7.4 Taxation

(I) Indirect taxes

Harmonisation of indirect taxes goes back to the 1960s and is well advanced. In 1967 "the Six" agreed to two Directives that required all member states adopt a VAT system. In 1985 the Cockfield Report advocated greater standardisation of indirect taxes in order to further the completion of the Single Market and these proposals were, with significant amendments, accepted in 1991.

In 1987 a proposal was made for a "standard" rate and a "reduced" rate of VAT and in 1989 a second proposal was made for a minimum "standard" rate of VAT of 15%. Eventually, in 1992, this was agreed along with a maximum "standard" rate of 25%. Member states may apply "reduced" rates (of 5%) to a specific list of goods and services and existing zero-rates, a particular feature of the British system, are currently allowed though they may not be extended. VAT revenue is an important part of the EU's "own resources".

Minimum rates for excise duties were agreed in June 1991, though there are still significant differences in fuel duties, tobacco duties and alcohol duties between the member states. British "booze cruises" to the Continent reflect the fact that British alcohol duties are higher than those in many Continental countries.

A resale royalty for artists, the "droit de suite", on sales of modern art is due to be introduced in January 2006.

(II) Company taxes

Up to 1997 business taxes had been regarded as a matter for national governments only. But in 1997 the Commission drew up plans for a "Code of Conduct on Company Taxation" aimed at countries with "significantly lower than average" business tax rates. The chief targets were countries with special tax regimes to attract inward investment comprising Ireland, Spain, Belgium and the Netherlands. Such special regimes were widely regarded to be guilty of "distorting the Single Market", "unfair and harmful tax competition", "upsetting level playing fields" and/or "fiscal dumping".

Since the 2004 enlargement of the EU the focus of the tax harmonisation debate has, however, shifted. This has arisen because certain new member states are offering very low tax rates on certain business activities. For example, Estonia set a zero corporation tax rate on retained profits to attract inward investment. Germany, for example, was critical of Estonia's move but, nevertheless, responded by cutting its federal corporate tax rate. Responding to these developments, the Commission has, de facto, switched its interest in attempting to harmonise tax rates to ways of promoting common tax structures, without fixing tax rates.

The current situation is member states are still bound by the Code of Conduct to prevent them providing tax breaks that unfairly distort investment decisions, but this is flexibly interpreted. EU rules or codes of conduct also have the aim of trying to ensure that the approach to taxing companies is broadly the same across the EU in many areas. So, for example, tax treatment of cross-border payments of interest, royalties and dividends to sister and parent companies is the same in all member states and based on the principle that income is taxed in the country of the recipient. There is broadly the same approach across the EU to taxing groups of companies and to cross-border intra-company sales of goods and services (so-called transfer prices). Discussion is under way on having a common tax base for companies, i.e. the rules applying to each type of transaction would be the same across the EU in order to prevent unfair competition. However, member states would still be free to set their own tax rates.

(III) Savings taxes

EU citizens can place their savings where they think they will get the best return. However, the tax remains due in the country of residence. EU governments lose legitimate revenue if their residents do not declare interest income on their savings abroad.

In 1997 the majority of member states were in favour of introducing a harmonised withholding tax on interest paid to individuals in EU member states from other EU member states. In May 1998 the Commission approved a draft Directive on the Taxation of Savings, proposing a minimum rate of 20%. The UK expressed its grave concerns - not least of all for the impact on the Eurobond market, which is largely based in the City of London. Subsequently, the harmonised withholding tax on interest paid throughout the EU was shelved and it was accepted that member states had an option. They could either opt for exchanging cross border information on interest paid or opt for a withholding tax. The UK opted for exchanging cross border information.

Since 1 July 2005, therefore, many EU and some other European governments have been exchanging information on non-residential savings. Austria, Belgium and Luxembourg are for the time being applying a withholding tax instead. This involves the transfer of a large part of the revenue from that tax to the investors' home country, where it is actually due.

RL, February 2007