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Getting U.S. companies ready for Europe 1992.

GETTING U.S. COMPANIES READY FOR EUROPE 1992

What CPAs should know to help their companies--or clients--plan for the integrated EC market.

Europe is mounting a competitive challenge. In 1992, it will move closer to becoming a single market, larger in population than the United States and Japan combined. American industry cannot afford to ignore what is happening there and CPAs need to be informed about the changes the single market initiative (Europe 1992) will bring in order to help their companies or their clients deal with them.

A single European market will affect the operations of U.S. exporters and investors. The United States and the European Community (EC) are each other's largest trading partners. U.S. exports to the EC increased more than 14% between 1988 and 1989, to $86.6 billion, and this trend is likely to continue. More than 23% of U.S. exports are destined for the EC and more than 20% of EC exports come to the United States. The EC accounts for almost 40% of all direct U.S. investment abroad ($126.5 billion in 1988); in addition to Japan, the top investors in the United States include the United Kingdom, the Netherlands, West Germany and France.

BACKGROUND

The EC began in 1957, when Belgium, France, West Germany, Italy, Luxembourg and the Netherlands signed the Treaty of Rome, which called for the progressive removal of all tariff and nontariff barriers between the member states. By 1968, all tariff barriers within the EC had been eliminated and a common external trade policy established. Subsequently, Denmark, Greece, Ireland, Portugal, Spain and the United Kingdom joined, but little progress was made toward a fully integrated market.

Then in 1985 a white paper, Completing the Internal Market, detailing over 300 internal trade barriers that existed between the member states, was published. In 1987, the white paper's legislative program was formally adopted in the Single European Act (SEA) by all 12 member states. The SEA set December 31, 1992, as the target date for removal of all remaining barriers to the flow of goods, services, capital and people among member states. The framework for conducting business in Europe will be overhauled completely. By 1992, about 60% of the changes necessary for the single market should be in place. Others, particularly in fiscal and social policies, will be phased in during the rest of the decade.

Changes will occur in the areas of physical, technical and fiscal barriers. (See exhibit 1 on page 66 for an overview of the directives in each category.) When the barriers have been eliminated, the EC will be a unified market of 322 million people, offering many opportunities for U.S. companies to reap the rewards of an integrated market. However, new regulations could undermine U.S. exports to, and investments in, Europe. Companies that anticipate and respond to these regulations will be in the best positions to capitalize on opportunities in the new economic arena. The Europe 1992 legislative process is in the process of unfolding now and many directives that cover key issues for U.S. companies have already been adopted.

ENACTING THE EUROPE 1992 DIRECTIVES

The SEA created a "cooperation procedure" to enable the EC's governing bodies to enact directives related to the Europe 1992 process (see the sidebar on page 74). A directive, after being drafted by the Commission and revised as necessary by the various governing bodies, is sent to the Council of Ministers for a final vote. On most nontax legislation, it is adopted if a qualified majority (two-thirds, or 54 out of 76 votes) is reached. This system prevents the larger member states from imposing their wills on the entire EC. The individual member states then transform an adopted directive into national laws or regulations. Votes are distributed among the member states based on population. This arrangement gives France, Germany, Italy and the United Kingdom 10 votes each; Spain, 8 votes; Belgium, Greece, the Netherlands and Portugal, 5 votes each; Denmark and Ireland, 3 each; and Luxembourg, 2.

Unanimous Council decisions are required on Europe 1992 directives dealing with taxation, the free movement of people and the rights and interests of employees. All of the other Europe 1992 directives can pass without the full support of all member states.

REMOVING THE PHYSICAL BARRIERS

Physical barriers currently restrict the unhampered flow of goods and people across internal EC borders. Physical barriers to the shipment of goods include

* Transportation restrictions that favor national carriers.

* Documentation and paperwork.

* Health and safety regulations for plants and animals.

* Monitoring payment of the different value-added and excise taxes among members.

* Quotas on third-country products.

The EC has estimated these physical barriers cost almost $10 billion annually. That equals about 2% of intra-EC trade. Considered together, these barriers can increase transportation costs up to 50%.

While the Council has already adopted several directives to reduce the physical barriers for goods, less progress has been made regarding barriers to the movement of people. These include, for example, immigration and security checks at all borders. Basic checks on people must be made for noneconomic reasons, such as thwarting drug trafficking, capturing criminals and monitoring movement of noncommunity residents. These checks will be streamlined. Checks eventually will be performed only at external EC borders.

