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THE HARMONIZATION OF DOMESTIC CORPORATE INCOME TAX LAW WITH EUROPEAN LAW: THE ITALIAN EXPERIENCE1
Prof. FRANCO PAPARELLA
DEVELOPING CRITERIA FOR CALCULATING A COMMON CORPORATE INCOME TAX BASE
From a systematic point of view, developing comprehensive solutions, an issue on which Community institutions have focussed a great deal of their attention, as opposed to adopting targeted solutions aimed at eliminating specific tax obstacles that hinder the smooth functioning of the internal market, is in my opinion achieved by attempting to establish a common tax base for companies operating in several Member States. In this sense, the Commission recently concluded that «the common consolidated corporate tax base is the only means by which companies in the Internal Market can overcome these difficulties in a systematic way and true Internal Market conditions can be established in the corporate tax field»2.
Although many agree with this conclusion, the Community has however failed to move in a common direction. The failure to do so has often been attributed to the fact that decisions on tax matters have required the unanimous approval of Member States. For this reason, in the last five years there has been an attempt to adopt a more flexible and non-binding approach, mainly through the issuing of Communications, as was the case for the Code of Conduct3.
As the situation now stands, it seems that out of all the proposals, the debate has now been narrowed down to two models (which differ on the issue of group consolidation and tax rates)4. The two models are:
a) Home State Taxation (HST), whereby all branches and subsidiaries operating in different Member States are taxed according to the laws of the home state of the parent company, irrespective of their country of residence5. First, the profits of a group of companies operating in several Member States are calculated according to the rules of the tax system of the home state of the parent company6 . Then, each participating Member State continues to tax at its ordinary corporate tax rate its portion of the profits of the group's business activities in that State;
b) Common Consolidated Tax Base (CCTB), by which EU firms would be given the option of calculating their aggregate profits according to a single set of Community rules and applying the tax rates in force in the State of residence of the parent company7 (this model patterned on the model used for the first time in Denmark and subsequently adopted in France8 and Italy9).
The widely differing implications of these measures10 provide many opportunities for discussion and in the coming years this issue will likely be the impetus for wide debates11.
Evidence suggests that the Home State Taxation model is best suited for SMEs active in cross-border markets. Indeed, after various studies showing that SMEs are the hardest hit by the absence of rules allowing the offsetting of cross-border losses and by the costs incurred to exercise their cross-border activities, the Commission initiated a trial experiment on «taxation according to the rules of the State of residence»12. On the other hand, the Common Consolidated Tax Base model seems to respond to the effects of taxation of multinationals and, according to the strategies outlined by the Commission, is considered the only real solution for a common tax base.
One of the objectives of the Home State Taxation model is to reduce the training costs and administrative burdens of enterprises wishing to expand their activities internationally. Indeed, these costs and burdens are notably reduced by the fact that the parent company need not be acquainted with the regimes applicable to its foreign subsidiaries since it would be able to use the familiar tax rules of its home State. However, no such tax compliance benefits would apply to subsidiaries since they would have to provide all the information necessary to calculate the overall economic result according to the rules of the State of the parent company13.
From an institutional viewpoint, this method would heavily burden the tax authorities of the Home States since they would be required to verify that the tax base has been correctly calculated also in relation to the entities resident in other EU States. For this reason, it is imperative that there be strong cooperation and collaboration among the tax authorities of the Member States14. Nevertheless, it is reasonable to say that Home State Taxation is a solution of compromise and as such can be implemented immediately since it does not alter the domestic rules of the single Member States and it presupposes that the States' only waive their sovereignty in the calculation of the taxable base of the companies done according to the domestic rules of the parent company's State of residence.
In actual fact, an important factor in choosing between the two methods is the problem, raised in the early 90s, of offsetting cross-border losses15 .
