Tax harmonisation in the European Union

The need to change the structure of taxation systems in Europe has increased with the pressure on fiscal revenues facing the ageing of the population and excessive deficits. Moreover, as the number of the European Union Member States has grown, the differences in tax policies in the Union have became more significant. The fifth enlargement of the European Union has strengthened tax rates competition. Highly divergent direct tax rates across Europe have raised questions about the limits of national sovereignty over direct taxes and the need to harmonise corporate taxes. As a result of the transposition of the community acquis into the national legislation of each new Member State, and given that the Treaty establishing the European Community does not directly specify provisions on direct taxes, the immediate impact of the enlargement has been first felt in the area of indirect taxes.

The new wave of flat tax regimes, implemented by some of the new EU Member States [1] , has intensified the necessity of corporate tax base harmonisation. First, decreasing direct tax rates have attracted more investors to these countries even if the tax regime is not the only factor for such a decision. After the German government’s proposal to cut the corporate income tax rate from 25% to 19% [2] , other countries think about restructuring their tax systems. In any case, the Member States’ tax policies have to be compatible with the European tax legislation although the principle of subsidiarity authorises tax sovereignty of the Member States. The political and social preferences of each country require independence in creating national tax policy. However, the divergence in the tax systems of the EU Member States has created many obstacles and therefore incompatibility with the internal market. By eliminating these distortions the Community has achieved its aim of a single market. Today, companies operate throughout Europe thanks to the common rules established in the internal market, but at the same time more distortions have been created because of differences in Member States’ interpretations of existing EU common tax rules and derogations [3] accorded to some Member States.

In the past, VAT rates and excise duties have attained a high degree of harmonisation, some areas of taxation have been coordinated and some laws have been approximated. There has never been an attempt to harmonise personal income taxes on a European level. However, the European Commission has emphasized that the coordination in the area of personal income taxes is needed to prevent double taxation of cross-border workers and other obstacles, harmful to the internal market. The Commission and the European Court of Justice share the same opinion saying that personal income taxes do not need to be harmonised. In fact, the internal market would not be disturbed without harmonisation of personal income taxes in the Union.

Even if direct taxation is not specified by the Treaty establishing the European Community (The EC Treaty), as the article 93 of the EC Treaty specifies the adoption of measures for indirect taxation, important Council Directives have been adopted in this particular area [4] . Moreover, the European Court of Justice’s pending cases concerning direct taxation have had an influence on Member States’ national legislation. Furthermore, the articles 94 and 95 [5] of the EC Treaty which do not specify the area of taxation have allowed their application to both, direct and indirect taxes.

The lack of primary law in the area of corporate taxation has been completed by directives, regulations, decisions and direct tax case law. Most provisions have aimed at coordinating the tax systems of the EU Member States although the Commission’s increasing initiative in this field expected some degree of harmonisation. The most significant are the Mergers Directive and the Parent-Subsidiary Directive adopted in 1990, the 2004 Directive on interest and royalty payments between EU companies, and the 2005 Directive applicable to mergers, divisions, transfers of assets and exchange of shares.

A common consolidated corporate tax base

The idea of a common tax base [6] for the EU companies was accepted neither by all Member States [7] nor by the whole business area [8] . First, the unanimity vote of the Council of Ministers could be an obstacle, but would possibly be resolved by closer cooperation of Member States in form of enhanced cooperation. Second, complicated technical implementation of the Common Consolidated Tax Base (CCTB) made the Member States’ governments more reluctant. Moreover, some Member States fear that a common corporate tax base could imply harmonisation of tax rates.

The proposal of a CCTB consists in existing national corporate tax systems plus a new one which would represent a new harmonised EU rule for the definition of a common tax base on a European level. Such a European system would not therefore require a harmonisation of the existing 25 taxation rules and its application would be optional [9] . A common tax base for the EU-wide companies’ functioning would be then allocated to the Member States via this rule. In this case national systems won’t be replaced, however, the most complete and transparent option would be to harmonise national rules and replace them with a single EU company taxation system [10] .

Nevertheless in the Communication COM (2003) 726 the European Commission proposed solutions allowing companies to use a single tax base. Since January 2005, the EU companies have implemented the International Accounting Standards IAS (under the International Financial Reporting Standards IFRS [11] ), which would permit linking the tax base to these standards. The IAS/IFRS would stay a neutral, common starting point for further discussions but nothing more [12] .

