Comparative Corporate Income Taxes in Europe

1. Comparative Corporate Income Taxesin Europe Prof. Dr. Geerten M.M. Michielse Technical Assistance Advisor IMF, Washington Georgetown University Law Center

2. What will be discussed? • Corporate Income Tax Systems • Measurement of Business Income • Thin Capitalization • Inter-company Dividends (EU Parent-Subsidiary) • Corporate Reorganizations (EU Merger) • Liquidations

3. Corporate Income Tax Systems

4. Current EU Systems

5. Central & East European Systems

6. Preliminary Conclusions • Only CZE has integration on corporate level (APTS); • GRC has moved from corporate level (DDS) to shareholder’s level (DES); • DEU, IRL and LTU have moved away from integration of tax liability (APTS/IMPS); • FRA is gradually moving out of IMPS (by reducing imputation-%); • Most countries favor FWHT.

7. Dividend Deduction andSplit Rate Systems(international aspects) • Non-Resident Shareholders • exclusion from DDS/SRS  discrimination? • high withholding tax • distribution quota • tax treaty protection • Permanent Establishment • moment of distribution parent company • allocation issues

8. Lithuanian Profit Tax(before 2003) Pre-tax profits 1,000 Profit tax (24%) 240 Dividend distribution 760 Withholding tax (29% of 760) 220 Profit tax 240 Less: WHT credit 220 MPT 20 At shareholder’s level: dividends taxable in full

9. Czech Corporate Income Tax Pre-tax profits 1,000 Income tax (31%) 310 Dividend distribution 690 Withholding tax (15% of 690) 104 Income tax 310 Less: 50% WHT credit 52 MCIT 258 At shareholder’s level: final withholding

10. Advanced Profit Tax Systems(European aspects) • No withholding tax on dividends paid to qualifying EU parent company; • No credit for withholding tax available; • Higher tax rate on companies owned by qualifying EU parent companies; • Non-discrimination issue.

11. Solution: Advanced Profit Tax Pre-tax profits 1,000 Profit tax (20%) 200 Dividend distribution 800 Advanced profit tax (25% of 800) 200 Profit tax 200 Less: Advanced profit tax 200 Main profit tax 0 At shareholder’s level: dividends taxable in full

12. Finnish Imputation System Pre-tax profits 1,000 Corporate income tax (29%) 290 Available for distribution 710 Imputation credit (CIT) 290 Grossed-up dividends 1,000 Personal income tax (38%) 380 Imputation credit 290 Net tax due 90

13. French Imputation System Pre-tax profits 1,000 Corporate income tax (34.33%) 343 Available for distribution 657 Imputation credit (10% of 657) 66 Grossed-up dividends 723 Personal income tax (49.58%) 358 Imputation credit 66 Net tax due 292

14. Imputation Systems(international aspects) • Distribution of foreign source profit to domestic shareholders • Equalization tax? • Distribution of domestic source profit to foreign shareholders • Tax credit? • Distribution of foreign source profit to foreign shareholders • Equalization tax exemption?

15. Cash Flow Tax Systems • Croatia (1994-2000): • Investment income is tax exempt; • ‘Protective Interest’ deduction (normal rate of return on equity); • Economic rent taxable (35%). • Estonia (2000-…?): • Retained earnings are tax exempt; • Distribution of profit establishes profit tax (26/74th); • Final withholding tax (26%).

16. Croatian Corporate Tax System Commercial profit 1,000 PI deduction (5% of equity) 500 Taxable profit 500 Corporate income tax (35%) 175 Available for distribution 825 At shareholder’s level: dividends exempt

17. Estonian Corporate Tax System Commercial profit 1,000 Dividend distribution 1,000 Corporate income tax (26/74th) 351 Available for distribution 649 Withholding tax (26%) 169 Net dividend received 480 At shareholder’s level: final withholding

18. Cash Flow Tax Systems(international/european issues) • Croatian variant: • Characterization as income tax? • FTC countries wipe out PI deduction • Harmful tax competition? • Estonian variant: • Characterization as withholding tax? • Harmful tax competition?

19. Harmful Tax Competition • Open only to non-residents or to transactions to non-residents; • Ring-fenced from the domestic market; (i.e. they do not have an impact on the national tax base) • Granted without any real economic activity and substantial economic presence; • Profit determination departs from internationally accepted (OECD) standards (??); • Lack of transparency.

