Taxation: the final frontier

Date: 09/10/1997

TAXATION Commissioner Mario Monti could go down in history as a great plumber if he can succeed in stopping up the tax leaks and re-channelling Europe's revenues by the end of the year.

Monti is going against the flow of political precedent - and, some would say, practicability and prudence - in trying to force EU governments to tamper with their tax regimes on such liquid commodities as international investment cash and individual savings.

Delivering on the Commissioner's plans to put a brake on governments unfairly attracting footloose companies to their backyards, stop tax dodging by non-residents and partially shake up some aspects of indirect taxation will be a tall order.

While the Italian's aides talk up the chances of success, many who have seen past Commissioners come to grief on the same path of tax reform say Monti is on a mission impossible.

Governments have consistently thrown out past attempts by the European Commission to tamper with their tax policies. “It would be significant if we succeed. We have not had any success in this area at all before,” admitted one official.

However, this time at least Monti could claim to have the tide of events running in his favour. The arrival of the euro has focused minds on tax as one of the Union's great unresolved issues.

The single currency will bring down yet one more barrier to the movement of company funds across borders and add one more incentive for tax dodging by removing the costs of currency exchange. Government constraints on capital movements have already disappeared.

“As regulatory barriers in the single market are dismantled, taxation is increasingly identifiable as a key factor influencing economic decisions. And as the introduction of the single currency eliminates exchange rate risks and reduces transmission costs, the differences between national tax regimes ... will become more visible and will have an even greater influence on the allocation of capital,” says a report by the Commissioner which will be discussed by EU finance ministers at a meeting next Monday (13 October).

Monti's arguments for action are also bolstered by the approach of the era of electronic trade and commerce, which will allow firms even more freedom of choice on where to base themselves and promises to make electronic banking and payments an everyday occurrence.

Jobs are perhaps the best card that Monti has to play. Governments will only be able to reverse the trend towards higher charges on labour and lower levies on capital if the threat of being trumped by a neighbour's tax regime is removed first, argues Monti, who points to figures laying the blame for nearly half of Europe's unemployment on the increased taxation of labour. Next month's Luxembourg jobs summit is conveniently timed for him to hammer home this point.

The Commission has couched its demands cautiously, first of all asking for governments to sign up to a code of conduct on tax, rather than a directive, and suggesting a freeze on further harmful measures before attempting to challenge those that already exist. “It is a small step, but extremely significant,” said an official.

“Over a period of years some progress will be made, but it could take a few years to feed through,” said Anno Rainer, director of the tax department of Deloitte and Touche Consultants NV, Brussels. “The euro has had a certain impact. Without it, member states might not feel the need to tackle the differences in their tax systems.”

The big question is whether governments will buy Monti's arguments. Here, a broad distinction can be drawn between the EU's largest countries, such as France and Germany, which are mostly lined up firmly behind Monti's moves and the smaller ones, such as Luxembourg and Ireland, which have arguably been the biggest promoters and beneficiaries of unfair tax competition.

However, even among the big boys there is uncertainty over how Monti's plans will pan out.

British officials will confidently say that the changes will have little effect on them. But mention the tax haven Channel Islands and they admit it is unclear whether they would be covered by Monti's tax code or not.

The Spanish will argue that the special tax status of the Canary Islands should not be touched, brandishing the fact that it has had an independent tax regime since the Middle Ages and pointing to Amsterdam Treaty provisions on peripheral regions as an extra defence. The Channel Islands and Gibraltar are, concidentally, the first places Madrid officials cite when asked where the code should bite.

Everyone appears to be favour of the code of tax conduct - as long as it applies to someone else. But everyone seems to be agreed on one point: that Luxembourg should make the biggest sacrifices.

The Grand Duchy's refusal to tax savings interest combined with its strict banking secrecy laws have enabled it to draw in savings from all over Europe, but especially from Germany, France and Belgium. Germany has estimated that 20.5 billion ecu a year make the short journey across its border into Luxembourg's welcoming banks.

“Concessions from Luxembourg are crucial,” said an official, who added that the least painful option for the Grand Duchy might be to sign up to a fairly low EU minimum rate of tax on savings, perhaps between 10&percent; and 15&percent; of earnings.

That is a move which Luxembourg has so far fiercely resisted, arguing that it is better to have a major tax haven in the Union with funds flowing in rather than no haven at all with funds flowing out to the likes of Switzerland or the Caribbean.

Now, however, its Prime Minister Jean-Claude Junker says he will accept a withholding tax as long as it is part of a much broader package of tax harmonisation. How much harmonisation Luxembourg will demand as the price for its surrender has not been disclosed. “It is a very political point,” said one official.

The other option suggested by Monti is for increased cooperation between governments on declaring tax earnings by non-residents. This would call in particular for both Luxembourg and Austria to relax their tough laws on bank secrecy.

The problem of investment and personal funds leaving the Union is one which Commission officials do not downplay. They would like developed countries to sign up to an Organisation for Economic Cooperation and Development (OECD) code on tax competition.

Talks about such a code have already been launched, but officials say other industrial powers are looking for the EU to take a lead. “It is a bit of a chicken and egg situation. If we do something, the others will be more prepared to follow,” said one.

Discussions at the OECD and Group of Seven (G7) on harmful tax have already been going on for 18 months. The G7's meeting in Birmingham, UK, next year is expected to endorse a code similar to that proposed by Monti with provisions for increased exchange of information between countries, guidelines against abusive regimes, and the creation of a permanent forum dealing with the issue.

“This is very advanced, the two projects are going forward in tandem. All of the G7, Japan, the US and Canada are very enthusiastic,” said an OECD official.