European Community's new directives.

Much has been said and written about 1992 and the European Community's (EC) integration. Now that 1992 has arrived, we can look at Europe's political developments and realize that 1992 is just a starting point for the many changes that will take place. These changes will generally span years, and tax developments will progress in the same fashion.

To facilitate the necessary commercial changes, the EC has issued two directives in the tax field, effective Jan. 1, 1992. One directive deals with parent companies and subsidiaries; the other with mergers, divisions and contributions of assets.

Under the first directive, if at least 25% of the stock of a corporation that is resident in a member state is held by a corporation that is resident in another member state, any dividends paid to the parent will be exempt from withholding tax. The directive allows a member state to require a holding period of up to two years. Some member states have enacted legislation requiring a one-year holding period.

There are exceptions. In general, there will be a 5% withholding tax on dividends from a German company until mid-1996. Greece, generally, has been excepted from this directive because of differences in its tax system. Portugal will gradually phase out its withholding tax by the year 2000.

Under the mergers directive, the EC members intend that corporate reorganizations be tax free and any capital gains arising from specified transactions be deferred in a manner similar to the reorganization provisions in the U.S. Internal Revenue Code. Specific definitions have been given to various terms that will be uniformly applied. This directive currently applies to all EC members except Portugal, which becomes subject to it on Jan. 1, 1993.

Although these directives have become effective, the domestic law in a particular country may not, as yet, have been conformed. Consequently, the local taxing authority may not initially comply with these directives. In this event, the taxpayer may appear before the European Court of Justice, which will resolve the conflict and enforce the directives. All EC member states whose domestic laws have not been conformed are presently working to make the necessary changes.

Proposed to take effect Jan. 1, 1993 are directives relating to interest and royalties, and the use of related-party losses. These directives still have to be formally issued by the EC commission. With respect to interest and royalties, withholding tax would be eliminated if payments were made to a 25%-or-more shareholder. As with the existing directives, certain exceptions would apply.

For related-party losses, the directive would allow losses of a subsidiary that is resident in one member state to offset the income of a parent company that is resident in another member state. The minimum ownership requirement is 75% and a majority of the voting rights would be required, unless a lower ownership requirement is approved by a member county. However, this loss relief would be recaptured after five years so that the effect would be only a timing benefit. No exceptions to this directive have been proposed.

Beyond 1993, two directives have been drafted but their proposed effective dates have yet to be determined. The first of these future directives involves arbitration procedures relating to transfer pricing issues, in an attempt to eliminate double taxation resulting from intercompany pricing adjustments. These proposed procedures would supplement existing competent authority procedures. (The U.S. competent authority procedures are set forth in Rev. Procs. 91-23 and 91-26.)

The other directive deals with the treatment of loss carryovers. This directive is necessary due to the differences in the treatment of such carryovers under the member states' tax systems. The proposal is an option to either carry losses back three years and then forward indefinitely of to forgo the carryback period.

In addition to these directives, a number of changes are also in process for the value added tax (VAT). The EC hopes to have a uniform system and VAT rate by 2000.

There still is much to be done, even in the tax area, to achieve European harmony; 1992 is simply the starting point. A committee formed in 1990, called the Ruding Committee, is presently examining other potential areas for revising company taxation to facilitate the EC's proper functioning. The committee's report is due this spring.

The EC presently consists of Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain and the United Kingdom.

From Craig S. Hartman, CPA, New York, N.Y.