Summary
The EU is a dysfunctional organisation in the area of corporate taxes because:
1. the EU Commission is not able to prevent EU countries such as Ireland, Belgium and Luxembourg operating as tax havens (this is because member states have not conferred legislative competence on the EU over direct taxation), and
2. the Court of Justice of the European Union (CJEU) has developed the fundamental freedoms in its case law to prevent other EU countries tackling the artificial diversion of profits to these tax havens, unless the arrangements are “wholly artificial” (please see the CJEU’s decision in the Cadbury Schweppes case (C-196/204)). The CJEU applies the most liberal, even extreme, interpretation of Organisation for Economic Co-operation and Development (OECD) tax rules to allow multi-national corporations to avoid taxation.
One of the advantages of the UK leaving the EU is that the UK will be free to prevent UK companies from shifting their UK taxable profits to EU tax havens, such as Ireland, Luxembourg and Belgium, and non-EU tax havens.
Background
Tax avoidance is costing the UK billions, and the UK Government is powerless to address the problem all the time the UK remains in the EU. This is because of the supremacy of EU law over English law. Consider, for example, the CJEU’s decision in the Cadbury Schweppes case (C-196/204). The case states that companies are free to shift their taxable profits to tax havens within the EU to reduce the burden of taxation in their host state unless the arrangements are “wholly artificial”. Given that companies are able to ensure that their tax avoidance activities are not “wholly artificial”, this means that the UK is powerless to prevent UK based multi-national companies from engaging in tax avoidance in the other 27 member states.
Large UK based multi-national companies are not only aware of the opportunity which the CJEU’s decision has created, they are readily exploiting this decision for their own advantage. This is one of the reasons why so many large UK based multi-national companies were in favour of the UK remaining in the EU. They know that if the UK leaves the EU, there will be no restriction on the UK Government from tackling tax avoidance.
Countries remaining in the EU can only solve this problem by conferring on the EU authority over direct taxes, to determine the tax base and the rates of tax, so that tax havens no longer exist within the EU. If this were to happen, companies operating within the EU would not be able to gain an advantage by shifting their taxable profits to the member state offering the lowest effective tax rate, or exploit the asymmetries between the bases on which member states levy tax. Such a proposal is on the EU Commission’s agenda, because it recognises that it is impractical to have a single market where member states compete against each other for the taxable income of companies. The only winners in such an environment are large multi-national companies.
The EU Commission has made proposals to remedy, one aspect of this problem, namely, for member states to have a common tax base (please see the Commission’s reports entitled A Common Consolidated EU Corporate Tax Base (2004), analysed first by the Bruges Group, and A Fair and Efficient Corporate Tax System in the EU (2015)). If the EU Commission’s proposal were implemented it would solve part of the problem. To solve the other part, the EU would need to be allowed to set the rates of tax for all companies operating within the EU.
In an environment where member states are able to compete for taxable income, the smaller EU states, such as Ireland, Belgium and Luxembourg, will always be able to offer the lowest effective rates of tax. This is because they have less to lose than the larger member states from offering lower rates of tax to their domestic companies. As a consequence, the EU has become an area for companies to seek out the lowest effective rate of tax for their taxable income. This problem is particularly acute where income arises from mobile capital, such as finance and intellectual property, which for many large multi-national companies is their main source of income. It is not as though the smaller states benefit from this situation, because the amounts of tax which they collect are negligible. The big winners are the large multi-national companies.
This is not a problem that critics of the EU have invented. One only has to read the following comments by the EU Commission to realise that this is a real problem:
“unfettered tax competition which facilitates aggressive tax planning by certain companies creates competitive distortions for businesses, hampers growth-friendly taxation and fragments the Single Market.
However, the co-existence of 28 different tax systems in one integrated market has also resulted in strong tax competition between Member States. As a consequence, Member States have progressively lowered their corporate tax rates, in order to protect their tax bases and attract foreign direct investment.
…….as corporate tax planning has become more sophisticated and competitive forces between Member States have increased, the tools for ensuring fair tax competition within the EU have reached their limits.
Differences in corporate taxation between countries are the driving force for corporate profit shifting”.
This is not a problem that was confined to Euro zone states, it applied to the UK. This is one of the reasons the UK Government has had to cut the rate of corporation tax to 17% by 2020. Because of the structural flaws mentioned above, all the time the UK remains in the EU it is engaged in a “race to the bottom” in corporate tax rates.
Somewhat disturbingly, the EU has no power to tackle the problems mentioned above. As the EU Commission states in its report the only way in which it is able to address this problem is by peer pressure:
The Code of Conduct for Business Taxation Group is composed of Member State representatives to deal with harmful tax competition in the EU, in a non-binding way, on the basis of peer pressure.
To tackle these problems the EU needs to have the unanimous backing of member states.
The flaws mentioned above have arisen because of the manner in which the EU operates. The aim of the EU is to create a Federal States of Europe, akin to that which exists in the US. The language of the EU Treaties, and in particular the fundamental freedoms, is open ended, which has allowed the CJEU to interpret these freedoms in an expansive manner. The CJEU has applied them in a much wider range of scenarios than was ever intended. For example, the Treaties were never intended to apply in the field of direct taxation, but the CJEU has not only applied them in this field more recently but also has prioritised the fundamental freedoms over domestic laws tackling tax avoidance. In contrast, the EU Parliament has been unable to enact a common corporate tax rate and basis for charging tax across the Union, because it has been unable to obtain the necessary support of all member states, as required. To date, the smaller member states have been unwilling to support such measures because they would remove one of their competitive advantages. However, the financial position of many member states is now so perilous that this has become a priority for the EU to address. As a consequence, pressure may be exerted on the smaller member states to withdraw their objection to the EU Commission’s proposals for a Common Corporate Tax Base.
State Aid
The EU is able to take action against any member State offering “sweet heart” tax deals to specific companies. This is because this type of behaviour distorts competition and violates the EU’s rules on State aide. However, countries such as Ireland, Belgium and Luxembourg is able to circumvent the EU’s State aide rules by simply making the “sweet heart” tax deal available to all companies.
This is yet another example of how the EU does not have the power to effectively tackle tax avoidance.