OVERCOMING TECHNICAL BARRIERS

Over one-third of the single market directives focus on technical barriers that favor national goods and services over those from other member states and non-EC countries. These barriers are the most costly in the following European industries:

* Automotive.

* Other transport equipment.

* Electrical and mechanical engineering.

* Precision and medical equipment.

* Pharmaceuticals.

* Metal articles.

* Nonmetallic mineral products.

* Food and tobacco.

* Leather.

Harmonizing the individual national regulations could reduce many trade barriers substantially. However, they could be redrafted to benefit EC companies and products to the detriment of outside nations. Additional technical barriers exist in the areas of technical product standards and specifications, government purchasing, cross-border mergers and acquisitions, financial services and company law.

ELIMINATING FISCAL BARRIERS

Fiscal barriers within the EC focus on variations in the value-added tax (VAT) and excise taxes among the member states. After border controls are removed among them, nothing will prevent consumers from purchasing items in the member states with the lowest tax rates. Currently, VAT rates range from zero to 33%. Excise taxes are levied on similar products but these rates also vary among member states.

VAT is now collected and rebated at the border. Without border controls, however, the chance for fraud increases. The Council has agreed to the elimination of VAT border formalities by December 31, 1992, after which a transitional system will become effective. In essence, the transitional system moves the border VAT formalities to within the individual company. Basically, all companies will make periodic declarations of their intra-Community transactions to the appropriate tax authorities. The VAT will continue to be the rate imposed in the country of final destination. The specifics of the transitional period, however, still need to be written.

Between now and the end of 1991, the Council will seek agreement on what VAT rates and bases will apply after 1993. This might include a minimum rate or a range of rates, along with reduced rates for certain essential goods and services. By the end of 1996, the Council will have to complete work on the final VAT plan, to be implemented after the transitional period. The only definitive aspect of the plan agreed to so far is that the payment of VAT will shift from the consuming member state's rate to the member state of origin's rate.

KEY ISSUES AFFECTING U.S. EXPORTERS AND INVESTORS

The key issues affecting U.S. companies have evolved over the past two years. Fears of "Fortress Europe" have dwindled with increased cooperation between the United States and the EC in both the public and the private sectors. In general, U.S. concerns focus on the following seven areas:

* Local content. In general, products manufactured in the EC are considered to be products of the EC. Under certain circumstances, however, the EC member states require foreign-owned companies operating in the EC to purchase a minimum percentage of locally produced components for goods sold in the EC as EC products. These local content requirements tend to force foreign-owned, EC-based subsidiaries to purchase EC-made components and raw materials, regardless of their price or quality, in order to escape import quotas and antidumping duties (to offset cases where imported products are found to be sold at less than fair value). In the past, these restrictions generally have applied to specific products--such as automobiles, electronic typewriters and copiers--manufactured by Japanese plants located in the EC.

Recently, however, much broader local-content requirements have appeared in drafts of some of the government procurement directives, as well as in the broadcasting directive adopted in 1989. In the case of broadcasting, a majority of programming time for television and radio will be reserved for "European works." The U.S. entertainment industry will be affected adversely; it supplies substantial programming to EC member states.

* Import quotas. The 12 member states currently have more than 700 protective quotas on products imported into the EC. These quotas will change. Some will be merged into one EC quota. Most quotas, because they are archaic or exist in only a few member states, will be eliminated. It is likely quotas will remain on only a few products, such as textiles, automobiles, footwear, consumer electronics and sewing machines. The most contentious quota issue revolves around automobile imports from Japan. Debate is brewing on how to merge the Italian quota, which allows only 3,000 Japanese automobile imports annually, with the open German automobile market.

Although none of the quotas currently affect U.S. products, U.S. companies are concerned. One potential problem is how the EC will classify Japanese cars manufactured in the United States and subsequently exported to the EC.

* Rules of origin. Over the past few years, EC rules of origin (concerned with the "economic nationality" of a product) have become a major issue for U.S. companies exporting to the EC. These companies believe the EC may be using these rules to promote investment in, rather than exports to, the EC.

The economic nationality of a product usually is not of major concern in international trade. It becomes a major issue, however, if the product in question is subject to trade restrictions, such as import quotas, antidumping duties or government procurement restrictions. In these instances, products are discriminated against based on their country of origin.

