'Home State Taxation' Will Make Life Easier For EU's Small Firms

by Ulrika Lomas, Tax-News.com, Brussels

25 July 2003

The European Commission is planning to dramatically simplify the taxation procedures for firms with income derived from more than one EU member state by introducing a system known as 'home state taxation'.

It is thought the system will be aimed primarily at small firms, which bear a particularly high burden - in terms of time and cost - when complying with different taxation rules. The new system will alleviate this by allowing a firm which derives, for example, the majority of its revenue from the UK, and a small proportion from another member state, to file a single tax return with the UK authorities. The UK would then take its share, whilst the other member state would levy tax on the subsidiary at local rates.

Speaking to the Telegraph, Chas Roy-Chowdury, head of taxation at the Association of Chartered Certified Accountants, announced that the current proposal "is seriously revolutionary, innovative and radical," and revealed that he expects a pilot scheme to get under way sometime next year. "There needs to be pressure on governments to push through this very significant simplification for small businesses," Mr Roy-Chowdury added.

However, such a measure is likely to be unpopular with the British government, which may interpret the proposal as a move towards tax harmonisation. The plan may also be complicated by the spat over German 'thin capitalisation' rules, which the European Court of Justice recently pronounced were contrary to the EU law on freedom of establishment.

Such rules set out maximum ratios of debt to equity capitalisation, seeking to prevent a company from financing a cross-border subsidiary with debt rather than equity, and thus escaping withholding tax normally levied on dividend distributions by remitting profits in the form of loan interest or repayments.

The Lankhorst case involved a German company, Lankhorst-Hohorst, which was capitalised through loans by its Dutch parent. The company argued that far from being a ploy to avoid German taxes, the loans provided vitally needed support for its failing German subsidiary. The ECJ agreed, and rejected arguments put forward by the German, British and Danish governments, as well as by the European Commission, that the loan-based capitalisation structure was illegal.

"The approach of the European Court is to demolish obstacles to the single market and it does not see tax rules as a special case, despite the absence of tax harmonisation," David Evans of Ernst & Young told the Telegraph, adding that: "While the European Commission's efforts to encourage tax harmonisation are stalled, the decisions of the European Court of Justice are now having a very significant impact on the shape of tax systems across the EU."

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