It is worthy to note that with Communication no 726 of 24 November 2003, the Commission identified tax consolidation as a solution to the problem and expressly referred to Denmark, where it is possible to algebraically sum the losses of the subsidiaries in the hands of the taxable parent company16 . In terms of timing, it seems that we are indeed on the verge of a solution since the stance taken on the issue by the European Court of Justice, also on individual autonomous work, seems to be ahead of its time, a fact that even the Commission has acknowledged17.
Indeed, in recent decisions the Court has ruled against States that disallowed the offsetting of losses made in other Member States concluding that this violates the non-discrimination principle and infringes on the freedom of establishment and the movement of persons as per Article 39 of the EC Treaty18. In this sense, the Court concluded that rules allowing losses to be offset only if the losses are realised in the State of residence of the beneficiary were non-compliant with Community principles and declared incompatible also the various conditions that indirectly discriminated against non-residents such as the requirement that parent companies must keep two books for permanent establishments making losses or the requirement that the accounts of permanent establishments must comply with the rules of the State of the parent company.
However, the possibility of repeating what happened in the Netherlands and therefore of becoming a «country that imports losses» in cases in which these are needed to reduce the taxable base of the parent company is a real problem and cannot be ignored19. The Home State Taxation method does not seem to fully tackle this problem since - although consolidation of losses is possible only if expressly allowed in the
State of the parent company - it is possible to offset losses not only vertically (ie, by the parent company for the losses made by the foreign subsidiaries, but not vice versa) but also horizontally (ie, between losses and profits of foreign subsidiaries)20.
On this issue, I refer to the recent ruling of the European Court of Justice on the now famous Marks & Spencer plc case whereby the Court - on the basis of the principle of proportionality - deemed that a parent company's use of cross-border losses made by its foreign subsidiaries is in line with Community principles provided that the parent company is resident in a Member State that adopts a tax consolidation regime and provided that there is no possibility of the losses being used in the Member State of the subsidiary21.
In my view, that the ruling is destined to have significant effects on the legislation of those Member States that preclude the use of losses, since this possibility is expressly allowed only in Denmark, the Netherlands and France, can be easily presumed from the proposals made during the course of the judgment and the observations put forth by Finland, France, Germany, Ireland, the Netherlands and Sweden. In Italy, the recent adoption of domestic and worldwide consolidation (and of flow-through taxation), as I mentioned earlier, which makes it possible for Italian firms to use intragroup losses, even if only upon certain conditions, I think will help lessen the problem.
No less important is the debate on the creation of a common EU tax base. In 2002 the debate was widened with discussion that the achievement of a common tax base could be facilitated with the adoption of commonly accepted accounting principles in the Member States22. In this sense, attention was turned to the adoption of EC Regulation 1606 of 2002 which from 1 January 2005 requires listed companies to use International Financial Reporting Standards (IFRS) - formerly known as International Accounting Standards (IAS). Inevitably, the impact of the Regulation will be wider since the requirement is also extended to controlled and affiliated companies.
Indeed, besides guaranteeing that company accounts in the EU will be more easily comparable, the introduction of common accounting principles constitutes a starting point for the creation of a common tax base, especially if the consolidated method proposed by the Commission is implemented. In fact, it would no longer be necessary to convert the results of a subsidiary according to the rules of the State of its parent company, an extremely onerous burden for the subsidiary and the parent company as well as for the tax authorities23.
However, Italy, unlike France and Germany, failed to implement the faculty envisaged under EC Regulation 1606 of 2002 of extending the IFRS requirement also to non-listed companies in an attempt to apply uniform rules on the entire internal market. Therefore, a compromise was reached whereby the Community law of 2003 imposed the IFRS requirement only on banking, insurance and financial companies in addition to listed companies. In this way, the ground work was laid for a system of comparing financial statements which in many aspects is irrational.
