International comparison of corporate income taxes

US Congressional Budget Office (CBO) released the following paper Corporate Income Tax Rates: International Comparisons. According to the CBO, corporate income taxes are a major source of revenues in other countries. For example, for OECD members corporate income tax revenues in 2002 averaged 3.4% GDP. The analysis compares statutory and marginal corporate income tax rates between 1982 and 2003 across a broad range of countries. The paper includes an international comparison of corporate income taxes , thaking into account several differences among countries.

QUOTE OF THE WEEK (Week XVII)

"The income tax created more criminals than any other single act of government."
Barry Goldwater (American Politician)

Previous quotes:
Week I Week II Week III Week IV Week V Week VI Week VII Week VIII Week IX Week X Week XI Week XII Week XIII Week XIV Week XV Week XVI

Asian Development Bank International Tax Conference

The Fifteenth International Tax Conference was held at the ADB Institute in Tokyo on October 17-20, 2005. The Conference dealt with several taxation issues, namely international tax developments (particularly concerning tax treaties) and value added tax.

From the material made available in the ADB website I would highlight the following presentations:

Treaty Shopping and Anti-Abuse Provisions by Aurobindo Ponniah (International Bureau of Fiscal Documentation - IBFD )

Taxation of Partnership and Tax Treaty Application and Paper by Bart Kosters (IBFD)

Application of Tax Treaties to Partnership-Case Study by Bart Kosters and Aurobindo Ponniah (IBFD)

Tax Treaty Developments and Tax Issues Relating to Cross-Border Outsourcing by David Partington (Organisation for Economic Co- operation and Development - OECD)

Extending the Dialogue on International Taxation by Shigeru Ariizumi (Center for Tax Policy and Administration)

Click here to access the program and remaining presentations (dealing with VAT and other issues)

Temporal limitation of the effects of ECJ judgments – recent developments

Two recent developments require an analysis of one of the current “hot issues” of European Tax, whether the European Court of Justice (ECJ) should limit the retroactive effects of some of its groundbreaking judgments.

Just last week Advocate General Tizzano issued an opinion on the Meilicke case, concluding that the already repealed German imputation tax credit system was contrary to the free movement of capital principles in the EC Treaty. For the ones that follow the developments of the ECJ jurisprudence, Tizzano's opinion is not unexpected. In fact, last year decision on the Manninen case (dealing with the Finnish imputation system) and the 2000 decision in the Verkooijen case (dealing with the Dutch exemption for dividends from companies in the Netherlands) were precedents that would foresee the conclusions of Advocate General Tizzano. Nevertheless, what was suppressing about this case was the considerations of the Advocate General on the request of the German government that the ECJ should restrict the retroactive effect of the decision.

According to the Advocate General, case-law of the Court of Justice allow that such a limitation be imposed if there is a risk of serious economic repercussions and if there is objective, significant uncertainty as to the scope of the Community provisions. The Advocate General considers that in the Meilicke case, both those conditions appear to be fulfilled (not only the amount of tax refunds at stake is enormous but also the provisions on the free movement of capital were far from clear).

The question now is how would such limitation operate? According to the Advocate General, if the ECJ would rule in favour of the taxpayer, only refunds for tax credit for corporate income taxes paid abroad for dividends received after 6 June 2000 (date of the judgment in the Verkooijen case) would be refundable. With regards to dividends received before that date, the Advocate General considers that only claims filled before 11 September 2004 (date the preliminary ruling request was published in the EU Official Journal) would be accepted.