Already in 2001, the Commission, in the Communication COM (2001) 582, presented its view on a common consolidated corporate tax base CCTB, considering that it is the only way of eliminating obstacles from the cross-border activities of the EU companies. Moreover, some tax obstacles were identified. The priority was given to the problem of high compliance costs and the problems with cross-border loss-offset which are due to the divergence of corporate tax systems between the Member States. Given that these problems are more significant in the small and medium-sized enterprises’ activities, the Commission has developed the project of the “home state taxation of the SMEs" based on a survey of the EU companies. The tax base would be calculated in accordance with the tax code of the company’s home state [13] .

Provided that there is enough political will, the pilot strategy of home state taxation for small and medium sized enterprises is likely to be launched in 2005 as a five years programme. Even if some countries oppose the project of a common corporate tax base, the concept is well established as a long term goal [14] for EU tax policy and the accounting consolidation method would be a suitable beginning for a common company tax base. On the contrary, a jurisdiction or a legal system that would resolve conflicts between Member States on the application of such new rules has not been mentioned.

Apart from the proposed changes in the EU company taxation, companies and co-operatives have the right to establish themselves as single entities under Community law. According to the Council Regulation EC 2157/2001 and the Council Directive 2001/89/EC the European Company can be created since 2004 and the European Co-operative Society [15] from 2006 [16] . On the contrary, the Commission’s idea of creating a common tax base with the European Company was accepted but would only be put into practice under the condition of operational EU tax rules [17] .

In case of reluctance of some Member States, the Union has still the possibility to get adopted measures on taxation, like the one on a CCTB via enhanced cooperation as a last resort solution, or using other legislative options that have increased its competence. Nevertheless, Member States control the EU tax legislation because the Treaty requires unanimity vote (articles 93, 94 EC Treaty) and because the principle of subsidiarity allows Member States keeping taxation under national legislation.

Enhanced cooperation and tax policy

Meeting political decisions on tax policy in Europe was difficult because of the required unanimous decision of the Council of Ministers. Today, if some European countries oppose steps towards a European integration, a minimum of eight EU Member States will be allowed to act via enhanced cooperation. This could be the case of the establishment of a common consolidated tax base for companies. On the one side, some Member States willing to further tax policy have the possibility to agree on this issue by enhanced cooperation, provided that there are no other possibilities mentioned by treaties and that Member States follow the objectives of the Union. On the other side, the enhanced cooperation reinforces the subsidiarity principle because it represents the Member States’ initiative and moreover helps to avoid the problem of unanimity vote in the field of taxation.

The Nice Treaty has established many changes by amending general provisions [18] on closer cooperation between Member States. The articles 43-45 of the Treaty on European Union (the EU Treaty) apply to enhanced cooperation in the area covered by the EC Treaty. The Article 43 of the EU Treaty was therefore amended by the Treaty of Nice [19] . Additionally, the article 11 of the EC Treaty was amended too, so that the procedure of establishing the enhanced cooperation was changed [20] . Moreover, the principle of last resort mentioned in the Article 43a and amended by the Treaty of Nice says that such cooperation could only be established if relevant objectives can’t be achieved by applying treaties. According to the amended article 43b, the principle of openness encourages those who want to participate and is opened to all Member States to participate on enhanced cooperation when it is established and at any time after its establishment.

The Treaty of Nice facilitated the enhanced cooperation between the EU Member States. The right of veto over the establishment of enhanced cooperation, that the Member States enjoyed until the entry into force of the Treaty of Nice was abolished, except in the area of foreign policy.

Furthermore, the Treaty establishing a Constitution for Europe provides even bigger possibility for enhanced cooperation [21] and therefore allows moving further in the area of tax policy. In the context of enhanced cooperation, the article III-422 of the Constitution authorises the Council to adopt (acting unanimously in accordance with the Article I-44 – general procedure of establishment of enhanced cooperation) a European decision stipulating that it will act by a qualified majority. As a result, the Council shall decide on qualified majority even if, in principle, the unanimity is required [22] . The Constitution changes the minimum of participating states from current eight to one third of the EU Member States.