For example, the EC decided in 1989 that Ricoh copiers made in the United States were really Japanese products and subject to the additional 20% EC antidumping duty on imported Japanese copiers, rather than American products subject to normal tariff rates. From the U.S. perspective, the danger is future decisions of this type may discourage investment in the United States in favor of investment in the EC.

The General Agreement on Tariffs and Trade (GATT) is the international agreement establishing rules and regulations for international trade. A recent preliminary decision by a GATT panel has found the EC's antidumping circumvention law (used in the Ricoh case) is discriminatory and violates the GATT. If the final decision follows the preliminary one, then the EC will have to rewrite its antidumping law to prevent further discrimination.

* Company law. The EC is working toward creating a system of company law that will facilitate cross-border operations of multinational companies. EC rules and regulations already exist for company behavior within a member state, but not between member states. The proposed directives include the following:

1. European company statute--a new legal entity would be created with a structure based on EC rather than national laws. An EC-based company has the option of deciding whether it wants to meet the criteria for this statute. If it does, the statute would facilitate the company's cross-border operations. Benefits would include administrative savings and management flexibility. While the new entity would be subject to the tax laws of the member state in which it was headquartered, losses in one member state could be offset by profits made in another. These benefits, however, would be coupled with increased worker participation in management decisions.

2. Directive on company structure and administration--this would establish the structure and administration of public liability companies. It would harmonize the structure of management, establish guidelines for the annual general meeting of shareholders and outline how the annual audit should be conducted. One of the major stumbling blocks to its adoption, however, is the proposed participation of workers in management decisions, which some EC member states, such as the United Kingdom, oppose.

* Mergers and acquisitions. There is a merger boom in Europe now as U.S. and European companies buy up other European concerns to position themselves better for Europe 1992. In 1988, more than 2,000 cross-border mergers and acquisitions took place, the vast majority in the United Kingdom. The EC wants to facilitate this activity EC-wide. Current proposals include provisions dealing with the availability of information on proposed activities and minimum shareholder approval of deals, particularly for takeover bids.

In December 1989, the Council adopted the merger regulation, establishing an EC antitrust law. The Commission will be able to review and, where appropriate, veto mergers involving companies with worldwide revenues of more than approximately $6 billion if at least two of the companies have EC sales of more than approximately $300 million. These threshold limits will be reevaluated in 1994, at which time the EC hopes to reduce the global revenues figure to about $2 billion. The Commission expects this regulation to affect about 50 mergers annually.

* Product standards. The different industrial, health, safety and environmental standards act as formidable nontariff trade barriers. Their harmonization plays a crucial role in the creation of the single market. The EC is creating a two-pronged approach to standards.

1. The Commission will draft "essential requirements" to meet basic health, safety and environmental needs.

2. The EC will develop a testing and certification system to ensure compliance with the essential requirements.

Until the early 1980s, the EC tried to write detailed product specifications, with little success. Companies still needed to manufacture multiple versions of a product in order to sell it in the different member states. The new approach allows the Commission to focus on the function, rather than the form, of the product. The development of product standards will be performed by three European standards groups from the private sector.

One initial concern for U.S. industry was access to these European standard-setting organizations. U.S. exports could be at a competitive disadvantage if companies did not receive adequate advance knowledge of new product specifications. EC-based U.S. subsidiaries do have access to these organizations because they manufacture within the EC and therefore are considered European companies. U.S. exporters, however, can participate only in meetings of the European Telecommunications Standards Institute (ETSI), not of the two other major standards organizations--the European Committee for Standardization (CEN) and the European Committee for Electrotechnical Standardization (CENELEC).

While U.S. exporters are still prevented from participating in the CEN and the CENELEC, they do have access to needed data on product specifications. The American National Standards Institute (ANSI) receives monthly information from CEN and CENELEC on their standards activities, which is available to U.S. companies. CEN and CENELEC will consider all comments submitted to them and will be working closely with other international standards organizations.

The second concern for U.S. companies, particularly exporters, is product testing and certification. The Commission has proposed a modular approach to testing and certification to replace myriad procedures currently in place among the member states. A product tested and certified in one member state will be allowed access to the other EC markets without additional procedures. Once the modular approach is adopted, the EC is expected to begin negotiations with its major trading partners, including the United States, to develop mutual agreements recognizing testing and certification outside the EC. The elimination of duplicative procedures would save exporters time and money. It also would remove a major stumbling block to small companies wishing to enter the EC market.