The second development involves the discussion around another high profile case pending in the ECJ, namely dealing with an Italian tax called IRAP (imposta regionale sulle attività produttive). IRAP is a regional tax payable by companies, partnerships and the self-employed. The tax, which applies broadly, is imposed on all commercial transactions involving the production of, or trade in, goods and the provision of services. There is some expectation in Europe as to whether IRAP conforms to EC law. In that regard, Advocate General Jacobs’s opinion delivered on 17 March 2005 already indicated that the local business tax might be contrary to the Sixth VAT Directive (“IRAP must be characterised as a turnover tax prohibited by Article 33(1) of the Sixth VAT Directive”). These recommendations raised concerns not only in Italy (where the amount of refunds can damage the budget equilibrium) but also to Hungary that apparently has a similar tax. In an unprecedented move, the ECJ published an order where it decided to reopen the oral proceedings. According to the ECJ, Italian, German, UK, Dutch, Belgium, Swede, Austrian, Check and French governments suggested the reopening of the proceedings. One of the issues that apparently forced the reopening of the case is the issue of temporal limitation of the effects of the judgment (see par. 72 to 88 of the Opinion).

If the ECJ were to decide that IRAP had been collected unlawfully, the Italian government would suffer a loss estimated in more than EUR 120 million. According to the Advocate General that damage is, in itself, insufficient to limit the temporal effect of the ECJ judgment. Nevertheless, the Advocate General mentioned that the ECJ may limit the possibility for parties to rely on a certain judgment. In order to impose such a limitation, two essential criteria must be fulfilled, namely that those concerned should have acted in good faith and that there should be a risk of serious difficulties. In that regard, the Advocate General proposed that the ECJ should consider a temporal limitation of the effects of its judgment in this case. The problem is to find an appropriate date from which the limitation applies. One possible approach is the German Constitutional Court approach, that sets the date from which citizens may rely on its judgments in such a way that sufficient time is allowed for new legislation to be enacted. But that would be a groundbreaking departure from previous case law.

Since the issue of temporal limitation of the effects of ECJ judgments can be applied in several “high profile” cases currently pending in the ECJ (like the Marks & Spencer), the move to follow the suggestion of the Advocate General to reopen the oral procedure to hear further arguments comes as good news for legal certainty in Europe (see point 88).

Another aspect to consider is the impact of such limitation of a judicial ruling on the dialogue between the ECJ and the legislative institutions of the Union and Member States. Some of the recent groundbreaking tax cases gave clear signs to Member States that their decisions should be followed by a normative change within the tax system of Member States and eventually by a reaction by the legislative institutions of the European Union. For example, the EU Commission already stated that it would issue a communication and a proposal on cross-border losses after the decision of the ECJ in the Marks & Spence case. The question that needs to be asked now is what would be the impact of a more ECJ “pro-member state approach” on the push towards tax harmonization in Europe that we experienced in the last 10 years?

“Tax harmonisation is not on the agenda, nor will it be.”

Quiz question: who is the author of the recent quote “Tax harmonisation is not on the agenda, nor will it be.”

The answer is the EU internal market Commissioner Charlie McCreevy.

In a speech last week, the Irish commissioner said tax competitiveness was a key ingredient of wealth creation across the EU. The curious thing is that it comes one week after the EU Commission which Commissioner McCreevy is part, released Communication (COM(2005) 532) on The Contribution of Taxation and Customs Policies to the Lisbon Strategy. In that communication the EU Commission clearly stated that it intends to carry out the necessary preparatory work towards a Common Consolidated Tax Base during the next three years in order to present a Community legislative measure by 2008.

Therefore bells start ringing as to whether the comments by the EU internal market Commissioner should be seen as direct criticism of the EU tax Commissioner or whether they are simply a reminder that a proposal like the Common Consolidated Tax Base goes against the interests of a country like Ireland (“the celtic low-tax tiger) and would difficulty be accepted.

It is common opinion that Ireland, with its low corporate tax regime, has long been a key jurisdiction for tax planning of multinational companies (MNE) and part of the recent economic success of Ireland. For example, a very recent and interesting article by Wall Street Journal (Irish Subsidiary Lets Microsoft Slash Taxes in U.S. and Europe) shows the scale of money involved on tax planning. According to the Wall Street Journal's report that Microsoft has a Dublin subsidiary (with few employees) that controlled assets of $16 billion and had gross profits of $8.9 billion last year, mostly related to money made on software licenses sold across Europe. The sums of money involved illustrate the huge value that MNE accrue from intellectual property - and the advantages to those firms of locating these assets in low-tax jurisdictions. When we think big the gains should also be big!

