Casting our minds back to the era of the last major pandemic, the so-called Spanish flu pandemic of 1918, we notice how different this time was from the one in which we live today. Capitalism has taken a firm stranglehold on our increasingly globalised society and this has changed the way in which business is conducted, as well as the way entities and individuals alike pay their taxes.
Back in the earlier decades of the 20th century, multinational groups carried out their business based on a country-specific model, whereby each legal entity of the group conducted a broad spectrum of functions in its jurisdiction. In today's world, such traditional models have given in to completely different business structures, with multinational groups acting as one single entity worldwide. This entails extremely high specialisation, functional fragmentation and, in the end, increased complications as the overall business activity is spread over a unique “globalised tax value chain”, covering several jurisdictions.
The issue is clearly portrayed in the foreword of the Council of the European Union’s 2011 directive, which states:
“There is a tremendous development of the mobility of taxpayers, of the number of cross-border transactions and of the internationalisation of financial instruments, which makes it difficult for Member States to assess taxes due properly. This increasing difficulty affects the functioning of taxation systems and entails double taxation, which itself incites tax fraud and tax evasion, while the powers of controls remain at national level. It thus jeopardises the functioning of the internal market.”
In the face of such clear roadblocks to a just society, we must ask ourselves, are current European domestic tax systems effective and up-to-date enough to keep the pace? How might countries deal with those globalised arrangements and ensure efficient taxation?
Multinational organisations such as the OECD and the G20 have spent the last four decades trying to detect loopholes and breaches in international tax systems, and to engineer effective tools aimed at tackling international tax avoidance and promoting transparency between jurisdictions.
The law today
The EU itself has released several directives on administrative co-operation, such as the DAC, amending the original 2011 directive. Several new measures have also been introduced, such as the country by country reporting (CbCR) and the automatic exchange of information related to unilateral rulings. EU anti-avoidance directives (ATAD), originating from the OECD “Base Erosion and Profit Shifting” (BEPS) project, also provide a common framework aimed at tacking cross-border tax avoidance, particularly addressing specific topics such as interest deduction, exit and entry tax, controlled foreign companies and hybrid mismatches.
Nowadays the debate on these topics has increased, embracing hot topics such as the digital economy, minimum taxation on multinational companies and the ever-present need for enhanced administrative cooperation.
When it comes to answering the above questions, you may notice that all the measures in place are ultimately founded on two main pillars. The first pillar relates to promoting and strengthening international co-operation and transparency. This includes exchanging relevant data among jurisdictions and encouraging mutual confrontations between tax authorities. The second pillar, in the wake of a more comprehensive approach shared by the OECD, is all about pushing the use of “traditional” tools to pursue a fair tax allocation among jurisdictions. Such tools include transfer pricing and the “arm’s length principle”; the definition of permanent establishment; and tax treaties to avoid double taxation.
Both pillars have displayed their inefficiencies in recent years. For example, mutual agreement procedures, which involve direct consultations between tax authorities of different countries to reach an agreement that avoids double taxation, are usually adopted to resolve controversies on transfer pricing, particularly the EU arbitration convention (EUAC).
Mutual agreement procedures (MAPs) are also activated to rule on permanent establishment identification and taxation, along with the interpretation of the tax treaties. The main problem is timing: MAPs usually take 2-3 years or more before proposing a solution – which in many cases does not solve the double taxation issue at a group level. During this time, the taxpayer cannot join the discussion.
Tax treaties are numerous and, in many cases, obsolete. The OECD has developed a dedicated tool (MLI) – to which the USA did not adhere – aimed at aligning and updating very particular aspects of bilateral treaties, such as permanent establishments and treaty abuse. Moreover, countries are free to decide which amendment to endorse or refuse through a flexible “option” or “veto” regime, resulting in misalignments among tax treaties.
Focusing our collective attention on transfer pricing and other tools, we see that they often turn out to be complicated when it comes to allocating a globally-generated profit among several jurisdictions based on the timeworn “arm’s length principle”. Moreover, carrying out dedicated analyses on relevant “comparable transactions”, which sometimes cannot even be reliably identified, may result in very serious administrative and compliance burdens for the taxpayer. On top of this, as transfer pricing is ultimately based on valuations, it is usually a matter of discussion with tax authorities, leading to increased litigation.
These complexities are highlighted when dealing with the digital economy, whereby conventional transfer pricing analyses based on “third-party comparables” needs to be rethought. In such cases, it is also harder to identify and tax a foreign (digital) company’s permanent establishment based on ordinary landmarks.
In order to try and overcome these failings, reduce uncertainty and ensure clarity when allocating profit among different jurisdictions, EU experts have been working on an ambitious, radical solution for two decades: a Common Consolidated Corporate Tax Base (CCCTB).
The EU’s CCCTB: the law tomorrow?