20. Epson case (C-375/98) Portuguese Inheritance and Gift Tax • Arguments by ECJ: • Chargeable event = payment of dividends • Taxable amount = income from the shares • Taxable person = holder of the shares • Decision by ECJ: • WHT: any tax of whatever nature or however described, which takes the form of WHT on dividends.

21. Athinaika Case (C-294/99) Greek dividend withholding tax under DDS • Arguments by ECJ: • Chargeable event = distribution of profit • Tax directly related to size of distribution • No absorption of loss carry forward • DTA provision indicates withholding tax • Decision by ECJ: • WHT if tax-exempt income re-incorporated in tax basis upon distribution, whereas otherwise exempt.

22. Profit / Corporation Tax • Profit Tax • Distinction between Business Income and Other Income • Profit vs. Income Tax • Corporate Income Tax • Distinction between Legal Entities and Individuals • Corporate Income vs. Personal Income Tax

23. Common Law Systems(Characteristics) Fear for strong Administration resulted in: • Extensive Legislative Texts (due to implementation of case law) • Extensive Set of Definitions (textual interpretation) • Separate Set of Tax Provisions (due to confiscatory character) • Separate Capital Gains Tax (capital gains vs. ordinary income)

24. What will be discussed? • Corporate Income Tax Systems • Measurement of Business Income • Thin Capitalization • Inter-company Dividends (EU Parent-Subsidiary) • Corporate Reorganizations (EU Merger) • Liquidations

25. Measuring Business Income • How are tax laws related to accounting practice? • What are the main issues that need to be determined in measuring the income of a business in its accounts? • In what areas do the principal problems arise in practice?

26. Balance Sheet • Commercial Balance Sheet • information instrument e.g. to shareholders / debtors • management tool  tendency to overvalue • Fiscal Balance Sheet • state revenue instrument  tendency to undervalue

27. Fiscal Accounts(current EU Member States) • ‘Autonomy of Fiscal Accounts’ Concept • Separate legal provisions • FIN, GBR and IRL • Jurisprudence (‘sound business practice’) • NLD • ‘Unity of Law’ Concept (i.e. business accounts) • AUT, BEL, DEU, DNK, ESP, FRA, GRC, ITA, LUX, PRT and SWE

28. ‘Unity of Law’ Concept(arguments pro) • Sound Business Practice & General Accepted Accounting Principles • No decisive reason to deviate • Measurement of ‘distributable’ profit • Juridical process can be streamlined • More in line with continental view

29. ‘Unity of Law’ Concept(arguments contra) • End of traditional freedom to choose a fiscal system and to revoke that choice • Treasury becomes a direct interested party in the application of GAAP • Linkage is not unquestioned • Different objectives / purposes

30. ‘Sound Business Practice’(Netherlands) • Starting Point: • Principles of Business Economics • Exceptions, when conflicting with: • any Regulation in Tax Law; • a General Intention; or • Principle of the Relevant Tax Law.

31. Commercial Code(Germany and Austria) ‘Maßgelichkeit’ Principle: • Assets and Liabilities • Materielle Maßgeblichkeit (DEU) • Commercial Valuation • Formelle Maßgeblichkeit (AUT)

32. General Accounting Plan(France) • Accounting Boards (‘tableaux comptables’) used in Tax Declaration must be established in accordance with accounting rules and • If no contrary tax law or regulation provides a different solution, accounting rules are applied

33. Profit-and-Loss Account Method(Latvia) Article 4(1): “The taxable income … shall be the amount of annual profit (loss) as stated in the profit and loss statement … calculated in accordance with [the provisions] of the law On Annual Reports of Enterprises, … . Taxable income shall be adjusted … in accordance with this Law.”

34. Measuring Business Income • Balance Sheet • measuring of income by comparison of two financial statements • Profit-and-Loss Account • measuring of income for a period of time

35. Profit-and-Loss Account • General Rule: Financial Statements • Tax Provisions: Increased by e.g.: • Non-deductible expenses • Provisions and reserves Decreased by e.g.: • Exempt dividends • Deferred capital gains

36. Balance Sheet Net Equity Balance Sheet Ending 2002 Net Equity Balance Sheet Beginning 2002 -/- Net Equity Accretion during 2002 Profit Distributions / Private Expenses + Taxable Business Income

37. Measuring Business Income • How are tax laws related to accounting practice? • What are the main issues that need to be determined in measuring the income of a business in its accounts? • In what areas do the principal problems arise in practice?