By coincidence, an article on the Economist on its 10 November issue talks about this conundrum of Europe's corporate taxes. The article starts by recalling the advice that Jean-Baptiste Colbert, treasurer to Louis XIV, offered the beleaguered taxman: “pluck the goose so as to get the most feathers with the least hissing. But suppose the goose is housed on one farm, eats the birdseed scattered in a second, and lays its eggs in a third. Which farmer gets the plumage?” In the end, who gets the money?

The EU Taxation and Customs Commissioner believes that the only systematic way to address the underlying tax obstacles which currently exist for companies operating in more than one Member State in the Internal Market is to provide companies with a consolidated corporate tax base for their EU-wide activities. But inside the Commission and outside such view appears to be raising the first problems.

According to Commissioner McCreevy, "to establish a common tax base we will need first to get agreement on what constitutes taxable profits. Assuming we can agree on [this] during our lifetime, we will probably then have completed one third of the journey. The harder bit comes next,". It has also been reported that the Slovak finance minister recently suggested he doubts that the "commission can find even three countries that would agree on the actual common provisions of such a base."

In fact, with the enlargement of the EU to 25 member states, Europe has now more diversity in terms of tax base. Therefore it is expected that, for example, Eastern and Central European countries and jurisdictions like Ireland, Malta and Cyprus will become hard liners when time comes to consider a proposal to consolidate tax bases in Europe. As the Commissioner previews “National vetoes will be retained and competition between member states for inward investment - some of it tax based - will continue”.

The clash between tax harmonization and tax competition appears to be back on the agenda! Perhaps the problem is even wider. As europeans appear to be split on almost every major issue, tax will be one more matter where “Polish plumber” type of arguments will appear. Let’s hope not.

QUOTE OF THE WEEK (Week XVI)

"There are two distinct classes of men... those who pay taxes and those who receive and live upon taxes".
By Thomas Paine (intellectual, scholar, and idealist, is widely recognized as one of the Founding Fathers of the United States)

Previous quotes:
Week I
Week II
Week III
Week IV
Week V
Week VI
Week VII
Week VIII
Week IX
Week X
Week XI
Week XII
Week XIII
Week XIV
Week XV

Standardising transfer pricing documentation requirements in the EU – the soft law approach

After a two-year activity, the EU Joint Transfer Pricing Forum presented the results of its activity and its conclusions on issues related to transfer pricing documentation requirements in the EU. Following the conclusions and in line with other soft law initiatives, the Commission proposed a new Council recommendation to Member States to implement the conclusions of the Forum and to establish a global standardised EU-wide transfer pricing documentation policy.

In fact, the European Commission “Communication on the work of the EU Joint Transfer Pricing Forum on transfer pricing documentation for associated enterprises in the EU” (COM(2005) 543 final), aims at standardising transfer pricing documentation requirements in the EU and thereby substantially reducing business compliance cost and thus strengthening their global competitiveness.

The word Code of Conduct is becoming a cliché on EU taxation policy. We have the famous Code of Conduct for business taxation that requires politely for Member States to refrain from introducing any new harmful tax measures and amend any laws or practices that are considered harmful. We also have the less famous Code of Conduct for the effective implementation of the EU Arbitration Convention. So basically, we have a conduct code when the EU needs to instruct softly the member states to do something it cannot require harshly to do! As the commission always states, such Codes of Conduct are not a legally binding instrument but they nevertheless have clear political force (although I do not know exactly what that means in the EU context!).