* Government procurement. The public procurement market is estimated to be worth over $600 billion, yet only about 2% of the contracts are awarded to nonmember state companies. The Council has adopted directives to strengthen the bidding and award procedure for public works (construction) and public supplies; a directive on services is expected to be drafted this year. These directives, along with a pending directive on enhancing compliance, will make it easier for U.S. companies to bid on EC contracts and petition for remedies if contracts are awarded unfairly. The directives that concern U.S. industry cover the "excluded sectors" of transportation, water, energy and telecommunications.

These excluded sectors are not currently covered by EC law. The pending directives would open all member state government procurement (national and local) to EC-wide bidding for contracts offered by public and private entities in each of these sectors. Because these sectors currently are not covered by international rules on government procurement, the EC is able to add provisions that could discriminate against foreign products. The two most troublesome provisions are

1. Products that have less than 50% EC content may be excluded from EC government procurement contracts.

2. EC-made products will be given a 3% price preference over foreign products.

It is important to understand that the 50% provision is directed at the content of the product, not at the company that manufactures the good. For example, it is possible products manufactured in the United States from EC components would fall under the 50% provision.

The EC formally acknowledges that these provisions have been added as a bargaining chip in the current round of GATT multilateral trade negotiations. (Uruguay Round) on government procurement. The EC does not want to open up its procurement market in these sectors unless other countries, including the United States, do likewise. Over 96 countries are participating in a series of negotiations to liberalize further international trade in a variety of areas (including services, intellectual property [such as copyrights, patents] and trade-related investment). These provisions will be reevaluated after the Uruguay Round is completed in December 1990.

PLANNING STRATEGIES FOR EUROPE 1992

U.S. companies need to plan their operational strategies so they are positioned to take advantage of the opportunities Europe 1992 will provide. It will affect the positions of U.S. companies not only within the EC but also in U.S. and third-country markets. The integration will replace myriad member state regulations and restrictions with a single open system applicable to business operations.

Important strategy questions include

* How will Europe 1992 affect overall business strategy in the EC and internationally? Should a company consider new ways of doing business in the EC (for example, joint ventures, M&As)?

* How will Europe 1992 affect a company's current EC markets? Will government procurement contracts be more available?

* Will a company need to modify its products based on new regulations or technical standards?

* How will Europe 1992 affect production, transportation, distribution and marketing operations and the cost of doing business in the member states? Should a company restructure its multicountry operations in the EC? Should it consider using new sources of supplies?

* What will the effect of Europe 1992 legislation be on customers in the member states?

* What will the effect of Europe 1992 legislation be on competitors (European companies, other U.S. companies and companies from elsewhere, notably Japan)?

* How will EC integration affect corporate and management structures in the United States and internationally?

* Has a company prepared an alternative strategic plan for the possibility that progress toward integration will be slower than expected?

* How should information flows be managed?

* What should a company's legal and tax structures be, both internationally and with respect to the EC? How can it take advantage of any member states' tax differences that will still prevail once the single market is achieved?

* Should a company reconsider how it manages its financial resources?

* What are the ramifications of EC trade policy on direct exports to EC customers and related subsidiaries?

* Should closer links be established with the EC Commission in Brussels?

LOOKING TO THE FUTURE

Over the past year, U.S. concerns have shifted from overall fears about "Fortress Europe" to concerns about specific issues associated with the detailed provisions of the single market initiative. Lobbying efforts in Brussels have intensified and U.S. business has been quite successful in getting its voice heard. New issues, however, are emerging. Foremost among these are the recent events in Eastern Europe, including the reunification of Germany. Others include the ongoing debate to move quickly toward creating a European monetary system and a single European currency and the closing months of the current round of GATT talks. These issues should not sidetrack the U.S. focus on Europe 1992. U.S. companies need to build on the successes they have already achieved. [Exhibit 1 Omitted]

CHRIS D. SIMPSON, CPA, is a partner in the Dallas, Texas, office of Price Waterhouse. He is a member of the American Institute of CPAs international practice committee. JOHN J. KORBEL, PhD, is managing partner of Price Waterhouse's International Trade Consulting Services, in Washington, D.C.
COPYRIGHT 1990 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Korbel, John J.
Publication:Journal of Accountancy
Date:May 1, 1990
Words:3548
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