Explanatory Memorandum to COM(2011)714 - Common system of taxation applicable to interest and royalty payments made between associated companies of different Member States - Main contents
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| dossier | COM(2011)714 - Common system of taxation applicable to interest and royalty payments made between associated companies of different Member ... |
|---|---|
| source | COM(2011)714  |
| date | 11-11-2011 |
1. CONTEXT OF THE PROPOSAL
Council Directive 2003/49/EC 1 (‘the Directive’) regulates the common system of taxation applicable to interest and royalty payments between associated companies of different Member States. Since it has been amended several times, this proposal recasts it in the interests of clarity. The explanatory memorandum states the reasons for each proposed substantive amendment and specifies which provisions of the earlier act remain unchanged.
The problems addressed by the Directive arise from the existence of particular corporate tax obstacles to the functioning of the internal market: cross-border interest and royalty payments are subject to heavier taxation than domestic transactions. In the case of purely domestic operations, the recipient of the payment is subject to corporate tax as a resident taxpayer in the Member State where it is resident for tax purposes. In case of international payments, they may be also subject to withholding taxes in the source Member State. The purpose of the Directive is to put cross-border interest and royalty payments on an equal footing with domestic payments, by eliminating juridical double taxation, burdensome administrative formalities and cash-flow problems for the companies concerned.
The Commission and international tax stakeholders have always been convinced of the need for an EU instrument in this area, as neither unilateral measures taken by Member States nor bilateral tax agreements have provided a satisfactory solution that fully meets the requirements of the internal market. Bilateral tax treaties do not cover all bilateral relations between Member States, they do not completely abolish double taxation and, in particular, they never provide a uniform solution for triangular and multilateral relations between Member States.
In its Communication of 5 November 1997 entitled ‘A package to tackle harmful tax competition in the European Union’ 2 the Commission stressed the need for coordinated action at European level to tackle harmful tax competition in order to help achieve certain objectives such as reducing the continuing distortions in the internal market, preventing excessive losses of tax revenue and encouraging tax structures to develop in a more employment-friendly way. The Ecofin Council meeting of 1 December 1997 held a wide-ranging debate on the basis of that Communication and decided, among other initiatives, to ask the Commission to present a proposal to harmonise the taxation of cross-border interest and royalty payments 3 . On 4 March 1998, the Commission adopted a proposal for a Council Directive on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States, COM(1998) 67 final. On 3 June 2003 the Ecofin Council adopted the Directive. In order to alleviate its budgetary impact for those Member States which were net importers of capital and technology and for which these taxes on such payments represented an appreciable source of revenue, a gradual approach seemed appropriate as far as the scope of the Directive was concerned.
The Directive was first amended in 2004 by Directives 2004/66 4 and 2004/76 5 due to the accession of the Czech Republic, Estonia, Cyprus, Latvia, Lithuania, Hungary, Malta, Poland, Slovenia and Slovakia. The former introduced in the text of the Directive the taxes and companies from these new Member States to which it applies. The latter amended the text of Article 6 of the Directive to introduce transitional arrangements for the Czech Republic, Latvia, Lithuania, Poland and Slovakia.
Later, Council Directive 2006/98/EC 6 included the reference to the taxes and companies from Bulgaria and Romania to which the Directive applies. Annexes IV.6 and VII.7 to the Act of Accession of Bulgaria and Romania included temporary derogations 7 .
Article 8 of the Directive required the Commission to report to the Council on the operation of the Directive, in particular with a view to extending its coverage to companies or undertakings other than those under its scope. In order to obtain the information required to draft the report, DG TAXUD asked the International Bureau of Fiscal Documentation to carry out a survey of the implementation of the Directive. The Commission’s report on the functioning of the Directive was presented on 23 April 2009 8 . It indicates that overall implementation of the Directive has been satisfactory and refers to possible amendments in order to extend its coverage.
