The fight of the EU against tax avoidance: More powers for Brussels

In its Resolution of March 25, 2015, on the Annual Tax Report (2014/2114(INI)), the European Parliament renewed its commitment to combating tax havens and tax avoidance. To be sure, most aspects of the resolution have been discussed before.

Bundling these aspects into one comprehensive package, however, provides an intriguing snapshot of the political momentum in Europe towards adopting more restrictive tax regulations and implementing concerted measures against tax avoidance.

The tax climate in Europe is indeed changing for the worse1.

Harbinger of tougher regulations and increased tax harmonization

The Resolution commences by emphasizing that an estimated 1 trillion euros of potential tax revenue is lost every year in the EU due to tax fraud and tax avoidance (so-called “BEPS”). The confidence with which the European Parliament keeps reiterating the quantitative effects of BEPS is somewhat surprising. In its Public Discussion Draft from April 16, 2015, the OECD highlighted that the current state of BEPS measurement is severely constrained by the limits of available data and that the proposed indicators are of preliminary nature – thus estimating the impact of BEPS with a reasonable degree of accuracy is not feasible at this time2.

Far from reflecting that the evidence for the scale of BEPS is preliminary and constrained, however, the Resolution illustrates that the European Parliament is strongly committed to preserving the corporate tax base at all costs. The two essential features of the Resolution can be summarized as follows:

1. Extending the scope of tax practices being classified as tax evasion
   The EU Parliament “strongly condemns” taxpayers shifting their tax base out of countries in which they consume public services or benefit from a workforce which does so. As a consequence, the EU Parliament appears (amongst others) intent on extending the definition of tax evasion by re-classifying tax avoidance as being illegal. It appears sensible to quote the wording adopted by the Parliament in order to highlight the all-inclusive nature of the proposed regulatory changes [emphasis added by author]: “many businesses, in particular multinationals, commonly structure their global tax position in ways that allow profit shifting towards lower tax jurisdictions or […] negotiate directly with tax authorities to obtain preferential treatment […] these and other dubious practices, such tax avoidance and aggressive tax planning, must be made illegal and appropriate sanctions implemented.” Never mind that the claim that the majority of taxpayers are engaged in profit shifting activities is unfounded and clearly disproportionate3. More importantly, the notion that tax structures that merely allow for profit shifting should be classified as a dubious practice effectively renders most tax structures to be (potentially) illegal.
2. Increased tax harmonization: Shifting tax policy prerogatives to Brussels

According to the European Parliament, focusing on developing a comprehensive strategy in the fight against tax evasion and avoidance, as well as setting up a global standard for administrative cooperation, are key priorities of international tax policies.

In regards to the proposed mechanism for coordinating the concerted efforts, the European Parliament proposes the utilization of the framework offered by the “European Semester” – i.e. the European Commission analyzing the fiscal and structural reform policies of every member state, providing recommendations, and monitoring their implementation.

The Resolution proposes to enhance the use of the European Semester by integrating the EU tax gap strategy into the annual national stability and growth programmers as well as national reform programs of the member states. The Resolution further proposes the utilization of the increased tax harmonization in order to support the wider EU policy objectives (i.e. Europe 2020 Strategy).

While these proposals are ostensibly of a technical nature, they are likely to facilitate shifting of competencies in respect to taxation policies away from the member states. Similar to other policy areas this could result in “integration by stealth,” with the European Commission setting the agenda. Three related aspects of the Resolution are noteworthy:

• the member states are urged to swiftly agree to a CCCTB4;
• the European Commission is urged to carefully study the options for the introduction of a minimum rate of corporate tax as a means of curbing damaging tax competition; and,
• the European Commission is urged to intensify its use of state aid rules (exploiting the full scope offered by the law) against aggressive tax planning and investigate all tax ruling cases (!) to verify that they are not breaking EU state aid rules.

