European Commission vows to improve cross-border tax rules

Out-Law News | 11 Jan 2006 | 2:27 pm | 2 min. read

The European Commission is proposing to address the tax obstacles and inefficiencies faced by SMEs when doing business across borders by allowing firms to calculate their tax profits according to the tax rules of the home state of the parent company.

In a Communication adopted yesterday, the Commission proposes a voluntary trial of its “Home State Taxation” scheme, due to run for five years from 1st January 2007.

At present, businesses engaging in cross-border and international activities are required to comply not only with the tax rules of their home state, but also with the requirements of every other state in which they are based, and with which they may be unfamiliar.

According to the Commission, these compliance difficulties hit Small and Medium Enterprises (SMEs) particularly hard. For instance, tax compliance costs in an international context seem to be regressive in relation to the size of the company and are often disproportionately high for SMEs. In addition, the administrative tax formalities and book-keeping requirements are relatively more difficult to sustain for SMEs than for larger enterprises.

While the Commission would prefer to solve these difficulties by establishing a common consolidated tax base for the EU, political problems make it unlikely that such a system will be adopted soon. It is therefore proposing an interim solution for SMEs.

The proposals

The concept of Home State Taxation presented by the Commission is based on the idea of voluntary mutual recognition of tax rules by EU Member States. Under this concept, the profits of a group of companies active in more than one Member State would be computed according to the rules of one company tax system only, i.e. the system of the Home State of the parent company or head office of the group.

An SME wishing to establish a subsidiary or permanent establishment in another Member State would therefore be able to use only the tax rules with which it is already familiar.

The definition of an SME would be that commonly used in the EU – companies with less staff than 250, with a turnover of €50 million or less and/or with a balance sheet total of €43 million or less.

The Home State Taxation scheme would not mean taxation in the Home State only. It would simply mean that an SME's tax base (i.e. taxable profits) would be calculated in accordance with the rules of the Home State. Each participating Member State would then tax at its own corporate tax rate its share of the profits determined according to its share of the total payroll and/or turnover.

According to the Commission, introducing the scheme on a pilot, time-limited basis would test the practical merits of the concept for SMEs and its broader economic benefits for the EU while limiting the administrative costs and potential risks for Member States.

The Commission's Communication provides detailed elements of such a Home State Taxation pilot scheme.

It provides that Member States agreeing to introduce the scheme could do so via a bilateral or multilateral agreement, by temporarily supplementing existing double taxation treaties or multilateral conventions, or by concluding a new multilateral convention.

"Heads of Government and Member States last March highlighted the important role of SMEs in the economic development of the European Union" said László Kovács, EU Commissioner for taxation and customs. "I urge Member States, therefore, to take this opportunity to eliminate some of the tax complications that inhibit SMEs from participating in the Internal Market".

The proposals were welcomed by UEAPME, the European small and medium business organisation. Gerhard Huemer, UEAPME Director of Economic and Fiscal Policy, said: “With the costs of complying with cross-border taxation systems as high as they are, it is little wonder that only 3% of SMEs have operations in states other than their country of origin."

He continued: "The proposed scheme on Home State Taxation would greatly simplify the process of operating cross border for small firms in the EU and help to slash the prohibitively high costs associated with heterogeneous tax systems in the different Member States.”