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
Country System Rate ()
AUT Final Withholding 34
BEL Final Withholding 33.99
DEU Dividend Exemption 39.58
DNK Classical 30
ESP Imputation 35
FIN Imputation 29
FRA Imputation 34.33
GBR Imputation 30
GRC Dividend Exemption 35
IRL Classical 12.5
ITA Imputation 38.25
LUX Dividend Exemption 30.38
NLD Classical 34.5
PRT Imputation 33
SWE Classical 28
5
Central East European Systems
Country System Rate ()
BGR Final Withholding 23.5
CZE Advanced Profit Tax 31
EST )1
HUN Final Withholding 18
LTU Advanced Profit Tax 24
LVA Dividend Exemption 25
POL Final Withholding 27
ROM Final Withholding 25
SVK Final Withholding 25
SVN Dividend Exemption 25
6
Preliminary Conclusions

• Only CZE has integration on corporate level
  (APTS)
• GRC has moved from corporate level (DDS) to
  shareholders 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 shareholders 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 shareholders 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 shareholders 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 shareholders 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 shareholders 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 SMEs),
  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
• Taxpayers 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
  SMEs (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)
Loans Affected Ratio Result
BEL Directors and Shareholders 11 Re-characterization
DEU Substantial shareholders (gt25) 1.51 Re-characterization
DNK Controlling shareholders (gt50) 41 Non-deductibility
ESP Non-resident related companies 31 Re-characterization
FRA Controlling shareholders (gt50) 1.51 Non-deductibility
GBR 75 non-resident parent companies 11 Re-characterization
IRL 75 non-resident parent companies n/a Re-characterization
LUX Shareholders undisclosed Re-characterization
PRT Related parties (gt25) 21 Non-deductibility
49
Thin Capitalization Rules(Central East
European Countries)
Loans Affected Ratio Result
BGR All 11 Non-deductibility
CZE Non-resident related parties 41 Non-deductibility
HUN Related parties 31 Non-deductibility
LVA All 21 Non-deductibility
POL Substantial shareholders 31 Non-deductibility
ROM All 11 Limited deductibility (50 of profits)
SVK Related parties 41 Non-deductibility
SVN Substantial shareholders 31 Non-deductibility
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

51
Equity Definition(Germany)

• Para. 8a, Abs. 2 Kist
• Anteiliges Eigenkapital des Anteilseigners ist
  der Teil des Eigenkapitals der Kapitalgesellschaft
  zum Schluß des vorangegangenen Wirtschaftsjahrs,
  der dem Anteil des Anteilseigners am gezeichneten
  Kapital entspricht. Eigenkapital ist das
  gezeichnete Kapital abzüglich der ausstehenden
  Einlagen, zuzüglich der Kapitalrücklage, der
  Gewinnrücklagen, eines Gewinnvortrags und eines
  Jahresüberschusses sowie abzüglich eines
  Verlustvortrags und eines Jahresfehlbetrags (
  266 Abs. 3 Abschnitt A, 272 des
  Handelsgesetzbuches) in der Handelsbilanz zum
  Schluß des vorangegangenen Wirtschaftsjahrs
  Sonderposten mit Rücklageanteil ( 273 des
  Handelsgesetzbuches) sind zur Hälfte
  hinzuzurechnen. Eine vorübergehende Minderung des
  Eigenkapitals durch einen Jahresfehlbetrag ist
  unbeachtlich, wenn bis zum Ablauf des dritten auf
  das Wirtschaftsjahr des Verlustes folgenden
  Wirtschaftsjahrs das ursprüngliche Eigenkapital
  durch Gewinnrücklagen oder Einlagen wieder
  hergestellt wird.

52
Back-to-Back Loans
Parent Company
Commercial Bank
bank deposit
or guarantee
loan
Subsidiary Company

• Example provision
• If a loan is received from a third party and an
  associated person of the recipient gives a
  guarantee on this loan, para. shall be
  applicable as if the associated person made the
  loan directly.

53
Re-characterization vs. Non-deductibility

• Re-characterization
• interest re-characterized as dividend
• debt re-characterized as equity
• ? profit allocation
• Non-deductibility
• ? profit determination

54
International Withholding Tax

• Re-characterization
• Art. 10(3) OECD refers to domestic definition of
  source state
• Art. 23 OECD requires relief for dividend w/h
• ? no double taxation
• Non-deductibility
• Art. 11(2) OECD
• Art. 23 OECD requires relief for interest w/h
• ? no double taxation

55
International Economic Double Taxation

• Recharacterization
• OECD-Commentary Art. 9 applicable
• IFA-Resolution arms length approach preferred
• Michielse nonsense, Art. 9 cannot apply
• Art. 9(2) OECD no obligation for corresponding
  adjustment
• ? danger of double taxation
• Non-deductibility
• profit determination is not profit allocation
• ? double taxation

56
Non-discrimination

• Article 24(4) OECD
• interest payments to non-residents shall be
  treated under the same conditions for tax
  purposes as interest payments to residents
  (except for Art. 9(1) and Art. 11(6) OECD)
• Article 24(5) OECD
• resident companies shall be treated under the
  same conditions for tax purposes irrespective
  whether its shareholders are residents or
  non-residents

57
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

58
Intercompany Dividends(parent company)

• Domestic subsidiary
• Qualifying EU subsidiary
• At least 25 shareholding
• Minimum holding period of (maximum) 2 years
• Other subsidiary

59
Intercompany Dividends Received(EU Member States)

• Exemption Method
• Full exemption
• AUT, DEU(r), DNK, FIN(nr), GBR(r), GRC(r),
  IRL(r), LUX, NLD and SWE
• 95 exemption
• BEL, DEU(nr), FRA, ITA(nr) and PRT
• Credit Method
• ESP, FIN(r), GBR(nr), GRC(nr), IRL(nr) and ITA(r)