So why is the Commission in the case of Transfer Pricing not proposing a proper instrument of Community law? The memo containing the FAQ includes this same question and it is interesting to see how this political juggle works. According to the Commission, “the Code of Conduct is an approach, which has regard to the sovereignty of Member States in the direct tax area”. In addition such instrument provides Member States the “flexibility as to how to implement it into their domestic law”. In fact, according to the Commission previous examples used in the area of direct taxation lead to substantive results. So if soft-law initiatives give results why go through the slow lane of Directives and regulations with all this unanimity limitations and implementation problems? Harmonization through soft-law is the new word.

Now let-me explain a bit of what is proposed by the Commission through my own FAQ.

What is the EU Joint Transfer Pricing Forum (JTPF)?
The Forum established by the Commission in June 2002 consists of one expert from the tax administrations of each Member State plus 10 experts from business. Representatives from applicant countries and the OECD Secretariat attend as observers.

What are the main achievements of the JTPF in this two-year activity?
The main achievements of the JTPF in its first term of activity were its less famous Code of Conduct for the effective implementation of the Arbitration Convention and on mutual agreement procedures under double tax treaties between Member States. The main achievements of the JTPF in its second term of activity relate to the work on standardising EU transfer pricing documentation requirements. According to the Communication, the JTPF will continue its work and will now focus on issues like alternative dispute avoidance and resolution procedures (including Advance Pricing Agreements and prior consultation); interest and penalties relating to transfer pricing adjustments; interaction of the mutual agreement and arbitration procedure with administrative and judicial appeals; and influence of accounting systems on transfer pricing (consequences and possibilities of more harmonized and integrated accounting systems on transfer pricing).

Why deal with EU transfer pricing documentation requirements?
Simple question - simple answer. The examination of EU rules lead to the conclusion that documentation requirements in the EU have increased and that there are significant differences in documentation requirements between Member States. Such differences can be considered an obstacle to the internal market since the place a higher burden on a company in one Member State that wants to set up and/or conduct business with an affiliated company in another Member State.

So what does the Commission is proposing on this field?
The Commission an EU-wide common approach to transfer pricing documentation requirements. The so-called "EU Transfer Pricing Documentation" (EU TPD) includes the following features (i) standardization of the documentation requirements; (ii) the possibility of centralization at group level of the core part of the documentation ("masterfile"); and (iii) the availability to all EU Member States of common standardized transfer pricing information relevant for all EU affiliates of a multinational enterprise ("country-specific documentation"). The novelty of this approach is that all Member States involved would have access to the same common documentation and information in the masterfile element, whereas the country-specific documentation would generally be available only to the specific Member State concerned.

So now what happens to member states that do not have TP documentation or have lax requirements?
Recalling the good and bad side of a soft law instrument, according to the Commission Member State are still free to decide not to impose transfer pricing documentation requirements or decide to impose less detailed documentation requirements. The only issue is that when they have such requirements in place, such rules should be compatible with the new EU TPD approach.

International Tax Treatment of Intellectual Property

The session on International Tax Treatment of Intellectual Property in the 58th Annual Federal Tax Conference of the University of Chicago, discussed the Current Strategies for Sharing IP Income Among the Members of a Multinational Group and the issue of How and When the US Should Tax IP Profits. Amosngst the conference materials made available, the following papers dealing with the IP tax treatment in the US were made available:

1. Gregg D. Lemein, Sharing Intangible Property with a Multinational Group: Facts Versus Theories
2. Paul M. Dau, Current Strategies for Sharing IP Income Among Members of Multinational Groups: Cost Sharing Arrangements
3. Barbara M. Angus, Revisiting the U.S. Taxation of Intangible Property Income of Controlled Foreign Corporations
4. Peter R. Merrill, Comments on Revisiting the Taxation of Intangible Property Income of U.S. Based Multinational Groups
   
   

Closing the loopholes in the EU Savings Directive

Slowly and one by one, the EU Commission is perhaps going to tackle the loopholes of the Savings Directive. At least to try to make this instrument more effective. In a recent a speech, EU tax commissioner, Laszlo Kovacs, said that the European Commission plans to work with financial centres outside of the EU, such Hong Kong and Singapore, to encourage them to adopt measures contained in the Savings Directive. That extension would already curb one clear example where the Directive failed.