This recast tries to solve some of the problems resulting from the limited scope of the Directive. There are cross-border payments outside its scope that face withholding taxes at source. Thus, it proposes to extend the list of companies to which the Directive applies and to reduce the shareholding requirements to be met for companies to qualify as associated. In addition, it adds a new requirement for the tax exemption: the recipient has to be subject to corporate tax in the Member State of its establishment on the income derived from the interest or royalty payment. This condition seeks to ensure that the tax relief is not granted when the corresponding income is not subject to tax and thus close a loophole that could be used by tax evaders. Finally, a technical amendment is proposed to avoid situations where payments made by a permanent establishment and deriving from its activities are denied the exemption on the grounds that they do not constitute a tax-deductible expense.
2. RESULTS OF CONSULTATIONS WITH THE INTERESTED PARTIES AND IMPACT ASSESSMENTS
A public consultation on possible amendments to the Directive ran from 24 August until 31 October 2010 on the ‘Your Voice in Europe’ web portal and DG TAXUD’ website. 71 responses were received from various stakeholders, including multinationals (25 replies), large firms (3 replies), business and industry associations (18 replies), tax practitioners (16 replies), professional associations (8 replies) and one civil servant from a Member State. The first conclusion from the replies received confirms the interest in the initiatives raised by the Commission. There is a clear tendency in support of the need to take action and amend the Directive. Only 7 % of the replies do not consider it necessary to update the list of entities covered by the Directive and 4 % do not agree with the change in the shareholding threshold for entities to be considered as associated. The majority of respondents also showed preference for the alignment of the personal scope of the Directive with that of the Parent-Subsidiary Directive (supported by 9 0% of responses); amending the Directive to allow the computation of indirect holdings to establish that companies are associated was favourably received by 9 1% of the contributors; lowering the threshold requirement to consider companies as associated from a 25% holding to 10% was viewed positively by 87 % of the replies.
The Commission’s impact assessment referred to the problems deriving from withholding taxes on cross-border interest and royalty payments: economic distortions in business behaviour; compliance costs due to paperwork and delays in making tax relief effective; and the risk of double taxation. Several alternatives were considered. Not taking any policy action was rejected since the difficulties identified would continue distorting the process of cross-border allocation of resources. Extending the Directive’s benefits to all payments between unrelated undertakings would be effective in reducing the negative consequences described but would be less efficient and inconsistent with other aims to improve the functioning of the Directive: the different taxation of dividends, interest and royalties would continue so that the corresponding economic distortions would remain; it would also involve steeper reductions in Member States’ tax revenues; and its implementation would be more difficult since there is no experience in harmonising cross-border payments between non-associated companies. Another alternative would be aligning the Directive’s requirements with those of the Parent-Subsidiary Directive 9 on dividend taxation. This is the option chosen by this recast since it offers a more balanced result: it is more effective in reducing economic distortions and does not diminish Member States’ tax revenue as much as the previous option, an important fact in the current context of public finances. Concerning interest payments, the loss should not exceed € 200 to € 300 million and would affect the 13 EU Member States that still apply withholding taxes to outgoing interest payments – Belgium, Bulgaria, the Czech Republic, Greece, Hungary, Ireland, Italy, Latvia, Poland, Portugal, Romania, Slovenia and United Kingdom -; concerning royalty payments, the loss should not exceed € 100 to € 200 million and would affect the seven countries with the largest negative royalty balances as a share of GDP - Bulgaria, the Czech Republic, Greece, Poland, Portugal, Romania and Slovakia As mentioned, it is the option preferred by stakeholders responding to the public consultation.
Excluding payments from the Directive’s benefits when the income is not subject to taxation by the Member State of the recipient as well as the technical amendment to avoid situations where payments made by a permanent establishment and deriving from its activities are denied the exemption on the grounds that they do not constitute a tax-deductible expense, are measures of a purely technical nature whose impact cannot be measured.
3. LEGAL ELEMENTS OF THE PROPOSAL
The subsidiarity principle applies insofar as the proposal does not fall under the exclusive competence of the European Union. The objectives of the proposal cannot be sufficiently achieved by the Member States. Withholding rates are fixed by each Member State in its national law according to its corresponding tax policy options. These charges may be reduced or waived under bilateral double taxation conventions. However, each particular convention fixes it own rate as a result of the trade-off between the two States agreeing it. The outcome is that withholding taxes vary according to each bilateral relationship between the Member States and there will not be spontaneous coordinated action by the Member States.