Following the article 95 of the EC Treaty in order to take some decisions on taxation has given the Union the possibility to adopt measures on qualified majority. In this article the role of the European Parliament in the legislative procedure is as important as the Council’s role because of the co-decision procedure. On the contrary, the Treaty establishing a Constitution for Europe has even restricted the role of the EP because the article III-172 of the Constitution, the successor to the article 95 EC Treaty, doesn’t involve the European Parliament.

The EU competence on tax matters

Even though the Article 95 (2) of the EC Treaty excludes fiscal provisions, some tax measures of administrative nature have been adopted using this article [23] . The article authorises the Council to adopt measures for the approximation of the provisions laid down by law, regulation or administrative action in a Member State which aim to a better functioning of the internal market. But, this only applies in accordance with the Article 14 and the Article 251 of the EC Treaty [24] .

As stated by a study [25] , some taxation measures have been adopted by co-decision procedure, none of them on direct taxation. Many Council directives have been adopted after consulting the EP not following the co-decision procedure, meaning that mainly the articles 93 et 94 EC Treaty were used, and as these do not require the Parliament’s decision, they get adopted easily and their adoption took less time.

But in fact, the article 94 (which does not specify direct or indirect taxation) and the article 93 (on indirect taxes, excise duties, turnover taxes) have allowed adopting the provisions on which the EU Member States were able to agree [26] , thus mainly on indirect taxation. That could be the reason why many Commission proposals on direct taxation were rejected. There were 33 withdrawals of Commission proposals for a Council Directive out of 42 and only one withdrawal of Commission proposal for an EP and Council Directive [27] .

Furthermore, the Commission has exclusive power under the Treaty to take decisions on whether aid granted by Member States is compatible with the article 87 of the EC Treaty. According to the article 87 EC Treaty, any aid granted by a Member State or granted through state resources, for example a tax relief, which distorts or threatens to distort competition, is incompatible with Community law, because it affects the trade between Member States and therefore affects the functioning of the internal market. However, some State aids could be considered compatible in situations which are described by the paragraphs 2 and 3 of the Article 87 [28] .

Under article 226 EC Treaty, the Commission can initiate an infringement procedure before the European Court of Justice in case of violation of Community law by a Member State.

Apart from enhanced cooperation, where the Constitution’s provisions are similar to those specified in the amended articles of the EU Treaty, the Council of Ministers shall decide [29] on fiscal provisions through the flexibility clause. If such action is necessary to achieve one of the objectives defined in the Constitution, and the Constitution has not implemented the necessary power, the Council shall adopt the appropriate measures, acting unanimously on a proposal from the European Commission and after obtaining the consent of the European Parliament. The flexibility clause of article I-18 of the Treaty establishing a Constitution for Europe allows the Union to use more power than conferred on it.

However, the article I-18 excludes harmonisation of Member States’ laws or regulations in cases where the Constitution does not authorise such measures. Given that, the article III-171 [30] of the Constitution authorises the Council to adopt harmonisation measures on indirect taxation, the flexibility clause applies also to fiscal provisions. As a consequence, the flexibility clause has widened the application of provisions of the article 308 of the EC Treaty and its use was expanded to other areas beyond the current Single Market.

In addition, the article IV-444 (2) of the Constitution covers the same area as the flexibility clause in order to adopt a European decision (for example on fiscal provisions) which would allow the Council to act on qualified majority instead of unanimity. If national parliaments do not oppose the decision of the European Council within six months from the notification of such a rule, the European decision allowing acting on qualified majority shall be adopted.

The flexibility clause as mentioned in the article I-18 of the Constitution [31] would empower the Union to act in some areas, including the fiscal area. According to the article I-18 (2), the Commission must inform national parliaments of proposals based on the flexibility clause, using the procedure for monitoring the subsidiarity principle. But as long as the unanimity is needed, the Council of Ministers shall adopt measures only on that condition.

The EU primary tax law and tax harmonisation

The EC Treaty articles constitute the primary law in the area of taxation and are, except for the article 95 of the EC Treaty, subject to the unanimity of the Council and to the subsidiarity principle.

The article 90 EC Treaty prohibits any Member State to impose directly or indirectly excessive taxation, or internal taxation to the products of other Member State, and/or any internal taxation that would form an indirect protection to other products. The article 90 EC Treaty therefore forbids tax discrimination that gives a Member State advantage to its domestic products. In case of non respect by a Member State, the matter may be subject to infringement procedure before the Court of Justice. The following articles, 91-93 EC Treaty abolish export subsidies in form of repayment of internal taxation.