Does the Resolution constitute a mere “wish list” of the European Parliament?
Not really. Granted, most of the proposed measures will take time to implement and for some measures (i.e. the CCCTB) it remains questionable whether establishing consensus among the member states is feasible. A recent example can be seen in the rather lackluster efforts by member states to cooperate with the European Parliament Committee mandated with investigating tax rulings5. Still, there should be little doubt that the EU remains dead serious in implementing further measures against tax avoidance – when they are not being investigated for granting state aid, most member states seem happy enough to fall in line. The EU fully cooperates with the OECD, the G20 and developing countries to address BEPS and appears to be determined to take the lead. Next on the agenda are the following:

• Extending the implementation of country-by-country reporting for cross-border companies, excluding SMEs, in all sectors and in all countries in which they operate, including non-cooperative jurisdictions and tax havens;
• The European Commission was called on by the European Parliament to come forward with an EU anti-BEPS Directive by the end of June 2015; and,
• The European Commission was called on by the European Parliament to make tackling tax evasion a top priority and draft a wide-ranging proposal against tax havens and tax avoidance.

The European Commission as a watchdog for transfer pricing

The most intriguing current development may be seen in the state aid infringement procedure by the European Commission against Luxembourg (alleged state aid to Amazon by way of tax ruling, Brussels, 07.10.2014 C(2014) 7156 final). What can be taken away from the proceeding at this early stage is that the European Commission is stipulating extremely low thresholds for qualifying tax ruling as being “selective” – a ruling is qualified as selective to the extent that it deviates from the arm’s length principle.

It should be noted that that determining the arm’s length nature of a specific transfer price arrangement is a rather complex issue, as an objective or “true” transfer price seldom exists. Based on the facts contained in the decision of the European Commission, it is not evident whether the transfer prices stipulated in the tax ruling between Amazon and Luxembourg are commensurate with the arm’s length standard or not. It is, however, clear that the European Commission is intent on basing its decision whether or not the tax ruling constitutes state aid solely on its own interpretation of the arm’s length principle6.

The proceeding against Luxembourg (Amazon) could set precedence for the European Commission acting as a “transfer pricing watchdog.” In the long-term it is conceivable that the European Commission could assume responsibilities similar to those of so-called “Arm’s Length Adjustment Service” (ALAS) of the Multistate Tax Commission in the USA. The focus of ALAS is to bundle transfer pricing–specific know-how and support individual states in conducting transfer pricing audits, including:

• Increase audit coverage of related party transactions;
• Provide the MTC Joint Audit Program with training and technical assistance to enhance the program’s ability to address related party transactions and transfer pricing issues;
• Establishing an information exchange process to support joint work by states on related party transaction issues;
• Provide technical expertise to evaluate taxpayer transfer pricing studies and, upon request, to recommend alternative state positions on related party issues; and,
• Provide timely and flexible audit, legal and economic expertise.
• The budget for ALAS was set for $2 million annually, while the services of ALAS were to yield additional revenues of about $27.5 million – that is approximately a 14 to 1 return on investment.
  Considering the above, it appears more likely than not that the EU would come up with much more impressive numbers in order to advertise the formation of a European equivalent to the ALAS.

Taxpayers beware

While it is difficult to anticipate specific effects of the political measures on tax regulations, it is evident that few international companies will remain unaffected by the OECD BEPS Action Plan or an EU anti-BEPS Directive.

The revision of the OECD Transfer Pricing Guidelines, including the introduction of country-by-country reporting, as well as guidance on adequately accounting for the value added of intangibles (focusing on economic substance rather than on legal ownership) and re-characterizing transaction for tax purposes, will translate into a more challenging tax environment.

Considering the higher degree of centralization, increased audit coverage and more discretionary decision-making by governing bodies (e.g. the European Commission challenging tax rulings), taxpayers will face increased uncertainties and thus tax risks.

As a result, taxpayers will likely have to invest significantly more efforts in order to justify the arm’s length nature transfer pricing structures in the course of tax audits. While most of these effects will take time to materialize, the potential costs for taxpayers neglecting to account for potential effects of anti-BEPS measures in structuring their international business relations could be huge.