Concern over the slow economic recovery in the European Union has meant that tax policy in European Member States has increasingly been used as an instrument to help promote economic growth. Member States have historically had the right to set their own fiscal policies and many have used these to attract investment from particular industries or permit particular operations by companies in the hope to gain a larger share of global business. This has resulted in increased competition between countries not only in the way they set corporate tax rates but also in how they use tax incentives. However some domestic rules are now under the spotlight, as the European Commission starts to investigate certain regimes deemed unfair by their critics.
The latest round of European Commission queries have concerned IP box regimes, but this is now widening in scope to include tax rulings between a Member State’s tax authority and relevant companies as the Directorate General for Competition plays an increasing role in the investigations.
Whilst the main elements of European fiscal policy fall within the remit of the European Commission’s Directorate General on Taxation and Customs (DG TAXUD), other DGs like DG Competition (DG COMP) with its state aid investigations and DG Economic and Financial Affairs (DG ECFIN) with its yearly countryspecific recommendations, also play key roles. In recent years, mostly due to the historic sluggishness of tax files, DG Competition has flexed its muscles and focused more on tax policy and how this might be distorting the market.
But why this DG and not DG TAXUD? The European Commission, especially during Mario Monti’s tenure as Competition Commissioner, found that it could use the stronger investigative powers of competition rules under the umbrella of state aid than the weaker and slower decision-making process of DG TAXUD, whose room to manoeuvre can often be stymied by a single Member State since EU decisions on tax require unanimity in Council. As a consequence of DG COMP’s increased role in the policy debate, the European Commission has become a much stronger force to reckon with when facing down national governments and this has been noticeable during Competition Commissioner Almunia’s tenure.
Code of Conduct Group
There are many channels through which Member States currently discuss tax issues. In Council, Ministers negotiate amendments to existing rules, such as on the Parent-Subsidiary Directive or the Savings Tax Directive. Ministers also negotiate on rules with new approaches to implementation, such as on the proposed Financial Transaction Tax under the enhanced cooperation procedure which gives the ability of a group of Member States to continue with the legislative process as long as it does not encroach on the liberty of the others. Other platforms, which enjoy a stronger influence, examine whether rules already adopted are effective or are out-of-date. The Code of Conduct Group is one such interface.
This group comprises, Member States, representatives from the European Commission and the OECD who discuss and analyse amongst themselves individual Member States’ tax regimes. These confidential meetings take place 6 to 8 times a year and seek to address tax issues deemed to be politically sensitive. As decisions are made according to broad consensus, some countries can feel targeted. Although the Code of Conduct Group does not have any executive powers, the mere raising of a Member State’s ‘problematic’ regime could lead to rule changes. The mere existence of tax breaks such as the IP box can lead to important differences in profits for multinational corporations, and in turn, important tax
receipts for governments.
Incentives for Innovation
Regimes that are currently under scrutiny and discussion among Member States and the Commission are the IP box regimes which over a third of Member States (Belgium, Netherlands, Ireland, UK, Luxembourg, France, Hungary, Spain, Cyprus) have in place and of which the UK Patent Box is one of the recent joiners. The regimes deliver tax incentives to corporations that receive an income stream from innovations and patents. Whilst the regimes are legal, there is a risk that the tax base moves without activities moving – critics of the regimes maintain this could be harmful and is something that could be deemed illegal or at least challenged.
The IP box has been the subject of the latest round of naming and shaming in Code of Conduct Group meetings. The most contentious result of this tax break is a concern that corporations are more likely to shift their activities to Member States that offer such a regime, to the detriment of countries that do not, although such decisions are rarely driven by one such measure or even tax in isolation. Consequently, many of the EU Member States that do not enjoy such a regime, notably Germany and Denmark, somewhat supported by Austria and France consider the aggressive regimes harmful to their own competitiveness. Currently active supporters of the regimes include the UK, the Netherlands, Luxembourg, Belgium, Cyprus and Spain.
The political stakes are high in European tax discussions but there is likely to be greater clarity on the perspectives for IP box regimes by the end of the year. Not only have IP boxes already been discussed at Finance Minister level in EcoFin meetings, but Member States have agreed to assess all national regimes and reach agreement on potential modifications by the end of 2014. The pressures such discussions can exert on an individual Member State are considerable, since the Code of Conduct Group agrees according to broad consensus. The group dynamics can bring pressure to bear on an individual Member State to conform which can be difficult to resist. Even without a formal decision being taken, discussions can have a lasting impact. If one regime is singled out, jurisdictions risk losing attractiveness for businesses and could miss out on crucial tax receipts. This simple fact has been picked up by the Commission as an effective method to apply indirect power by threatening the investment climate of a Member State by creating a sense of regulatory uncertainty.
There is also discussion within the OECD on how best to deal with IP boxes as part of the Base Erosion and Profit Shifting programme (‘BEPS’). The OECD has defined the transfer pricing method and the NEXUS method as two potential mechanisms to deal with this.
Nexus vs Transfer Pricing
EU and OECD work streams have tried to move away from the political sensitivities and focused on technical aspects – such as how to define what income can be brought into a regime. One clear objective is to assess the relative merits of the transfer pricing method which connects income with associated risks and functions from the NEXUS method which has a force of attraction to the underlying development of the IP. This second issue is particularly sensitive for some, who have argued the method goes against the EU treaties which provide for freedom of movement and capital. For companies in smaller Member States this is problematic, as they would need to outsource more than those in larger Member States. Thus, more costs could fall outside the scope of the IP box. The European Council has made this issue a priority, aiming to tackle it before summer 2014. This could explain why the Code of Conduct Group has focused on EU-wide regimes (as IP boxes largely exist in the EU) and has not targeted specific regimes. Although the NEXUS method is not favoured by those Member States which have an IP box, it is supported by the majority of Member States.
Is the regime a political scapegoat?
As regimes differ widely in the Member States that have them, some have been singled out more than others, adding fuel to fire in discussions. The United Kingdom for example, has staunchly defended its newly-implemented regime (April 2013) claiming it does not infringe EU state aid rules. A recent report by the European Patent Office published in September 2013 endorses the value of the regimes, noting that they can, in some instances, promote Research and Development activity. The importance of stimulating the sector is clear, the report continues, as industries that are intensive in intellectual property rights pay significantly higher wages and are responsible for almost 14% of EU GDP. This is well known by national governments, and explains why IP box regimes are considered effective in attracting business.
The tax debate in the EU is shifting and businesses need to be conscious of domestic and EU bodies who will have influence. Whereas it was previously seen as negative to set a low corporation tax rate, the majority of OECD countries today have opted for that to be more competitive. Whilst tax competition is viewed as healthy, a regime that would enable artificial profit diversion would not. As the European Union institutions grapple with the results of the European elections, the need to find simple and well-designed policy solutions that can stimulate economic growth are at the top of the agenda. Many see IP regimes as doing just that, nurturing the knowledge economy in a post-crisis era. A priority for governments today is to ensure that these regimes are simple, are linked to substance, and respect the wider developments in tax policy as it evolves. Beyond that, industry needs clarity and longevity in any regime so that investment decisions can be taken with confidence.
Richard Turner, Louise Harvey and Luc Cade 3 June 2014
This article has been reproduced with permission from Richard Turner who is Managing Director, Tax & Innovation at FTI’s London based European Tax Advisory Team. Richard can be contacted via his email: richard.turner @ fticonsulting.com