Harmonising competing corporate taxes has created a passionate debate between ‘old’ and ‘new’ Europe. Where does Malta stand?
Pressure is mounting on the accession countries to tow the line with EU directives on harmonisation of their tax codes.
EU tax commissioner Laszlo Kovacs announced last year that the Barroso commission will step up efforts to set up a law harmonising corporate tax bases, setting 2008 as a target date for the legislation.
Three of the states rejecting Mr Kovacs's scheme, Estonia, Lithuania and Slovakia, have been leading the way in offering companies far lower corporate tax rates than in the Western part of Europe.
For a start, Estonia and Slovakia run effective tax rates of around 17 percent, while the effective rate in Lithuania is the lowest in the EU at around 13 percent.
Effective company tax rates in the "old" EU member states lie at an average of 28 percent. Sceptics on the other hand have pointed out that a single EU corporate tax base will hamper competition between states on tax levels as there will be no real corporate tax differences.
To counter this point, Commissioner Kovacs has frequently tried to reassure the five mistrustful states, saying in a recent speech "Let me be clear: the purpose of the commission is to harmonise only the corporate tax base. Tax rates should remain in the competence of the Member States".
Company tax base harmonisation is backed by business organisations like the European employers' organisation, UNICE, which says one set of rules across the EU will make life easier for companies operating across the bloc. So is this a race to the bottom?
Hardly so since many contend that tax harmonisation is a double edged sword. How does Malta fare in this tug of war? Is it in favour of tax harmonisation? Certainly we resist it boldly albeit since accession contrary to other members we did not embark on lowering our corporate taxes. The issue of harmonisation of corporate taxation last year sparked a passionate war of words between "old" and "new" member states.
The ideal world would envisage firms operating across borders to be able to file tax returns based on a single system to save the cost of complying with different national regimes. In theory, a common tax base would allow a company to offset losses in one member state against profits made in another - a principle the European Court of Justice backed last year in a case brought by British retailer Marks & Spencer. Typically, the recently decided case was brought by Marks & Spencer against the UK government and focussed on the losses incurred by Marks & Spencer's foreign operations and whether they could be written off against tax. Currently UK tax law allows a company and its UK based subsidiaries to write off losses against tax. However Marks & Spencer wanted to be allowed to write off losses in other member states against UK tax.
Despite the fact that the EU has no jurisdiction over member states' taxation law the court found that: "Member States must none the less exercise that competence consistently with Community law." If the harmonisation policy was enforced by Brussels then this case would have been lost.
The court sidestepped its inability to intervene in taxation policy by ruling that the UK policy was discriminatory and interfered with the EU's freedom of establishment for businesses. Harmonisation or a one tax code fits all runs contrary to the freedom of establishment.
Undoubtedly, it argued that restricting such a tax advantage to subsidiaries based in a home country, "is of such a kind as to hinder the exercise by that parent company of its freedom of establishment by deterring it from setting up subsidiaries in other Member States." Regrettably, the decision has been widely seen as a sign that the EU, and in particular the Commission and the ECJ, are now openly pushing for greater tax harmonisation to prevent tax leakages. As a result of the judgement large corporations will have a new tax-avoidance loophole, potentially costing national finance ministries throughout the EU billions. The Marks & Spencer ruling alone will force the British Exchequer to repay around £30 million in back taxes .But this ruling on its own should not trigger a fast lane for imposing tax harmonisation.
A lot has been discussed among larger high tax jurisdictions about unfair tax competition and the challenges presented by the competitive tax policies of the new states. Last year a number of proposals were tabled by the French, German and Swedish governments to call for an EU minimum company tax standard.
In their view they contend that direct investment will migrate away from their turf. The real challenge is dawning on them that the ex-communist countries are proving successful in their strategy to entice companies to shift production.
The French finance minister even suggested that cohesion funds should be slashed if accession countries did not raise their taxes. This is very strange since the proposal goes against the principle of solidarity.
How can you encourage new states to join and offer them generous funds to help them reach the EU average GDP levels and simultaneously force them to raise taxes? The solution came out recently when the so called "old" member states have followed the new member states' example by themselves cutting their company tax rates. Will Malta follow suit, one may ask. The reform promised by Dr Gonzi in the budget speech is eagerly awaited, as hopefully the task force concludes its recommendations next month.
The air of expectancy is palpable and financial commentators expect tangible moves and not just cosmetic tinkering of the tax free bands.
Rumours are rife that the existing high labour taxes will be scaled down to encourage and give some breathing space for small enterprises and that banks will be encouraged to invest more in attracting international business linked to financial services.
Naturally more VAT exemptions need to be announced for start-ups and a wider band of small traders to be relieved of bureaucracy by being zero rated. GRTU expects food consumed in hotel registered eateries be charged at the lower 5 % rate. This and other fiscal measures will help control underlying inflation that is permeating itself in the cost of the travel package. The competition minister is fully conscious that we are losing our shirt in the tourism sector as evidenced in recent reports by MHRA.
Actions are therefore expected ahead of onset of the peak tourist season.
It is now more than two years that we introduced a 20% in additional VAT levied over a wider net of products and services. Currently our VAT exceeds the rate of the UK. Paradoxically seven old EU member states decided to reduce rates, with Austria frequently advertising one full-page ad in "The Economist" that its preferential rates are most attractive to manufacturers.
Last week it was reported in the media that Malta experienced the highest tax burden increase in the EU. According to Eurostat, the EU's statistical arm, Malta registered the highest increase in the overall tax burden among the 25 EU member states between 1995 and 2004 - 7.6 per cent of GDP.
This mainly results from an increase in VAT receipts resulting from a decrease in the range of goods exempted or taxed at lower rates coupled with marginal increases in personal income tax. Short term property gains are now being taxed at a higher rate. Taxes on departures by air have also been doubled.
So the Eurostat report confirms the unpalatable truth that there is ample scope for revisiting the entire tax code book since we seem to have chosen to buck the trend of accession countries in their drive to lower taxation. In general our incentive tax legislation has been scaled down amidst fears of infringing state aid. In general, we note that tax bases refer to rules on what share of businesses' profits are taxed, taking special tax breaks and exemptions into account.
It is not surprising that, Malta, UK, Ireland, Estonia, Lithuania and Slovakia are fundamentally opposed to the harmonisation of tax bases, fearing that the next step for Brussels will be interference in the levels of their corporate taxes as well. As stated earlier, some states fear it will lead to harmonised corporate tax rates.
We must strive to revise our tax code and while resisting tax harmonisation, it pays us to start on a fresh note to rekindle the right environment to attract more tourists and improve our chances in luring quality inward investment.