An overview of corporate tax issues involving the European Community.
AS THE EUROPEAN Community begins functioning as an economic entity, more U.S. multinational companies will do business there. Among the concerns these companies face is the effect of taxes on operations.
* DESPITE ECONOMIC integration in the EC, member countries will continue to have different tax laws and rates. Because all members must approve tax changes, harmonization is unlikely in the near future.
* ALL EC MEMBERS levy both indirect and direct taxes. The most common indirect tax is the valueadded tax. Direct taxes include income and profits taxes.
* MULTINATIONAL corporations have a powerful incentive to operate in, and shift profits to, lowtax member states.
* COMPANIES DOING business overseas also must be concerned with U.S. tax laws, which tax U.S. corporations on their worldwide income. Prudent tax planning involves minimizing the overall effective tax rate worldwide.
* AS TRADE BARRIERS are lifted, tax considerations take on added importance in corporate decision making. Familiarity with EC tax issues will make it easier for CPAs to counsel clients.
In 1992, considerable attention was focused on the economic integration of member states in the European Community. This integration, designed to create a single economic market, will have far-reaching implications for U.S. multinational corporations. As trade barriers are reduced or eliminated, tax considerations will become even more important in corporate decision making.
This month, Caroline Kern Craig, CPA, PhD, associate professor of accounting, Illinois State University, Normal, and Heidi I. Todd, manager, Country Investors Life Assurance Company, Bloomington, Illinois, explain why it is important for all CPAs--not just tax practitioners-to be familiar with the tax issues faced by U.S. multinationals operating in the EC.
The movement to integrate the EC into a single market can be traced to 1951 when the European Coal and Steel Community was founded. Further integration occurred in 1957 when the Treaty of Rome established the European Economic Community and the European Atomic Energy Community. These communities combined in 1965 to form what is now referred to as the EC.
In the mid-1980s, the EC began a campaign to establish a single economic market, a move considered necessary to compete more effectively in the world marketplace. To that end, the Single European Act, an amendment to the Treaty of Rome, established December 31, 1992, as the target date for completing market integration. The act also formalized a "cooperation procedure" stipulating that only a qualified majority of member states (rather than unanimity) is required to approve legislation on most matters. Interestingly, unanimity is still required on tax matters, which will make harmonization of tax laws particularly difficult.
Given the magnitude of U.S. investment in the EC (over $100 billion in recent years), an integrated European market will undoubtedly affect how U.S. multinationals conduct foreign operations. In particular, as trade barriers are removed, tax differences between member states will greatly influence the structure and location of these operations.
Currently, all E C member states have two general categories of taxes: indirect (consumption-based) and direct (income-based). Both affect how U.S. multinationals make business decisions.
Indirect taxes. The most common indirect tax, the value-added tax (VAT), exists in all 12 member states. This tax, which is ultimately borne by the consumer of a good or service, is collected as the good or service passes through the production and distribution cycle. (A complicated system of tax credits eliminates multiple taxation and ensures the consumer bears the ultimate burden.) At a given stage of production or distribution, the tax is based on the "value added" to the good or service by that particular stage.
Most member states have at least two rate categories: a reduced rate for exports and other select items and a standard rate for essential goods and services. Some states also impose a higher rate on other items.
Although the rate categories are similar, there are notable differences in actual tax rates imposed by the member states. (See exhibit 1, below.) Efforts are under way to eliminate these disparities, but many believe market forces, rather than a vote by member states, will ultimately dictate the EC VAT rate structure.
Direct taxes. The most common direct tax is the income or profits tax. Income tax rates differ across member states. As exhibit 1 indicates, corporate income tax rates range from a low of 33% in the United Kingdom to a high of 50% in Germany.
The tax base computation also varies across member states, particularly for depreciation and capital gains. Although some effort has been made to create a uniform corporate tax structure, market integration likely will occur without complete harmonization. Indeed, if complete harmonization is required, integration may be impossible.
Clearly, both indirect and direct taxes affect the flow of capital in an integrated EC. Corporations will have powerful incentives to operate in, and shift profits to, low-tax member states. Given the current EC tax structure, one might expect to see capital shift toward Luxembourg, Spain and the United Kingdom and away from Greece and Ireland. Ideally, corporations should do business to maximize aftertax cash flows; U.S. multinationals need to continually reevaluate the structure and location of foreign operations.
Tax directives. Several new tax directives were adopted in anticipation of EC market integration and changing capital structures. Two of the more important ones involve mergers and divisions and parentsubsidiary transactions.