In conclusion, I wish to underline that, however, signs of progress can be seen following the recent report of the Commission of 4 April 2006 COM (2006) 157 final «Implementing the Community Lisbon Programme: Progress to date and next steps towards a Common Consolidated Corporate Tax Base (CCCTB)». Indeed, this document strongly reiterates the need to achieve a common tax base, highlights the progress made and goals set by the work group, and concludes with a work plan for the immediate future (in primis, ECOFIN Council Meeting in June). It is also significant that the EU Taxation and Customs Commissioner, the Hungarian Lazslo Kovacs, was able to reach the greatest convergence of opinion among Member States, without prejudice to the everlasting problem that unanimous approval of all the States, even the smaller ones (such as Malta), is required24.
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BRIEF CONSIDERATIONS ON A TYPICALLY ITALIAN CASE:
THE ITALIAN REGIONAL TAX ON PRODUCTIVE ACTIVITIES (IRAP)
Given the repercussions that the matter is likely to have in Europe (as evidenced from the high number of Member States that participated during the course of the judgment, including Hungary), it seems to me to be opportune to mention the litigation pending before the European Court of Justice on the compatibility of IRAP with Article 33 (1) of the Sixth VAT Directive.
This is a typically Italian matter regarding a tax - of a real nature and important for domestic revenues - enacted in 1997 for the purpose of simplifying the Italian tax system and replacing no less than seven widely dissimilar taxes. At this time I will not examine the principle characteristics of IRAP nor do I see the need to analyse the events that led the Italian Constitutional Court to rule that IRAP is in line with the principles of the Italian constitution25.
I underscore however the two passages from Ruling no 256 of 10 May 2001 where the Court states that IRAP «is not levied on the taxpayer's personal income but rather on the added value produced by independently run activities» and that «the economic burden of the tax may in fact be passed on in the price of the goods or services produced, according to the laws of the marketplace, or be wholly or partly recouped by means of appropriate organisational choices». Although the Italian Court ruled that the tax was not unconstitutional, now the tax risks being censured by the Community, as clearly evidenced in the conclusions of Advocate General Christine Stix-Hackl of 14 March 200626.
The rest is recent history and can be summarised in the opinion of the Advocate General Jacobs delivered on 17 March 2005, in the reopening of the oral proceedings (in which several other Member States participated), and in the further aforementioned conclusions of the Advocate Stix-Hackl confirming the judgment of Advocate General Jacobs ruling that IRAP must be characterised as a turnover tax prohibited under Article 33 (1) of the Sixth VAT Directive.
In my opinion, both documents are extremely appreciable and precise, particularly in examining the four essential characteristics of VAT patterned on the ruling of the European Court of Justice in the Dansk Denkavit case, reaching perfectly reasonable conclusions both with regard to the irrelevance of the distinction within the ambit of the EU between direct and indirect taxes, and with regard to the fact that IRAP, as VAT, applies generally to transactions relating to goods and services with the same criterias for all productive sectors27.
Lastly, aspects of the conclusions of the Advocate Jacobs that received the most attention on the part of the Member States regarded the limited temporal effect of the judgment, which proposed a completely innovative solution making - with regard to Italy - the ruling applicable ex nunc as a consequence of the case law that attributed juridical relevance at the risk of grave economic repercussions, but with an important exception in terms of retroactivity (see the Meilicke case) based on the date of delivery of the AG's conclusions.
Given the interpretational nature of the ruling, the conclusions of the Advocate General also clarify the implications for the other Member States, so that «in accordance with the basic principle governing the effects of all of the Court's preliminary rulings on interpretation, the judgment will apply ex tunc in regard to any other tax having the relevant characteristics in another Member State» (par. 184).
CONCLUSIONS
In conclusion, in the light of the foregoing considerations, I believe that, despite recent attempts on the part of the Italian legislator, there are still important areas of Italian taxation in which harmonization has not by any means been achieved or, in any event, is seriously lagging behind the more rapid innovations
of Community institutions. It would be reasonable to say that the Italian situation is far from being homogeneous and that in certain sectors there is a pressing need to take swift action - if nothing but to prevent possible interventions by the Court of Justice - even though there are areas in which Italy is in the vanguard compared to the other Member States.
