Midweek Money: Taxing time for Europe

It is not often that tax policies of other countries form the lead story in the UK media. But a sense of proportion needs to be brought to the furore over EU tax harmonisation that has dominated the run-up to this weekend's introduction of the euro.

First of all, what does harmonisation mean? People seem to assume that equalising the corporate tax rates means companies would pay the same tax in each state. This is a gross oversimplification, as the tax bases - the underlying system of calculating the profits on which companies pay their tax - would remain very different in each country.

To date there has been minimal progress in harmonising the direct tax systems of the EU's member states. In the early Nineties, the European Commission brought forward a number of directives designed to facilitate the operation of the single market and reduce double taxation - that is where companies end up paying tax twice on the same profits. Just two of these proposed directives were approved - the parent/subsidiary directive that reduces taxation on dividends, and the mergers directive which facilitates cross- border reorganisations, disposals and acquisitions. Other proposals for directives were dropped as it was not possible to reach agreement between all the member states.

More recently, as member states focus on protecting their tax revenues, the Commission has found a more receptive audience to its exhortations to co-ordinate tax policy. France and Germany, in particular, have been concerned to prevent companies establishing themselves in tax havens and reducing the tax payable at home. EU Tax Commissioner Mario Monti - who has taken a much more cautious approach to the whole subject than the German and French governments - has said: "If you create a tax haven for a few people, you condemn the rest to a tax hell." As a result, in December 1997 EU Finance Ministers reached an agreement on a package of measures intended to combat harmful tax competition between member states.

The package consisted of these three elements:

A code of conduct for business taxation.

A proposal for a directive on interest and royalties.

A proposal for a directive on the taxation of interest income from savings - the savings directive.

The first, the code of conduct is perhaps the most interesting element of the package: it is designed to prevent "harmful tax competition" within the EU by encouraging member states to withdraw special tax regimes. These aim to attract businesses that are internationally mobile without affecting the general rate of business tax in the country. For example, in a country with a headline rate of tax of 40 per cent, a regime that offered a 10 per cent rate of tax to financing activities might be harmful in this context, especially if it applied only to foreign companies or foreign income.

The working party established under the code of conduct - chaired by the UK's own Dawn Primarolo [Financial Secretary at the Treasury, and MP for Bristol South] - has now identified 82 low-tax arrangements for businesses within the EU which might be harmful. Ten of these are reported to be UK provisions, including special measures for the film industry, for ship operators, and for the tax breaks provided by enterprise zones - but this has yet to be confirmed.

The EU savings directive has also been much in the headlines. This proposes that each member state introduce either a minimum 20 per cent withholding tax on payments of interest to individuals in other member states, or a requirement to report such payments to the tax authorities in the member state of the recipient. The UK Government would not favour introducing a withholding requirement in domestic legislation, but would probably be happy with a reporting requirement, provided an exemption was introduced for Eurobond interest. Without an exemption, it is feared, there would be very harmful effects on the London Eurobond market, and the Government has stated that, unless adequate protection is introduced, it will veto the proposal. There is no reason to doubt their word.

The code of conduct for business taxation does not go far enough for some. With EMU levelling the playing field in 11 member states, tax will be one of the few remaining areas in which countries can still compete: there is no prohibition in the code of conduct on lowering the national rate of business tax - Ireland has said it will a progressively lower its national rate to 12.5 per cent by 2003.

While some view competition as a bad thing, others believe it encourages member states to have disciplined public finances, and provides a last remaining lever in running the economy within the Eurozone. However, given the political tensions, we are bound to see more headlines in the tabloids before long.

But in many ways, the current debate on tax harmonisation misses the point for business - the real concern is how barriers to doing business can be overcome and Europe can be a true single market? It is, for example, the inability to offset losses in one country against the profits in another, and the requirement to determine taxable profits according to the different tax bases in 15 member states that increase tax costs in the single market. These are the issues that the Commission must focus on - the current debate on tax rates will be of little or no help to business.

Ian Barlow is UK head of tax and David Evans is director of international tax at KPMG.