The second aspect to be considered is whether and how the objectives could be better achieved by action on the part of the EU. The rationale for European action stems from the cross-border nature of the problem. Clearly, action at EU level will guarantee harmonised and coordinated tax policies in this particular area of taxation. Member States would be bound by the exemption of withholding taxes to the same extent.
The amendments proposed in this recast should be proportionate. On the basis of the problems detected, they should offer solutions likely to meet the objectives fixed. The main cause of economic distortions, compliance costs and the risk of excessive or double taxation is the existence of taxes levied at source; also, the disparities in taxation of the different types of cross-border capital flows distort business behaviour. The amendments proposed in this recast aim to extend the Directive’s scope and apply the tax exemption in a wider number of cases. This solution will contribute to achieving tax neutrality, reducing compliance costs and eliminating the risk of double taxation in a larger number of cases so that economic operators can allocate resources more efficiently. The initiative does not go beyond what is necessary to achieve these objectives and leaves Member States scope for national decisions since it limits its effects to EU cross-border payments.
The proposal therefore complies with the proportionality principle.
As mentioned above, the rules establishing the tax regime for cross-border interest and royalty payments are laid down in the four Directives and two annexes to the Act of Accession of Bulgaria and Romania; there is no consolidated text. This situation results in legal complexity for those needing to consult the legislation in force. Gathering existing legislation in a single act will simplify, clarify and facilitate the application of harmonised law by businesses and professionals dealing with these matters.
The assessment of source taxation and the refund procedures to implement the tax relief provided for in domestic laws or in double taxation conventions result in high compliance costs. Paperwork is required to attest the right to apply the relief from double taxation or to credit the amount of foreign tax paid and reduce accordingly the corporate tax charged in the State of residence. In addition, firms are required to withhold taxes and are subsequently reimbursed if the tax administration deems that they qualify for the treaty exemption or reduction. Also, when withholding tax rates are matched by tax credits in the home country, the withholding is levied on the payment while its reduction in the residence State is only possible later when the tax return is submitted. The result is that businesses incur liquidity costs. According to the impact assessment, the initiatives contained in this recast proposal to eliminate withholding taxes in a larger number of cases would entail compliance cost savings estimated at between € 38,4 and € 58,8 million.
• Tax exemption
Article 1 i is amended. Its purpose is to exempt payments of interest and royalties from any taxation at source. The ‘Statements for entry in the minutes of the Council’, when the Directive was adopted, contained the following passage: ‘The Council and the Commission agree that the benefits of the Interest and Royalty Directive should not accrue to companies that are exempt from tax on income covered by this Directive. The Council invites the Commission to propose any necessary amendments to this Directive in due time’. The recitals to the Directive state that ‘it is necessary to ensure that interest and royalty payments are subject to tax once in a Member State’ 10 . The Commission shares the Council’s view that there should be no loopholes in the Directive allowing the taxation of interest and royalty payments to be circumvented. To this end, it adopted a proposal in 2003 11 which was close to an agreement in the Ecofin Council. The Commission withdrew that proposal because it was due to put forward this recast of the Directive, as planned in Annex II to the Commission’s Work Programme 2010 12 . Thus, the recast amends Article 1 i in order to make it clear that Member States have to grant the benefits of the Directive only where the interest or royalty payment concerned is not exempt from corporate taxation in the hands of the beneficial owner in the Member State where it is established. In particular this addresses the situation of a company or a permanent establishment paying income tax but benefiting from a special tax scheme exempting foreign interest or royalty payments received. The source State would not be obliged to exempt it from withholding tax under the Directive in such cases.
• Definition of source State
Article 1 i which identifies the source State as the Member State from where the payments are made remains unchanged.