But what about other issues like for example the controversy about the definition on beneficial owner, and what is covered and what is not?. As pointed out by several practitioners, for example trustees are not dealt with by the E.U. Directive. In fact, it is not clear why such an important instrument is not considered giving the magnitude of investment income collected and distributed by trusts.

Time Has Come For Dual Income Taxation?

After the release of the US tax reform plan, the paper of Peter Birch Sorensen (from the University of Copenhagen) gained a new momentum. The paper deals with the dual income tax system, which is a system that combines a progressive tax schedule for labour income with a low flat tax rate on capital income and corporate income. We should note tat the Nordic experience has been valuble to understand the advantages of this type of system. The paper restates the case for the dual income tax and discusses alternative methods of taxing business income under such a tax system, paying special attention to the taxation of income from closely held corporations. If you are interested read Dual Income Taxation: Why and How?" (September 2005). CESifo Working Paper Series No. 1551

QUOTE OF THE WEEK (Week XV)

After the presentation of the US Advisory Panel on Federal Tax Reform recommendations, the follwing quote seems adequate!

"The simplification of anything is always sensational."
G. K. Chesterton (English born Gabonese Critic, Essayist, Novelist and Poet, 1874-1936)

Previous quotes:
Week I
Week II
Week III
Week IV
Week V
Week VI
Week VII
Week VIII
Week IX
Week X
Week XI
Week XII
Week XIII
Week XIV

Has the issue of “Tax Treaty Override” been exaggerated?

In its report “Tax Treaty Override”, adopted by the OECD Council on 2 October 1989, the OECD clearly stated that “the tendency in certain States for domestic legislation to be passed or proposed which may override provisions of tax treaties” implies a loosening of the principle “pacta sunt servanda”, in other words, that treaty override is a breach of international law. “Under international law treaties have to be observed by the parties as long as they are valid, and unless they have been formally denounced. Domestic legislation (whether subsequent to signature or otherwise) or other reasons in no way affect the continuing existence of that international obligation.”

As suggestions for action the OECD strongly urged Member countries to avoid any legislation, which would constitute a treaty override. Accordingly, the motive for enacting legislation that overrides treaties can be less strong if all countries agree that they will promptly undertake bilateral or multilateral consultations to address problems connected with treaty provisions, whether arising in their own country or raised by countries with which they have tax treaties. OECD Working Party No. I of the Committee on Fiscal Affairs is an appropriate forum for facilitating such consultation. In that context, in 1989 the OECD Committee stated that it intended to follow developments closely in domestic legislation of Member countries and publicly and forcefully to condemn any action which would constitute a breach of international obligations, including bringing such situations to the attention of the OECD Council (did it?).

This small introduction helps to frame the most recent paper by the distinguished US scholar R. Avi-Yonah on "Tax Treaty Overrides: A Qualified Defense of US Practice"

According to Prof. Avi-Yonah, “the ability of some countries to unilaterally change, or "override," their tax treaties through domestic legislation has frequently been identified as a serious threat to the bilateral tax treaty network. In most countries, treaties (including tax treaties) have a status superior to that of ordinary domestic laws. However, in some countries (primarily the U.S., but also to some extent the U.K. and Australia) treaties can be changed unilaterally by subsequent domestic legislation. This result clearly violates international law. However, since in the same countries courts are likely to follow domestic law even if it violates international law, both taxpayers and the other treaty partner have little practical recourse in the case of a treaty override beyond terminating the treaty, which is an extreme and rarely taken step. Therefore, the OECD in 1989 issued a report urging member countries to refrain from treaty overrides.

The paper of Prof. Avi-Yonah argues that the seriousness of the treaty override issue has been exaggerated. Accordingly, "in practice, most countries, including the U.S. (which was clearly the target of the OECD Report) rarely override treaties, and when they do, in most cases the override can be justified as consistent with the underlying purposes of the relevant treaty. Moreover, treaty overrides can sometimes be an important tool in combating tax treaty abuse. Thus, I believe that if used correctly, treaty overrides can be a helpful feature of the international tax regime, albeit one that should be used sparingly and with caution."

