report on harmful tax competition, which is likely to include guidelines on harmful preferential tax regimes. Although there are a few differences between the Unionís code of conduct and the proposed OECD guidelines, they seem to be broadly compatible. Ideally, harmful tax competition should be tackled on the broadest possible geographical scale. The chances of reaching a satisfactory solution at OECD level will be greatly improved if EU member states act in a more co-ordinated way.


Another pressing issue as we are approaching the introduction of the EURO is the taxation of income from savings. As a result of the introduction of the EURO, mobility will no longer apply only to large portfolio investors, but also to those who, under the present system of different currencies, are unwilling to invest in other Member States because of a lack of information and fear of the risks involved.

As part of the tax package the Council asked the Commission to bring forward a proposal for a Directive on the taxation of savings, to ensure a minimum effective taxation of savings income within the Community, and to prevent undesirable distortions of competition. The new proposal will be presented to the ECOFIN Council shortly. It will reflect a number of points which were approved by the Council last December as the possible basis of that proposal.

The general starting point is that the Directive will be limited to the absolutely necessary, in full respect of the subsidiarity principle. For instance, it is proposed that it will only cover interest paid in one Member State to individuals who are resident in another Member State. But most importantly, where many earlier attempts failed, Member States agreed now that, as a first step, it could be based on the "co-existence model".

Under the co-existence model Member States will either operate a withholding tax, or provide information on savings income to other Member States. This co-existence model should provide a solution which could be acceptable both to Member States with banking secrecy as well as to Member States which rely on the exchange of information.

In conformity with the idea that this solution would only be a first step, it was also stated that the Directive could contain a review clause, for the purpose of determining to what extent further progress would be conceivable with a view to better effective taxation of savings income.

Another point that was already in an earlier proposal on this subject is the idea that the paying agent, and not the debtor, should levy the withholding tax. The paying agent would be defined as anyone who in the framework of business activities pays interest to an individual person. In principle this approach seems best fitted to combat tax evasion. It will, however, be subject to refinement in order to make it more effective and to avoid double taxation.


The December Council also considered that the Commission should submit a proposal for a Directive on interest and royalty payments between companies. The Commission presented its new proposal for such a Directive at the same 9 March ECOFIN Council meeting when the Code of Conduct Group was established.

The proposal aims at eliminating withholding taxes on payments of interest and royalties between associated companies of different Member States. Such withholding taxes often create problems for the functioning of the Single Market, such as double taxation or burdensome administrative formalities which lead to cash flow losses. Member States have not been able to completely resolve these problems by unilateral measures or by bilateral tax treaties.

According to the proposal, companies are considered to be associated if one company owns directly or indirectly 25% or more of the capital of the other company. The proposal would allow Member States to take appropriate anti-abuse measures. It would also provide for a gradual rather than immediate abolition of the taxes in Greece and Portugal, as those Member States are large net importers of capital and technology.


The tax rules for pensions and life insurances are very complex and specific to each Member State. Discriminatory tax treatment of contributions is an important barrier to the Single Market. National regulations often discriminate directly or indirectly against foreign funds or insurers. As a rule, tax deductions are available only for contributions to domestic schemes. This both distorts competition and limits labour mobility. Non-discriminatory tax treatment would lead to increased competition which would lead to increased returns for pension or and life insurance subscribers. Fragmentation of the product market due to discrimination based on nationality also increases transaction costs. Products must be designed for a specific Member State market and typically must have the unique characteristics required to benefit from tax relief in that Member State. Given such discriminatory tax barriers, providers of supplementary pension plans or life insurances are not able to benefit from economies of scale. They must create unique products and establish specific policies for what may be relatively small markets. The need to establish offices in each Member State to manage these unique products further drives up costs.

The Commissionís Green Paper "Supplementary Pensions in the Single Market" discusses these and other issues. Furthermore, the 1 December ECOFIN also noted a statement for the Council minutes, saying that the Commission undertakes to consider the problems relating to the taxation of pension and life insurance benefits with the assistance of the Taxation Policy Group, with a view to possibly drawing up a proposal for a Directive. Discussions on this issue in the Taxation Policy Group are expected to start later this year. Apart from the Taxation Policy Group framework the Commission is organising a public hearing on the follow up to its Green Paper on supplementary pensions, on 21 April in Brussels.


The concern of Member States about EMU and the risks of tax competition to tax revenues have no doubt had a strong influence on the decision to agree on the taxation package. But the decision of last December is also a result of the dialogue between Member States and the Commission which had been underway for 18 months, first in the High Level Group, and afterwards in the Taxation Policy Group (both Groups consisting of high level personal representatives of the Member Statesí Ministers of Finance, and chaired by Commissioner Monti). The establishment of the Taxation Policy Group represents a significant step in the dialogue between Member States and Commission in the tax field. It demonstrates clearly that Member States are conscious of the increasing difficulties of setting tax policies without reference to developments in other Member States. The 1 December ECOFIN called on the Commission to take forward its work on taxation, continuing to draw on the assistance of the Taxation Policy Group.


To conclude, challenges such as EMU are creating an atmosphere in which Member States are beginning to see tax co-ordination in certain fields as increasingly necessary. It is this scenario which has been, to a large extent, responsible for the consensus on the tax package and which hopefully will lead to such other agreements in the field of taxation as are necessary. The package represents a new willingness on the part of Member States to compromise in the tax field and a recognition that solutions which are perfect for everybody are simply not available. It also suggests that the new approach of considering tax policies in a comprehensive way and in the context of current challenges facing tax systems is a good one which should continue in the Taxation Policy Group.