60
Intercompany Dividends Received(Central East
European Countries)

• Domestic subsidiaries
• Exemption method
• BGR, HUN, LTU, LVA and SVN
• Separate tax base method
• CZE, PLN, ROM(fwh) and SVK(fwh)
• Foreign subsidiaries
• Exemption method
• HUN, LTU and LVA
• Separate tax base method
• CZE

61
Intercompany Dividends Paid(EU Member States)

• Domestic Parent Company
• Exemption (except ESP 25)
• Qualifying EU Parent Company
• Exemption, if
• At least 25 shareholding and
• Minimum holding period (BEL, DEU, DNK, ESP, ITA
  and NLD 1 year AUT,FRA and PRT 2 years)
• Other Foreign Parent Company
• Exemption (DNK and SWE)
• 25 (IRL 24, ITA 27, FIN 29)

62
Intercompany Dividends Paid(Central East
European Countries)

• Domestic Parent Company
• Exemption (BGR, EST, HUN, LVA and SVN)
• General WHT (CZE, POL, ROM and SVK)
• Foreign Parent Company
• WHT rates (10-20) apply

63
What will be discussed?

• Corporate Income Tax Systems
• Measurement of Business Income
• Thin Capitalization
• Intercompany Dividends (EU Parent-Subsidiary)
• Corporate Reorganizations (EU Merger)
• Liquidations

64
Capital Gains on Shares

• Common Law
• Separate Capital Gains Tax (basis and rate)
• Civil Law
• Shares are business assets
• Substantial shareholding
• Speculative transactions

65
Common Law Regime(assets / liabilities)

• Distinction between income and capital gains
• Capital allowances for depreciation
• Only capital gains on assets (!)
• At disposal of assets
• Recapture of capital allowances in Income Tax
• Capital Gains Tax on difference between market
  value and acquisition price

66
Civil Law Regime(assets / liabilities)

• Capital gains are treated as ordinary income
• Depreciation (business expense)
• Capital gains on both assets and liabilities
• At disposal of assets
• Capital gain / loss taxable at normal rate on
  difference between market value and book value

67
Mergers Reorganizations

• Capital Gains / Losses
• Depreciation Basis
• Transfer of Provisions / Reserves
• Transfer of Loss Carry Forward
• Liquidation Proceeds

68
Reorganizations(covered by EU Merger Directive)

• Transfers of Assets
• Exchanges of Shares
• Mergers
• Division

69
Transfer of Assets
Sh R
Sh T
Sh R
Sh T
Transferring entity
Transferring entity
Receiving entity
Receiving entity
Before
After
70
Exchange of Shares
Sh AG
Sh AD
Sh AG
Sh AD
Acquiring entity
Acquiring entity
Acquired entity
Acquired entity
Before
After
71
Mergers

• into an existing company
• into a newly established company
• into the parent company

72
Merger
Sh R
Sh T
Sh R
Sh T
Receiving entity
Receiving entity
Transferring entity
Before
After
73
Division
Sh T
Sh T
Receiving entity
Receiving entity
Transferring entity
Before
After
74
EU Merger Directive

• Introduction of cross-border mergers within EU
  Member States
• Loss carry-over facility extended if available
  to cross-border mergers
• Roll-over-relief for capital gains realized

75
EU Merger Directive(problem areas)

• Issuance of new shares /
• Transfer of existing shares
• Omission of certain valuation rules
• Shares received as consideration (both States)
• Shares / Assets received in State of residence
• Interpretation issues
• 10 cash payment
• Anti-avoidance rule

76
Transfer of Assets(valuation issues)
Transferring company
D
C
Receiving company
B
A
PE
77
Exchange of Shares(valuation issues)
Sh AD
E
F
Acquiring Company
G
H
Acquired Company
78
Merger(valuation issues)
Sh T
Sh R
E
Transferring company
F
E
Receiving company
A
B
PE
79
Omission of Valuation Rules

• Shares received in consideration company T or
  shareholder AD
• (a) in State of residence D
• (b) in State of source C or FH
• Nonresidents (corporate entities) exempt
• Tax treaty protection
• Shares / assets received in State of residence
  company R or AG B or G
• (Participation) exemption

80
France

• Prior approval of MoEF in several cases
• Reporting requirements
• Revaluation gain company R
• Business purpose test / 5 years holding period

81
Germany

• Buchwertverknüpfung
• i.e. double tax claim on both assets transferred
  and shares received
• PE merger questionable
• Condition for merger German unlimited tax
  liability

82
The Netherlands

• Motivated by valid commercial reasons
• Restructuring
• Rationalization of business activities
• Same tax regime requirement
• 3-years holding period

83
United Kingdom

• No implementation of Merger / Division
• Special EU provisions
• (a) Transfers of Assets
• ownership test (Sec. 343 ICTA)
• bona fide commercial transaction requirement
• (b) Exchanges of Shares
• Limited to Secs. 126-138 TCGA
• business purpose test (Sec. 139-5 TCGA)

84
What will be discussed?

• Corporate Income Tax Systems
• Measurement of Business Income
• Thin Capitalization
• Intercompany Dividends (EU Parent-Subsidiary)
• Corporate Reorganizations (EU Merger)
• Liquidations

85
Corporate Liquidations

• Last opportunity to tax shareholders on
  undistributed profits
• Dividend distribution
• Occasion to tax shareholder on appreciation in
  value of his investment
• Capital Gain on shares

86
Corporate Liquidations(dividend distribution)

• Liquidation payments
• Less nominal value of shares
• (or if higher)
• acquisition price of shares
• Dividend distribution
• Difference between acquisition price and nominal
  value of shares might be treated as Capital Loss