US tax reform - going for CIN instead of CEN?

US tax policy preference has been always for Capital Export Neutrality (*) (e.g. the CFC rules and the foreign tax credit system). Is that changing? Is it now time for the US to adopt a more Capital Import Neutrality approach and what are the effects that such a change may have in the tax systems of other countries?

Why do I ask this questions? Basically, because the Advisory Panel on Federal Tax Reform recommendations released on 1 November, 2005 which may impact significantly on the U.S. international tax rules, as we (some like me think they do) know them.

You may recall, that President George W. Bush created the President’s Advisory Panel on Federal Tax Reform in January 2005. The President instructed the Panel to recommend options that would make the tax code simpler, fairer, and more conducive to economic growth. Since then, the Panel has analysed the current federal income tax system and considered a number of proposals to reform it. After 12 public meetings in five states and Washington D.C., the Panel reached consensus to recommend two tax reform plans. The Panel’s recommended plans, labelled the Simplified Income Tax Plan and the Growth and Investment Tax Plan (which I plan to tackle later because it is very inovative and I need some time to mature the ideas).

The two plans differ in the taxation of businesses and capital income. The President directed the Panel to submit at least one option using the current US income tax system as a starting point for reform. The Panel developed the Simplified Income Tax Plan to meet this objective. The Simplified Income Tax Plan would simplify the process of filing taxes and consolidate and streamline a number of major features of our current code – exemptions, deductions, and credits – that are subject to different definitions, limits, and eligibility rules. This changes also impact US international tax rules.

With regards to the international issues, three options were (form the outset) under discussion for US international outbound tax reform. The first option involves the modernization of the current regime, which could include not only a modernization of Subpart F rules but also a liberalization of foreign tax credit rules and the closing of planning opportunities (e.g. check-the-box rules). The second option would involve repealing deferral, simplifying the foreign tax credit rules and making allocation rules easier to deal with. The third option would be based on a territorial taxation system, by limiting the tax system to US source income, but retaining current tax on passive type income and eliminating the foreign tax credits (except for passive type income). This last option appears to be the chosen one by the President’s Advisory Panel.

Accordingly, the Simplified Income Tax Plan would update the US international tax regime by adopting a system that is common to many industrial countries (e.g. France and the Netherlands), a “territorial” tax system that exempts some (or all) of business earnings generated by foreign operations from home country taxation. The Simplified Income Tax Plan would adopt a straightforward territorial method for taxing active foreign income. Active business income earned abroad in foreign affiliates (branches and controlled foreign subsidiaries) would be taxed on a territorial basis.

The Simplified Income Tax Plan also would modify the definition of business subject to U.S. tax to ensure businesses that enjoy the benefit of doing business in the U.S. pay their fair share (residency rule). Under current law, residency is based on the place a business entity is organized (incorporation principle). To prevent this tax-motivated ploy, the Simplified Income Tax Plan would provide a comprehensive rule that treats a business as a resident of the U.S. (and subject to U.S. tax) if the United States is the business’s place of legal residency or if the United States is the business’s place of “primary management and control.” The new two-pronged residency test would ensure that businesses whose day-to-day operations are managed in the United States cannot avoid taxes simply by receiving mail and holding a few board meetings each year at an island resort.

Check out the complete report!
Chapter One - Four
Chapter Five - Six
Chapter Seven - Nine
Appendix
(For international issues see e.g. pages 281-287 and 314 -317)

(*) The credit method in its pure form, or full credit, is based on the principle of Capital Export Neutrality (CEN). This principle aims to achieve equal tax treatment for foreign and domestic income. The exemption method in its pure form, or full exemption, implements the principle of Capital Import Neutrality (CIN). This principle aims to achieve equal fiscal treatment of income received by domestic and foreign investors.