For the purposes of this definition, Article 1 i clarifies that a permanent establishment is considered to be making a payment when it represents a tax-deductible expense. The Commission’s report on the Directive mentioned that it is clear from the context that the purpose of the ‘tax-deductibility’ requirement is to ensure that the benefits of the Directive accrue only in respect of those payments that represent expenses which are attributable to the permanent establishment. However, in its current wording the provision would also apply to cases where deduction is denied on other grounds. The recast amends this paragraph to make it clear that the Directive applies when the payment is linked to the activities carried out by the permanent establishment.
• Definition of beneficial owner
The beneficial owner is identified in paragraphs 4 and 5 of Article 1, which are not amended.
• Payments made or received by permanent establishments
Article 1 (6), governing the cases where payments are made or received through permanent establishments, is not amended.
• Requirement of association
Paragraphs 7 and 10 of Article 1, which refer to the conditions of association between the companies involved in the transaction giving rise to the payment, are not amended.
• Territorial scope
Article 1 (8), providing that the Directive only applies to intra-EU payments, remains unchanged.
• Taxation in the Member State of the recipient
Article 1 (9), referring to the taxing rights of the Member State of the recipient, is not amended.
• Attestation procedure
Paragraphs 11, 12, 13 and 14 of Article 1, on the procedure to attest the right to the exemption are not amended.
• Refund procedure
Paragraphs 15 and 16 of Article 1 which set out the procedure to refund the tax withheld when the company has the right to the exemption, are not amended.
• Definition of interest and royalties
The definitions of interest and royalties set out in Article 2 remain invariable. This Article is merged with Article 3 which also contained definitions relevant for the application of the Directive.
• Definition of company
In accordance with Article 3 (a), now Article 2 (c), the Directive covers companies of a Member State that take one of the forms listed in Annex I, are resident in a Member State and are subject to one of the types of income tax listed in the Directive. The list of entities to which it applies is made by reference to national company laws and is included in Annex I.
This recast modifies the personal coverage of the Directive with a view to extending it to the largest possible number of entities. To that end, two criteria have been followed.
In the first place, the list of entities to which the Directive applies is currently narrower than the list annexed to the Parent-Subsidiary Directive. This latter Directive applies to profit distributions and pursues the same aim as the Directive, namely to eliminate withholding taxes and the risk of double taxation in the case of cross-border capital flows: the Directive covers interest and royalty payments and the Parent-Subsidiary Directive relates to dividend payments. The amendment to the Directive extends its list with a view to bringing it into line with that of the Parent-Subsidiary Directive. This solution will help make taxation more neutral.
One of the results of this amendment will be the inclusion of the European Company (SE) and of the European Cooperative Society (SCE) in the list of companies covered by the Directive. The aims pursued with these two European legal types - creation and management of companies with a European dimension, free from the obstacles arising from the disparity and the limited territorial application of national law – will be furthered 13 . Thus, the SE will give companies operating in more than one Member State the option of being established as a single company under EU law and thus being able to operate throughout the EU with one set of company law rules and a unified management and reporting systems. While there are no provisions in the SE Statute directed specifically at taxation, nevertheless, the instrument does require the SE to be subject to ‘the provisions of Member States’ law which would apply to a public-limited company formed in accordance with the law of the Member State in which the SE has its registered office’ 14 . Such public-limited companies, which are listed in the annex to the SE Statute, are also included in the list of companies Annex to the Directive. So, in practice the SE already enjoys the benefits of the Directive because the Member State where it has its registered office is required to grant the same benefits as those which apply to the respective national type of public-limited company. However, both for the purposes of clarification and to underpin the importance that the Commission attaches to it, the Commission proposes that the SE be specifically mentioned in the list of companies annexed to the Directive 15 .