According to the article 93 EC Treaty, the Council shall, acting unanimously on a proposal of the Commission and after consulting the European Parliament and the Economic and Social Committee, adopt provisions [32] for the harmonisation of legislation concerning turnover taxes, excise duties and other forms of indirect taxation, to the extent that such harmonization is necessary to ensure the establishment and the functioning of the internal market.

The article 94 EC Treaty authorises the Council, acting unanimously on a proposal from the Commission and after consulting the European Parliament and the Economic and Social Committee, to issue directives for the approximation of such laws, regulations or administrative provisions of Member States as directly affect the establishment or functioning of the common market.

The article 94 allows the Council to take measures on tax rules approximation without emphasizing that such a measure has to be focused on indirect taxation. As a consequence, the article 94 EC Treaty neither excludes issuing directives on the matter of direct taxation, nor does the article 94 encourage harmonisation. In any way, every directive must be compatible with the rules of the internal market and has to respect the fundamental freedoms of the EC Treaty. Moreover, the article 94 emphasizes that the establishment or functioning of the common market is a stricter condition for the Council’s intervention than it is in the article 93.

First, the article 93 authorises the Council to adopt provisions concerning indirect taxes, particularly to adopt provisions on the harmonisation of legislation on turnover taxes, excise duties and other forms of indirect taxation. Secondly, the article 94 which authorises the Council to issue directives for the approximation of laws etc., confirms that neither harmonisation of direct taxes nor provisions on direct taxation are included in the primary legal basis. However, an approximation of direct tax systems is possible due to the article 94, which has been used to adopt measures on direct taxation.

Compared to the article 93 of the EC Treaty, the Constitution in the article III-171 adds the avoidance of distortion of competition as the extra condition for adopting a harmonisation measure. The Council shall still act on unanimity (after consulting the European Parliament and the Economic and Social Committee), but according to the article III-171, without a proposal from the Commission.

Furthermore, the article 308 of the EC Treaty gives the Council the right to act unanimously on a proposal from the Commission and after consulting the European Parliament, if such an action is necessary to achieve the Community objective related to the functioning of the internal market. So the Council shall adopt measures (including a harmonisation measure) on direct taxation under specific conditions, not only directives for the approximation of tax laws as mentioned in the Article 94 [33] .

Given that the articles 93 and 94 EC Treaty serve as primary law in the tax field and that the legislative procedure does not require the co-decision of the European Parliament, the EP is less involved in the adoption of tax provisions. However, the EP could set up committees of inquiry, send questions on Commission proposals or appoint the Commission.

As long as the Treaty does not specify provisions on direct taxation, some measures can be adopted under article 95 EC Treaty given that such laws have as object the establishment and the functioning of the internal market and that they have been approved by both, the European Parliament and the Council of Ministers.

In the EU tax policy, the subsidiarity principle [34] which allows Member States keeping the taxation under their national legislation reinforces the fact that direct taxation should, in principle, stay under national law. In fact, Member States intend to harmonise areas in which distortions of competition can be influenced by their national means [35] , especially in the field of indirect taxation. Consequently, many provisions adopted in the past were especially Council directives on the VAT, while many Commission proposals on direct taxation have been withdrawn because the Commission wasn’t successful to get it adopted.

The subsidiarity principle

According to the subsidiarity principle, the EU Member States have independence in creating policy and legislation, which is advantageous to the new policy developments, while finding a European solution would be very long. Moreover, the tax sovereignty gives countries direct control over the tax rules and the tax revenues. Although the reform of corporate tax systems in the European Union is necessary in order to comply with the requirements of the internal market, harmonisation of direct taxes would be incompatible with the subsidiarity principle. Moreover, harmonisation of direct taxes (for example corporate tax rates) would have a negative impact on business activities, especially on the small and medium-sized enterprises. For many countries the competitive tax policy is a comparative advantage. A competitive European tax policy is beneficial to the SMEs which are considered as the biggest growth and employment creators [36] .

