Monday, April 18, 2005

Taxing times

Apr 8th 2005

From The Economist Global Agenda

A court ruling is likely to favour Marks & Spencer, a retailer, in its case against the British government over cross-border taxation. This could cost European exchequers dear. But harmonisation across Europe remains a distant dream for those favouring a common corporate income tax

JEAN-BAPTISTE COLBERT, Louis XIV’s treasurer, advised that “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” The sound of hissing coming from Marks & Spencer (M&S) may soon resonate all over the European Union (EU). In February, the British retailer appeared before the European Court of Justice in Luxembourg in an attempt to overturn a ruling by Britain’s Inland Revenue that the firm could not offset past losses at its French, German and Belgian subsidiaries against its British tax bill. The ruling, said M&S, unfairly penalises overseas investment. On Thursday April 7th, Miguel Poiares Maduro, an advocate-general at the European Court whose opinion the court generally follows, agreed with the company, saying that banning consolidation of taxes across the EU was incompatible with Union law.

M&S stands to recoup over £30m ($56m) if it wins the case. But Britain’s government may have to pay over £1 billion to reimburse some 60 multinationals that have brought a class-action case for similar recompense. And other firms are sure to follow, possibly bringing the final total to several billion pounds. Governments in other EU countries fear that they too may end up having to make massive reimbursements. Since several of them are already running large fiscal deficits, the timing could hardly be worse.

This case pits one gaggle of heavweights against another. The European Commission is behind M&S. Denmark, Belgium, Austria and Italy already have rules that allow this sort of consolidation of profits. But Germany, the Netherlands, Greece, Finland, Sweden and Ireland are all backing the British tax authorities, as is France (even though it allows the biggest companies to claim tax relief on cross-border losses). Germany has complained of “major budgetary difficulties” if the measure is enforced—by one estimate it may have to pay out €30 billion ($38 billion).

If M&S wins, it would be a boost for the European Commission’s goal of unifying tax treatment across the EU. So far, it has met with mixed results, though a measure of concord has been achieved through the courts or the threat of legal action. In a number of cases, national tax regimes have been judged to transgress rules set up to encourage the workings of the Union's internal market. Sometimes this has meant bringing laws for local firms into line with those applied to multinationals. Last year, for instance, Britain introduced legislation to pre-empt an adverse ruling on its laws governing transfer pricing, “transactions” between a parent company and a subsidiary that have beneficial tax effects. Britain tightened the law so that the same rules applied to deals within Britain and across borders.

Court action may well force the pace of further harmonisation. Some, including the commission, particularly want to see a convergence of corporate income-tax rates across the EU, arguing that the maintenance of a variety of differing tax regimes is bad for business. But the prospect of a single rate of corporate tax, from Paris to Prague, remains a distant one.

France and Germany, the EU's core, both support harmonisation of corporate income-tax rates. In 2004, they launched an initiative designed to lead to the setting of minimum corporate-tax rates. All well and good, except that these countries want to maintain their own high rates and want other countries to charge the same.

The pair is particularly displeased with Ireland and the new EU members from central Europe, which have low rates of corporate income tax. For example, Poland and Slovakia both recently reduced their rates to 19% and Hungary charges just 16%. Germany fears that “harmful” tax competition will induce many more of its companies to move operations eastward. This, and a more general appetite to stimulate its lacklustre economy, pushed Germany’s chancellor, Gerhard Schröder, to propose reducing corporate income tax last month, from 38.3% to 32.7%. France charges 34.3%.

But should fans of harmonisation worry about tax competition? Central Europe is attractive to businesses as much for its low wages as its meagre taxes. And plenty of other issues inform relocation decisions. Infrastructure and access to a suitable labour force may also deter or encourage a shift. In any case, Germany’s effective corporate income-tax rates are nearer those of its eastern neighbours when loopholes, special concessions and the like are taken into account.

For many EU countries, new and old, the ability to set tax rates is not yet to be negotiated away. Britain is loth to concede further powers of this sort to Brussels, and Slovakia and the other new members from the east are just as adamant. So long as a unanimous decision is required from Europe’s leaders to harmonise tax rates (whether low or high), any move in that direction is bound to fail.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

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