EU Closing Tax Loophole for Multinational Firms

by: Smith and Howard

July 24, 2014

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In early June, the European Commission increased pressure on Ireland, the Netherlands and Luxembourg over their corporate tax practices, saying it would investigate deals they cut with Apple, Starbucks and Fiat. In fact it warned Ireland, which offers offshore tax status, that it could investigate more companies beyond Apple as part of its probe into taxes.

Subsequently, the European Union (EU) moved to close a loophole that has allowed multinational companies to reduce their tax bills by exploiting differences in national tax rules, ending months of negotiations and potentially boosting EU states’ tax revenues.

“The aim is to close a loophole that currently allows corporate groups to exploit mismatches between national tax rules so as to avoid paying taxes on some types of profits distributed within the group,” finance ministers said in a statement.

Creating tax law unanimity

Corporate profit-shifting has come under the international spotlight in recent years following reports of how companies such as Apple and Starbucks use complex structures to slash their tax bills.

The change in the so-called parent-subsidiary directive addresses “hybrid loan arrangements,” a combination of equity and debt often used as a tax planning tool. Some member states classify profits from such tools as a tax-deductible debt; others do not. That has prompted some multinational companies to open subsidiaries in other member states so they pay little or no tax.

“Using an (EU) directive that was based on common sense — avoid double-taxation — a few cunning devils had managed to pay no tax at all,” French Finance Minister Michel Sapin reportedly said.

EU tax law requires unanimity among member states, and getting all states on board has been an uphill struggle. Europe has been torn between the demands of small member states fiercely resisting change to low-tax regimes that attract foreign investment, and others wary of driving away big employers.

Member states will have until the end of 2015 to change their tax laws.

Other developments

German Finance Minister Wolfgang Schäuble said the EU should go even further and tackle what he said was the growing abuse of “patent boxes” — countries adopting lower taxation for companies to commercialize their research and development and their patents. Governments that offer them say they encourage innovation and high-value jobs in research and development. Critics see the scheme as government-sanctioned tax avoidance.

In another move toward more cooperation on tax issues, the Swiss government reaffirmed in June that it is willing to abolish some corporate tax regimes, such as the different treatment of domestic and foreign revenues. Disagreements over corporate taxation have strained relations between the EU and Switzerland for almost a decade.

More to come

The story isn’t over. The European Commission continues to look into tax avoidance and gather information on the tax practices of member states, including Luxembourg, which is used by many multinationals such as online retailer Amazon, U.S. equipment maker Caterpillar and U.K. mobile telecoms group Vodafone. There are likely to be more developments.

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