Since the creation of the Single Market, many distortions in the tax field have been resolved by a coordinated action at EU level. In such cases the tax sovereignty has been limited. These situations have been mainly related to cross-border problems, actions that cause obstacles to the internal market, or to tax fraud and tax avoidance. Considering that convergence of national tax legislation in the area of indirect taxes has already increased the effectiveness of the internal market, there would be no reason to harmonise direct tax legislation unless national tax policies are incompatible with the EU tax legislation. Even if there is an impact of the incompatibility of national laws with the Treaty on the four freedoms or on the right of establishment for individuals and for companies, these particular cases are subject to procedures of the European Court of Justice and thus serve as case law. Generally, there would not be a need of primary direct tax law.

To summarise the EU initiatives on tax harmonisation, only the VAT rates and the excise duties have achieved a high degree of harmonisation with the establishment of the Single Market and the abolition of intra-Community tax controls. Apart from the VAT and the excise duties, the indirect taxes may be harmonised following the article 93 EC Treaty and therefore help preventing double taxation, tax avoidance and disturbing of tax competition.

Tax coordination under the principle of subsidiarity refers to the compatibility of national legislation with treaties. At least a sufficient level of coordination is needed in the area of company taxation; however, the Commission proposed a common tax base for European companies without fixed rates, aimed in the long term at a harmonised European corporate tax base. The Commission proposal of the Home State Taxation scheme would be based on mutual recognition of the Member States’ tax rules and tax coordination. European coordination may help to avoid tax revenue losses as the capital is mobile across EU countries.

However, the personal income tax and the tax on dividends of individuals should stay under each Member State’s national rules. According to the Court of Justice, in the absence of the EU harmonisation, the personal income taxation shall be safeguarded as each Member State’s national policy. Moreover, there must not be unjustified restrictions to the free movement of services, workers, capital and the freedom of the establishment as defined in the articles 39, 43, 49 and 56 of the EC Treaty, or any direct or indirect discrimination based on nationality. In addition, general and final provisions of the EC Treaty abolish under article 293, double taxation within the Community and encourage the respect of the rights of individuals in cross-border situations.

Regarding the approximation of national tax legislation, the Code of Conduct for business taxation of 1997 has aimed apart from eliminating distortions in the Single Market, the abolition of harmful tax measures. It also included a proposal on savings taxation, and a proposal of a directive which would eliminate withholding tax on payments of interest and royalties between associated companies. In 2004, a proposal for a Code of Conduct was established in order to eliminate double taxation on profits from cross-border transfer pricing.

The tax systems of the Member States have been restructured to the extent of achieving some approximation via cooperation. In fact, as direct taxation is not directly specified by the Treaty, its harmonisation would be incompatible with Community law, but its coordination will be legally acceptable. In case of the proposal of home state taxation for SMEs, a tax rules harmonisation is not intended. On the contrary, a common tax base for companies would be a step forward to a European integration based on a harmonised rule. In any way, in the context of tax competition, the maintaining of 25 different corporate tax regimes within Europe will be in the long term difficult.

Another way for the Union to intervene in Member States’ tax policies is through the European Court of Justice’s cases. Even though Member States benefit from national sovereignty under the subsidiarity principle, they are required to apply treaties as well as the interpretation of ECJ cases.

The EU direct tax case law and the role of the European Court of Justice

An increasing number of corporate tax cases referred to the Court of Justice have strengthened the role of the ECJ in the field of direct taxation, mainly by the ECJ decisions in pending cases. Consequently, the ECJ jurisprudence has had significant influence on the application of the Treaty by all Member States because its decisions have implications for most of the EU Member States not only those involved in a case. However, some legal tax matters subject to the ECJ have authorised the application of domestic taxation rules and thus confirmed that not every measure that favours another Member State is an obstacle to the functioning of the internal market. In any case, the European Court of Justice has to deal mostly with the reluctance of some Member States to make their tax systems compatible with the EU tax legislation. The Court of Justice therefore promotes the convergence of Member States’ tax systems.

