EU plans to battle corporate tax avoidance unlikely to succeed

EU plans to battle corporate tax avoidance unlikely to succeed

The EU crackdown on tax avoidance is a step in the right direction. But it is unlikely to prove effective and its implementation will be made difficult by the lack of international cooperation.

Corporations have to pay their fair share of taxes at a time when European states battle to reduce their debt burdens under the Commission’s supervision. This assumption is at the basis of the EU executive’s plan to fight tax avoidance by multinational companies.

This sentiment was exacerbated following the Luxleaks scandal involving the head of the Commission, Jean-Claude Juncker, who was the prime and finance minister of Luxembourg at the time when PepsiCo and IKEA lowered their tax rates to as little as 1% in secret pacts with tax authorities in the country.

Since Juncker’s credibility has been challenged by this affair in late 2014, EU officials have gotten their nose into such “sweet-heart” deals passed between corporations and member states (see chart below). The Commission is currently investigating 300 of these deals — including the most recent one between British authorities and Google — and hopes to limit the discrepancy between member states that some use to their advantage.

Source: The Economist

Differentiated rules in a single market

In addition to the investigated “sweet-heart deals”, the issue highlights one of the recurring flaws of the European Single Market: a lack of common regulation leading to unfair competition. In fact, member states have been competing to attract businesses, including by using taxes as an incentive. This partly explains — along with the benefit of operating in an English-speaking country — the high-tech boom in Ireland, where corporate tax level is among the lowest in the bloc.

Source: KPMG

Thereby, multinationals have been able to exploit these disparities. The real problem, according to EU officials, is that companies have gone further, by avoiding paying taxes anywhere through well-thought out structures that enable them to shift profits from country to country. Using subsidiaries in notorious fiscal havens is also thought to cost tax authorities part of their annual revenue.

As a result, estimates show corporate tax dodging costs the bloc up to €70 billion (about $76 billion) every year, and the European Commission estimates multinationals in Europe pay as much as 30 percent less in taxes than their domestic rivals.

Falling short of ambitious measures

With this assessment established, the Commission has announced a new anti-tax avoidance plan which includes legally-binding measures to block the most common methods used by companies such as profit shifting to a low/no tax country, double non-taxation of certain income, avoiding tax when re-locating assets, artificial debt arrangements designed to minimise taxes, or exploiting of national mismatches to avoid taxation. The EU executive proposed Member States to share tax-related information on multinationals operating in the EU (see infographic below) and a new EU process for listing third countries that refuse to play fair.

Source: European Commission

The plan is a step, but it remains likely that international groups will find new loopholes in the legislation. A plan to make companies publicly report their tax contribution country-by-country — which was intended to put multinationals under public scrutiny — was pushed back to the conclusions of an impact assessment that will have to prove it wouldn’t undermine competitiveness.

This step back shows the Commission did not go full speed on its tax avoidance scheme in order to ensure that all member states would be on board — the bill requires unanimity.

The risks of an assertive approach

But even these watered down rules carry a risk of leading to a race to the bottom on corporate taxation, with countries dropping their incentives while lowering the corporate tax rate, a pledge already made by Luxembourg . This would in turn put poorer member states under stress, with less revenue to pay for public services and increasing public deficits.

Both the scheme and EU investigation into Google’s deal with the UK tax authority could also play a role in the public debate ahead of the referendum on EU membership if Brussels shows over-zealousness. Thus it is likely that European officials will wait until the result of the referendum before they rule on the case.

The EU tax avoidance fight has also revived tensions between the continental bloc and the US, as it adds up to internet privacy — a deal was reached on February 2 on a new scheme to transfer data across the Atlantic — and an antitrust inquiry into the alleged dominance of Google. US officials have raised critics on the EU’s discriminatory actions against American companies.

However, this opposition reflects two main patterns. First, US leaders feel that they should show toughness as a response to the EU’s measures with approaching presidential elections. Secondly, they have failed to adequately tax these companies themselves, and this broken tax code is an important theme in the political debate.

For instance, some Republican candidates want to deter merger transactions known as inversions, which US companies are using to cut their American tax bills by relocating to some EU countries (including Ireland and the UK). Considering this level of contention, the long-delayed agreement on the TTIP — a free trade agreement across the Atlantic that would boost economic activity on both sides — remains far-fetched in the short to mid-term.

Need for international cooperation

It also makes negotiations on an international scheme for corporate taxation unlikely to advance in the short run, regardless of the fact that an international effort is the most likely to succeed.

The think-thank International Fiscal Studies recently said the international tax system is broken and governments should work out a new strategy that would accommodate multinationals that are currently escaping paying taxes in some countries.

But current affairs suggest that despite the OECD’s efforts in this field, countries are not ready to agree on an ambitious and efficient system.

Categories: Europe, Finance

About Author

Julien Freund

Julien is an analyst with a focus on Europe. He has worked as a lobbyist in Paris and Brussels and has written extensively on the rise of nationalist parties. He holds two master's degrees in geopolitics and international relations and in European relations, and received his BA in economics and social sciences from the Catholic Institute of Paris.