Similarly, the SCE Statue does not have specific provisions on taxation 16 , so that the tax laws of the Member States and of the EU apply. The Commission considers it essential to support this new type of company and to provide the framework to allow businesses to make the best use of this legal form. The SCE will receive the same treatment as cooperatives in the Member State of their registered office and therefore, indirectly, the benefits of the Directive provided for those national types already covered by it. While some of them are already included in the list annexed to the Directive, it is proposed that more of such cooperatives be included the new Annex. In these circumstances the Commission proposes that the SCE be also included in the list of companies. Although, as in the case of the SE, the inclusion is seen more as a signal underlining the importance that the Commission assigns to the SCE, and to avoid any uncertainty or doubt, this measure ensures that the SCE will enjoy the full benefits of the Directive.
In the second place, there are some national entries in the list annexed to the Directive which are broader than those included in the Parent-Subsidiary Directive. This is the case of entries corresponding to the Czech Republic, Cyprus, Slovenia and Slovakia. For these cases, the list is not amended since it is considered that those legal types already enjoying the benefits of the Directive should not be deprived of the harmonised tax regime. Otherwise, their legitimate expectation would be breached and they would face the tax obstacles to the internal market whose elimination is sought in the TFEU and in the Directive.
There are also some entries that are not amended since they are identical to those included in the Parent-Subsidiary Directive. This is the case of the Latvian, Lithuanian, Maltese, Polish, Portuguese, Romanian, Finish and UK entities.
On the other hand, the list has to be updated and there are two entities that should be removed since they do no longer exist. These are the German ‘bergrechtliche Gewerkschaft’ and of the Hungarian ‘közhasznú társaság’.
This recast will also replace the list of taxes to which the companies have to be subject, currently included in Article 3 (a) (iii) which will be inserted as Annex I Part B.
• Definition of associated company
According to Article 3 (b), an association is currently deemed to exist when one of the companies has a direct minimum holding of 25 % in the capital of the other company, or a third company has a direct minimum holding of 25 % in the capital of both the payer and the recipient companies. Member States can if they so wish provide for a level of holding lower than 25 % in order to determine whether a company exercises sufficient control over another. Furthermore, they can replace the criterion of a minimum capital holding by the criterion of a minimum holding in the voting rights.
This shareholding threshold is higher than that provided for in the Parent-Subsidiary Directive, which only requires a 10 % direct or indirect holding. The recast amends this provision to align the association requirements of the Directive with those established in the Parent-Subsidiary Directive. Thus, the direct 25 % shareholding threshold is reduced to a direct or indirect 10 % shareholding threshold. This new threshold should avoid some economic distortions arising from the different scope of the two Directives. This provision is renumbered as Article 2 (d).
• Definition of permanent establishment
Article 2 (c), containing the definition of permanent establishment is renumbers as Article 2 (e) but its content remains unchanged.
• Exclusion of payments as interest and royalties
Article 4, renumbered as Article 3, excluding from the interest and royalties definition payments deriving from transactions of a hybrid nature, is not amended.
• Fraud an abuse
Article 5, renumbered as Article 4, which contains anti-abuse provisions, is not modified by this recast.
• Transitional arrangements
Article 6, renumbered as Article 5, is not amended in substance, but its wording is adjusted to take account of the transitional arrangements provided for Bulgaria in the corresponding Act of Accession and to delete the reference to Slovakia, which ceased to enjoy the transitional derogation from 1 May 2006.
• Review
Article 8 required the Commission to report to the Council on the operation of the Directive and its report was presented in April 2009. This provision is renumbered as Article 7, updated and establishes a new deadline for reviewing the impact of the Directive and verifying how its objectives are fulfilled. Four years after its implementation, the Commission is to report to the Ecofin Council and to the European Parliament on the impact of this recast.
• Delimitation clause
Article 8 is a standard tax harmonisation provision. The Directive establishes the minimum obligations concerning the taxation of cross-border interest and royalty payments but does not rule out other more beneficial regimes provided for in national laws or in double taxation treaties.
• Implementation, repeal, entry into force and addressees
Articles 6, 9, 10 and 11 are standard provisions used especially for the purpose of recasting. Article 12 is a standard provision stating that the Directive is addressed to the Member States.
4. BUDGETARY IMPLICATION
This recast does not have any budgetary implications for the EU.
🡻 2003/49/EC (adapted)