Although the reasons that have led to this situation are varied and complex (legislative instability, high levels of tax evasion, and conservative tax authorities are some of the reasons that come to mind) perhaps the most important reason is the fear of negative financial consequences. It does not appear that the Italian legislator has shown particular inclinations or openness to Community rules. On the contrary, it is safe to say that most of the important innovations that have occurred in Italy are essentially a reaction to the fear of negative consequences resulting from influential rulings of the European Court of Justice.
This is not to say that in Italy an Europeanist tax culture is not widespread. One need only think of the efforts made by leading Italian jurists to include in the plan for a European Constitution certain general tax principles in addition to the general principles already contained in the Treaty28. We are therefore in the presence of a situation in which the initiatives of cultural spheres - clearly oriented towards a more European-style system - are counter opposed to the more traditional and conservative decisions of the Italian legislator.
Clearly, it is hoped that in the years to come the Italian bodies of government will make definitive and decisive choices with a view to fully observe and harmonise national tax rules with those of the Community, while at the same time honoring fundamental constitutional taxation principles. In this sense, the principle of «progressiveness of the taxation system» contained under Article 53 of the Italian constitution is indeed an obstacle to Italy's assimilation of certain Community proposals29.
Consider in particular the proposal for a «flat tax» made by the professor and former judge of the German Constitutional Court, Paul Kirchof - a proposal based on a drastic tax rate reduction and the sweeping away of taxpayer subsidies - a move that would be in stark contrast with the principles of the Italian constitution regardless of the undoubted benefits that would arise in terms of tax simplification30.
1 Continuation, the first part was published in N 3, 2009.
2 See COM (2003) 726.
3 Indeed, as an alternative to the long-running request for modifying the Treaty and in order to pass tax decisions with a qualified majority (instead of unanimously), the European Parliament, with a recent working paper entitled Taxation in Europe: recent developments (ECON 131 of January 2003) suggests the possibility of using the instrument provided under the Treaty of Nice of enhanced cooperation, which allows single groups of Member States to overcome the minority hurdle.
4 For the sake of completion, I should add that the proposals of the European Commission envisaged two further models:
a) the European Union Corporate Income Tax (EUCIT) model, which introduces an EU-wide income tax characterised by a single tax rate and managed entirely by a Community authority on the presumption that a European Tax Code has been previously adopted and that the single Member States fully relinquish their tax rights; and
b) the Single Compulsory Harmonised Tax Base model, essentially based on a single criterion for calculating an EU-wide taxable base.
5 For an in-depth investigation of the Home State Taxation principle, see LODIN-GAMMIE, Home State Taxation, Amsterdam, 2001; STEVANATO, La tassazione dei gruppi europei: l'Home State Taxation, in Rass. trib., 2003, page 1248. In addition, for an analysis on multinational enterprises, see GALLO, Mercato unico e fiscalita: aspetti giuridici del coordinamento fiscale, in Rass. trib., 2000, page 736; GARBARINO, Imposizione diretta e imprese multinazionali nella Comunita europea, in Le Societa, 1991, page 1182.
6 In this sense, the Home State Taxation model is characterised by the fact that subsidiaries are treated as permanent establishments of the parent company given that profits are aggregated to the economic results of the parent company and are calculated according to the rules of the State in which this latter is resident.
7 However, academics point out that, in substantial terms, the consolidation method precludes competition among Member States since the applicable tax rate is not the one in force in the country of the parent company over the one applied in the State in which the income is produced, but rather is the highest rate of the two (see STEVANATO, La tassazione dei gruppi europei, op cit, page 1264). In particular, if the tax rate of the controlled company's State of residence is lower than that of the State of the controlling company, this latter State can levy an additional tax on the income from activities carried out abroad; viceversa, if the State of the parent company has the lower rate, tax will be levied in the State of the subsidiary on the activities carried out therein.