The crux of the idea is that multinational groups would determine a unique taxable basis for their operations in the EU based on a single tax system, rather than complying with various European tax codes. This consolidated taxable basis would be attributed to different EU jurisdictions based on a lean apportionment formula and considering simple allocation factors such as labour, capital and sales attributable to the group members. Each Member State would tax its share based on its domestic tax rates. Moreover, as it operates on a “consolidated” basis, tax losses posted in a jurisdiction might be offset against taxable income generated elsewhere in the EU.
The supposed advantages of the CCCTB are evident: counteracting tax avoidance by overcoming mismatches between domestic tax systems within the EU; tackling loopholes and elusive tax planning by large multinational groups.
The perks don’t stop there. The CCCTB would reduce uncertainty and compliance burdens for multinational groups, which would deal with a single and defined corporate tax system in the EU. In addition, formalities would be simplified as the group may file its tax declarations with a single tax administration. This is particularly relevant when considering that strategic corporate decisions, also impacting the group layout, are often heavily influenced by considerations on tax system efficiencies and reputation. Reducing compliance costs, unpredictable challenges and long-lasting litigation is an increasingly crucial factor when structuring the group value chain.
As a consequence, a more favourable legal environment would likely foster investments and growth within the EU.
A pipe dream or a genuine possibility?
A bit of a fairy-tale so far and, in reality, this initiative has experienced so many issues since it first appeared that many argue it may never come to fruition.
As a matter of fact, preliminary discussion on the CCCTB took place in the early 2000s and the Commission first proposed it in 2011 but it was almost immediately stopped as no agreement could be reached by the Member States at the time. A new version was proposed again in October 2016, based on a more gradual approach to facilitate negotiations. It was agreed to focus on determining a common corporate tax base (CCTB) first and introduce a consolidation mechanism (CCCTB) afterwards. In addition, the CCCTB would be mandatory for large multinational groups only – those with turnover exceeding €750 million – as they have often engaged in aggressive tax planning. In the newly reformed version, CCCTB also allowed a robust deduction connected to research and development expenditures.
But, where do we stand now?
Although CCCTB proposals have never made it to the next level, discussions on a consolidated tax base for multinational groups have not ceased in recent years. On May 18th, 2021 EU Commissioners Gentiloni and Dombrovskis presented the new action plan to be adopted by 2023, which includes a renewed discussion on a unique EU corporate tax framework, named “Business in Europe: Framework for Income Taxation” (BEFIT).
Political pushback preventing progress
Unfortunately, no substantial progress has been made, mainly due to political pushback from EU Member States. It is no secret that some EU countries – Ireland, Luxembourg, the Netherlands, Hungary, Malta and Cyprus – have focused their tax policies on attracting multinational corporations with low tax rates, favourable unilateral rulings and high tolerance for aggressive schemes. No wonder these countries, considered true EU tax havens, have always fiercely blocked any tax reform proposal which could threaten their competitive advantage, which is, let’s remember, founded on the lack of harmonisation among EU domestic tax systems. This unfair competition has caused a massive revenue loss at EU level, estimated at approximately €240 billion per year.
There are further political obstacles to tax harmonisation within the EU. Unlike the US, where similar tax reforms based on consolidated taxable basis and formulary apportionment have been put in place, today’s EU does not even remotely resemble a federal republic, looking more like a loose ensemble of countries, often nostalgically tied to bygone glory. This comes out quite clearly any time these states strive – with little or no success – to converge on relevant matters from sovereign debt, foreign policy and immigration, to fishing, olive oil labelling and football’s European Super League. Not surprisingly, most of these countries are reluctant to give up their sovereignty on delicate issues such as taxation. The “no taxation without representation” principle is very much alive and kicking.
There is much more at stake here than a “transfer of competencies”, as was the case during the fallout from the 2008 financial crisis. Robust action to empower the political framework is indispensable. This constitutes a crucial element in establishing effective EU tax harmonisation reforms. Without this prerequisite, there would be room for short-range, unilateral, domestic reforms only, ultimately increasing discrepancies, misalignment and uncertainty within the EU tax system.
Considering the extent and intricacy of these constraints, some enlightened EU politicians have come around to the idea of solving the issue at the root. This would mean no longer seeking an implausible agreement within the four walls of the EU, instead bringing the discussion to a higher level, involving the G20 and even the majority of OECD members. This could potentially be facilitated by leveraging the precious support of the US, as President Biden is proposing a tax reform that includes a global tax for multinational companies with a 21% minimum tax rate, eventually reduced to 15%. At first glance, this proposal has been favourably received here in Europe and there are encouraging signs that negotiations on this could move forward during the next G20 meeting, scheduled in Venice in July 2021.
Should this be the case, then we could all witness a more concrete opportunity to finally start overcoming domestic resistances from EU tax havens, as well as multinational groups that, after all, would happily continue paying no taxes on a €44 billion turnover in Luxembourg.
One hundred years on from the Spanish flu and, once again caught in the midst of a global pandemic, we continue to wait for our much-lauded EU to be the global leader it so desperately wants to be. As we move into the post-Covid, world the CCCTB may be the first step in suring up the tax system.