In the early 90s, the European Commission has respected the principle of subsidiarity [37] that gives countries the right to follow their national policies in the area of corporate taxation. But as many obstacles have been harmful to the functioning of the internal market, the Commission’s approach has stimulated a pro-active coordination of tax systems dealing better with the problem of those tax systems that are in conflict with Community law. In the corporate tax field, the Commission has insisted on the respect of the EU Treaty as well as the existing Council directives and has later promoted the approach of a harmonisation of some rules. The Commission Communication COM (2003) 726 resulted in the scheme application of the home state taxation for SMEs and in the possible implementation of a common tax base for EU companies. In addition, the Commission’s activity, focused on promoting the convergence of corporate tax systems has been completed by the ECJ decisions on infringement procedures. A recent example refers to the taxation of company capital by the Greek fiscal authorities, applicable (under Greek legislation) to a company transferring its registered office or place of effective management to Greece from another Member State. The European Commission considers Greek rules incompatible with the Directive 69/335/EEC which imposes tax duty only in case of the establishment of companies. Furthermore, Greek law exempts maritime and agricultural companies from taxation. Despite the Commission’s request asking Greece to conform its legislation to the EU law, Greece has not made the necessary changes. The Commission was authorised to start the infringement procedure under article 226 of the EC Treaty. If the Member State does not comply with the request of the Commission, the matter may be subject to the European Court of Justice. If the Member State fails to take measures in order to comply with the Court’s judgment, it may be imposed penalty payment under article 228 of the EC Treaty.

Another recent EU tax case was incompatible with the freedom of establishment. In April 2005, the Advocate General expressed its opinion in the Mark & Spencer case. The United Kingdom legislation authorises tax advantage to a parent UK company operating exclusively within the UK, but does not allow a tax relief (under any circumstances) to a UK company with overseas subsidiaries what therefore dissuades companies from creating subsidiaries in other Member States. As a result, the freedom of establishment is restricted and the UK tax relief scheme is incompatible with Community law. The UK system of corporate taxation provides a tax relief under which a company may surrender its losses to another company which then may deduct those losses from its taxable profits. In any case, the relief may be granted only to a surrendering company operating in the United Kingdom because offsetting losses at foreign subsidiaries is against the UK corporate tax law. However, such a regime would be compatible with the freedom of establishment if it allowed deducting losses of foreign subsidiaries under condition that those companies won’t benefit from other tax relief in Member States where their foreign subsidiaries are established.

Even if offsetting losses cross-border may be difficult to accept for some of the EU Member States there is a need to harmonise the tax treatment of losses between domestic and foreign subsidiaries in the European Union. Consequently, the Commission will aim to achieve a new proposal [38] so that a directive can be adopted in this area.

At the same time, multilateral tax treaties on double taxation (mainly on taxation of cross-border workers) between Member States will continue to be reviewed by the ECJ. The company exit taxes in case of the migration of companies is another ongoing issue as well as the tax exit rules on individuals which are designed to prevent tax avoidance by moving abroad [39] . In the area of VAT rates, transitional measures such as zero rates and certain reduced rates have been tolerated; but it is desirable to have reduced rates that would apply to all EU Member States equally [40] .


The current application of Council directives, the ECJ direct case law and soft law measures [41] have raised questions about the efficiency of direct tax legislation. While using a non-legal approach like the Code of Conduct on Business Taxation has had weak enforceability and as the political will of Member States is insufficient, the progress in EU direct tax rules seems limited.

Indeed, soft law measures have no legally binding force and being often the result of the European Commission or its working groups, they largely promote the Commission’s view. On the contrary, the European Parliament is hardly involved in the tax field. Despite the ECJ cases, removing cross-border obstacles has been slow and has not implied convergence of Member States policies, but issued amendments to the Member States’ legislation, incompatible with the Treaty. Consequently, the specification of a direct tax primary law would make tax cooperation easier, because it would precise the limits of the Union’s competence on direct taxation. As long as a proposal from the Commission is needed [42] in all 93-95 EC Treaty articles, the Commission will attempt to propose more harmonisation measures on company taxation, without affecting tax rates. Furthermore, the Commission still intends to implement qualified majority voting in more areas of taxation [43] . Even if a Commission proposal seems beneficial to EU tax policy, the Member States’ veto will likely slow any process of harmonisation. Finding an agreement on a common company tax base is achievable, but changing rules on VAT rates or corporate tax rates would be a challenge.

In any case, the European Court of Justice only decides on interpretation of European law related to those cases which have created distortions in the internal market and therefore has no authority to order any restructuring of Member States’ direct tax systems. The ECJ’s impact on tax regimes of the EU Member States is low; yet its influence on the Commission’s opinion remains real.