8 See ANGELUCCI, La tassazione dei gruppi di societa (Francia), in Dir. prat. trib. int., 2003, page 531.
9 I allude to the worldwide consolidation scheme referred to previously.
10 It is sufficient to underscore the incidence of losses and the different rate application system to justify the possibility of sufficiently divergent tax measures based on the criteria for calculating the tax base (for further details, see STEVANATO, La tassazione dei gruppi europei, op cit, page 1253).
11 For an in-depth analysis of the characteristics of the two models and the methods of implementation, see CERIANI-GIANNINI, Trends in EU. Proposal on taxation of transnational business profits and tax coordination, in Tax Notes International, 2003, page 31.
12 On this point, consult Document de consultation concerning L'Application a titre experimental de «l'imposition selon le regles de l'Etat de residence» aux petites et moyennes entreprises de l'UE published in January 2003 by the European Commission.
13 See LODIN-GAMMIE, Home State Taxation, op cit, page 26.
14 On the delicate issue - of a substantial and procedural nature - of rules for identifying the Home State and the correlated phenomenon of Home State shopping, see STEVANATO, La tassazione dei gruppi europei, op cit, page 1252.
15 As confirmation, we point out that in 1991 the Commission withdrew its proposal for a Council Directive concerning arrangements for the taking into account by enterprises of the losses of their permanent establishments and subsidiaries situated in other Member States (OJ C53of 28 February 1991, page 30) since the proposal was deemed to be obsolete. For an examination of the problem of using losses within the ambit of the EU, see PISTONE, Il trattamento delle perdite e l'evoluzione del diritto comunitario primario in materia di imposte dirette, in Riv. dir. trib., 2001, I, page 78.
16 Alternatively, the Commission suggests «an EU-level consolidation system in the form of a European Tax Allocation System (ETAS) based on extensive recourse to the instrument of tax credits», even though this method is clearly inadequate to govern a cross-border situation because of the sharp differences among the regimes in force in the EU Member States. On this last aspect, see PISTONE, The impact of community law on tax treaties, The Hague-London-New York, 2002, page 46; AVERY JONES, A comment on progressive taxation of non-resident and intra-EC allocation of personal tax allowances, in Eur. Tax., 2000, page 375.
17 Indeed, the Commission document states that «the Commission hopes that recent and forthcoming developments before national Courts and the ECJ will provide additional clarification of the legal situation and contribute to an increasing acceptance of the need for action in this area among European tax policy makers.»
18 On this issue, from the well-known decision of the ECJ of 15 May 1997, case C-250/95, Futura Participations SA and Singer, in Riv. dir. trib., 1998, II, page 15, with a note by MELIS, Stabili organizzazioni, obblighi contabili e riporto delle perdite; in Racc., 1997, I page 2471, as well as ECJ decision of 16 July 1998, case C-264/96, ICI, in Racc., 1998, I, page 4695, particularly significant is the more recent decision of 14 December 2000, case C-141/99, AMID, in Racc., 2002, -I-11819; in Giur. it., 2001, page 1517, with a note by ANTONINI, Riflessi del diritto di stabilimento in materia di compensazione, ai fini fiscali, tra perdite della casa madre e utili della stabile organizzazione; in Dir. prat. trib. int., 2003, page 617, with a note by BIZIOLI.
19 Indeed, the proliferation in the Netherlands of «formally resident» companies regularly operating abroad and producing significant losses that participate in fiscal units has led the Dutch tax authorities to modify the requirements for taking part in a consolidation scheme, so that subsidiaries must be effectively resident in the Netherlands.
20 For further considerations, complete with numerical examples, on the greater effectiveness of the HST model in preventing double taxation over the mere consolidation method of taxable income adopted unilaterally in the country of the parent company, as well as for keen observations on the more complex problem of the distribution of profits among Member States in relation to the State where the losses made elsewhere will be offset, see STEVANATO, La tassazione dei gruppi europei, op cit, page 1254, referring repeatedly to the contribution of LODIN-GAMMIE, Home State Taxation, op cit, passim.