38. Fiscal / Commercial Profit(typical areas of deviation) • Non-deductible Expenses • Depreciation • Provisions and Reserves • Bad Debts • Losses • Inflation • Capital Gains and Losses • Tax Incentives

39. Non-Deductible Expenses • General rule excludes private expenses • Technical (legislative) • dividend distributions, recoverable VAT • Private Elements • representation, entertainment • Avoidance • thin capitalization • Political unwanted • bribes, penalties

40. Provisions / Reserves(EU Member States) • Risks and Future Expenses • AUT, BEL, DEU, ESP, FRA, GBR, IRL, LUX, NLD and PRT • Bad Debts • General: DNK (limited), ESP (only for SME’s), GRC, ITA and NLD • Specific: all other Member States, including those above • Pensions • AUT, BEL, DEU, GRC, ITA, LUX, NLD and SWE • Repairs • FIN, DEU (substantial maintenance), ESP (if plan approved), FRA, IRL, ITA, NLD and SWE

41. Risks and Future Expenses(AUT, BEL, DEU, ESP, FRA, GBR, IRL, LUX, NLD and PRT) • Common conditionalities: • Taxpayer’s estimation (e.g. in AUT and ESP) • Objective facts and circumstances (e.g. in AUT and ESP) • Business experience (e.g. in AUT) • Cause in current tax year (e.g. in BEL, DEU and GBR) • Mandatory under commercial code (e.g. in DEU) • Claim lodged or very possible (e.g. in BEL and DEU) • Some countries (e.g. DNK and SWE) allow only a provision for guarantees

42. Bad Debts(all EU Member States) • General Provision (allowed in DNK, ESP, GRC, ITA and NLD) • Typically limited, e.g. max. 5% of trade receivables (GRC and ITA) or only available for SME’s (ESP) • Specific Provision (allowed in AUT, BEL, DEU, DNK, ESP, FIN, FRA, GBR, IRL, LUX, NLD, PRT and SWE) • Based on loan-by-loan approach

43. Pensions(AUT, BEL, DEU, GRC, ITA, LUX, NLD and SWE) Main Characteristics: • Obligation to pay future pensions • Legally ‘qualified’ pension scheme • Actuarial computation • Mandatory inclusion in commercial balance sheet (BEL) • Discount rate (AUT: 20%, DEU: 6%)

44. Repairs(FIN, DEU, ESP, FRA, IRL, ITA, NLD and SWE) • Replacement Reserve (FIN, NLD and SWE) • max. 2 years (FIN) • max. 3 years (SWE) • max. 4 years (NLD) • Substantial maintenance and repair (DEU) • Approved Repair Plan (ESP) • Limited to 5% of book value (ITA)

45. Ordinary Losses(EU Member States) • Carry Forward • Unlimited: AUT, BEL, DEU, DNK, GBR, IRL, ITA (only for start-up losses), LUX, NLD and SWE • Limited: • 5 years: FRA, GRC and ITA • 6 years: PRT • 10 years: ESP and FIN • Carry Back DEU (1 year + max), FRA (3 years), GBR (1 year), IRL (1 year) and NLD (3 years)

46. What will be discussed? • Corporate Income Tax Systems • Measurement of Business Income • Thin Capitalization • Inter-company Dividends (EU Parent-Subsidiary) • Corporate Reorganizations (EU Merger) • Liquidations

47. Treatment of Interest Expenses • Limitation of Interest related to Exempt Income • Obligation to Pay Subscribed Capital in Full • Limitation of Interest Rate • Debt-to-Equity Ratio • Tax Haven Creditors • General Anti-Avoidance Rules

48. Thin Capitalization Rules(EU Member States)

49. Thin Capitalization Rules(Central & East European Countries)

50. Thin Capitalization(technical issues) • Equity definition • Revaluation reserve • Negative equity position • Back-to-back loans / Guaranteed loans • Non-deductibility vs. Re-characterization • Non-discrimination