Under the merger and division directive, corporations involved in "cross-border' mergers and reorganizations will be allowed to defer the tax on gains resulting from such transactions. The parent-subsidiary directive exempts parent corporations from withholding taxes on dividends repatriated from a subsidiary operating within a different member state.
In addition to these directives, member states also formalized a plan to oversee arbitration of transferpricing disputes. (Transfer prices are internally determined prices charged on intracompany sales. Such prices may not be based on external market values.) In the past, these disputes resulted in double taxation for corporations operating in more than one member state. The new plan provides a uniform set of rules to arbitrate these disputes and address double taxation concerns.
Both the tax directives and the arbitration plan clearly are designed to encourage corporations to engage in cross-border operations, including mergers, joint ventures and crossborder leasing arrangements. Such activities will contribute to the EC's economic integration.
The tax position of U.S. multinationals operating in the EC will be affected not only by the EC tax system but also by U.S. tax laws. Subject to certain technical exceptions, the U.S. federal income tax is imposed on the worldwide income of all U.S. corporations. As a result, tax planning for U.S. multinationals typically revolves around minimizing the worldwide or overall effective tax rate, which can be influenced by several key elements of the U.S. tax system.
Tax treaties. Favorable tax treaties exist between the United States and all EC member states except Portugal. They provide some form of leniency for the taxation of income earned by a foreign company in a host country. Thus, it is advisable for U.S. multinationals to operate in EC countries that have existing tax treaties with the United States.
Foreign tax credit. To avoid double taxation, the U.S. tax system allows companies with so*called foreign-source income to receive credit against their U.S. tax liabilities for taxes paid to foreign countries. However, the availability of the foreign tax credit is limited.
Because of these limits, many companies have excess (or unused) foreign tax credits and are paying tax twice-- to the foreign country and the United States. The existence of these excess credits reinforces the view U.S. multinationals should structure EC operations to reduce foreign tax liabilities, eliminate excess foreign tax credits and ultimately reduce the overall effective tax rate.
Subpart F income. The Internal Revenue Cede mandates that certain types of income (known as subpart F income) earned by controlled foreign corporations be subject to U.S. taxation when earned, rather than when distributed to U.S. shareholders. In effect, the subpart F designation forces U.S. shareholders to accelerate recognition olincome for U.S. tax purposes. The taxes paid on this income generate limited foreign tax credits for U.S. corporate shareholders. Given the less-than-favorable tax treatment of subpart F income, U.S. multinationals need to monitor EC investments carefully.
IRC section 482. Section 482 empowers the Internal Revenue Service to reallocate income, deductions and credits among controlled corporations to reflect more accurately the related entities' income. This provision, one of the most powerful in the code, is aimed at forcing related entities to engage in arm's-length transactions, particularly with respect to transfer-pricing policies. As noted earlier, transfer-pricing issues have already commanded considerable attention in the EC and are likely to continue to do so as market integration becomes a reality.
IRC section 36Z Subject to certain technical exceptions, section 367 requires U.S. corporations to recognize (and pay tax on) gains resulting from transactions involving the transfer of property to a foreign corporation. This provision undoubtedly will have an impact on U.S. multinationals as they transfer assets and attempt to establish an economic presence in an integrated EC.
The economic integration of the EC will have far-reaching implications for U.S. multinationals. As trade barriers fall, tax considerations will be even more important in corporate decision making. For that reason, all CPAs should be familiar with the tax issues faced by corporations operating in the EC. Additional sources of information about these tax issues are listed in exhibit 2, at left.
R.H. Aland, "Europe 1992: Tax Planning for U.S. Multinationals," Taxes-- The Tax Magazine (December 1990), pp. 1072-1102.
M. Burge, K. Kral and M. Dionne, "New Tax Directives in Europe," Journal of Accountancy (February 1991), p. 19.
I. Carson, "Accounting for Europe's Differences," International Management (June 1991), pp. 52-55.
J.A. Frenkel, A. Razin and S. Symansky, "International VAT Harmonization," International Monetary Fund Staff Papers (December 1991), pp. 789-827.
International Bureau of Fiscal Documentation, The Taxation of Companies in Europe, 1992.
Price Waterhouse, Doing Business in the European Community, 1991. J. Sasseen, "Setting Up Shop Across Europe," International Management (June 1991), pp. 29-32.
B.C.J. van Gils, "Tax Harmonization in the European Community," CPA Journal (February 1990), p. 20.
W.J. Zink, "Europe 1992--From a Tax Perspective," The Tax Adviser (February 1991), pp. 84-87.
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|Author:||Todd, Heidi I.|
|Publication:||Journal of Accountancy|
|Date:||Jan 1, 1993|
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