21 See the decision of 13 December 2005, case C-446/03, in Riv. dir. trib., 2006, III, page 3, with a commentary by RUSSO, Tassazione di gruppo e deduzione delle perdite di societa controllate estere: un ostacolo fiscale alla liberta di stabilimento ancora in attesa di soluzione? In this regard, see also DI GREGORIO, La questione del riporto trasfrontaliero delle perdite nei grandi gruppi europei. Il caso Marks & Spencer, in Il Fisco, 2006, 1, page 587; SCARIONI-MUNI, Riflessioni sul consolidato mondiale alla luce del caso Marks & Spencer, in Boll. trib., 2005, page 1612.
22 Refer to MADDALUNO, L'armonizzazione della base imponibile del reddito societario: dai criteri della fonte all'adozione dei principi contabili internazionali, directed by DI PIETRO, in Lo stato della fiscalita europea, II, op cit, page 1107.
23 In particular, in the ambit of the EU, it is held that an important factor in using accounting principles to establish a common tax base is the need to re-examine the relationship of dependency between the accounting values and the criteria for calculating tax relevant income (for confirmation, see Commission document of 24 November 2003, 726, page 19). On this issue, see GAFFURI, I principi contabili internazionali e l'ordinamento fiscale, in Rass. trib., 2004, page 87.
24 See also KOVACS, The European Commission's Business Taxation Agenda, Oxford, 23 March 2006.
25 See the first ruling of the Italian Constitutional Court no 256/2001 of 10 May 2001.
26 For confirmation, see paragraphs 9-11.
27 In this sense, we refer to the conclusions made on the Hungarian government, which has held that a tax is not of general application if it is levied at a local or regional level (see paragraph 84 of the conclusions of the Advocate General Stix-Hackl).
28 For a critique of the draft of the European Constitution on taxation, see the conclusions and proposals by the Astrid working group in the document entitled «Trattato costituzionale per l'Europa. Proposte relative alla fiscalita» and the relevant contributions by Fantozzi, La Rosa, Marongiu and Maisto published in Riv. dir. trib., 2003, IV, page 97; DI PIETRO, presentation of the volume, Lo Stato della fiscalita nell'Unione Europea. L'esperienza e l'efficacia dell'armonizzazione, published by the Guardia di Finanza (the Italian Finance Police), I, June 2003, page 9; CARINCI, La questione fiscale nella Costituzione europea tra occasioni mancate e prospettive per il contribuente, in Rass. trib., 2005, page 543; BIZIOLI, Impostazione e Costituzione europea, in Riv. dir. trib., 2005, I, page 233.
29 Indeed, with the development of the harmonisation process, on a theoretic level, the debate was centred on verifying the existence of a system of common principles in force in the Member States. It is in this sense that studies were conducted in the light of principle of taxability codified under Article 53 of the Italian Constitution (for confirmation, see, among many others, FANTOZZI, Un'occasione sfumata?, in Riv. dir. trib., 2003, IV, page 97; DI PIETRO, The principle of equality in the tax field, directed by MEUSSEN, in The principle of equality in European taxation, London, 1999, page 115; LANG, I presupposti costituzionali dell'armonizzazione del diritto tributario in Europa, directed byAMATUCCI, in Tratt. dir. trib., II, Padua, 1994, page 765, where wide references to academic writings can be found; BIZIOLI, Potesta tributaria statuale, competenza tributaria della Comunita Europea e...competenza tributaria della Corte di Giustizia: il caso Saint-Gobain, in Riv. dir. trib., 2001,I, page 192).
30 In this same sense, see DE MITA, Partita europea sulla «flat tax» alla tedesca, in Dir. prat. trib., 2006, I, page 217.
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