THE MAJOR ISSUES

What is tax co-ordination?

5. Looking at the terms used in relation to taxation policy in the European Union, we understand "co-ordination" as having fewer connotations of compulsion and imposition from above than "harmonisation", and as leaving more room for variations as between Member States. But, whatever terminology is used, in our view the crucial point is that it is no longer practicable for Member States to establish some elements of their tax régimes in isolation, without recognising their interdependence with other Member States. In our Report, we shall refer to the results of this approach as "co-ordination". We note from the outset, however, that despite all the attention which it is receiving we believe that there are more important issues currently facing the European Union (paragraphs 51-56).

What is tax competition? When is it harmful?

6. We do not believe either that tax competition is always harmful or that it never is. In other words, we accept that some types of tax competition may be harmful, though we note that they are not easy to define exactly, and that they may bring benefits to one Member State at the expense of others. We noted a possible analogy between predatory pricing, a recognised concept in competition policy, and what one might term "predatory tax measures" (paragraphs 57-61).

Does the Single Market require more tax co-ordination?

7. We do not think that a general answer can be given to the question of whether the Single Market requires more tax co-ordination. Decisions on taxation (especially direct taxation) are primarily for individual Member States, but they cannot always be taken in isolation. Of its nature the Single Market will tend to lead towards some convergence of tax rates. But it may also lead to pressures to introduce selective tax inducements, and in this regard some positive co-ordination between Member States may be necessary. We would emphasise that there will always be a trade-off between limitations to national freedom of action and gains from co-ordination, which must be considered in relation to each proposal (paragraphs 62-73).

Will progress on the Single Market for financial services require more tax co-ordination?

8. We attach importance to the completion of the Single Market. Cross-border selling should be easier for financial services than for goods, because there is no need for physical transport. So in the long-term, in the absence of other impediments, the financial services sector would be likely to show a high degree of integration. A non-distortionary tax régime would help to maximise the gains from this integration. We had therefore expected that witnesses might use this argument in support of tax co-ordination. In fact, they did not, other than arguing in favour of some minor tax adjustment measures (for example of stamp duty on share transactions) on condition that they did not damage the competitive position of EU Member States in relation to third countries (paragraphs 74-77).

Does EMU require more tax co-ordination?

9. There is more than one view on this question. One is that EMU increases the pressure for tax co-ordination since the successful management of monetary and tax policies can be achieved only if both are under the same political control. The other is that since national governments can no longer have recourse to monetary policy they have an even greater need to use tax policy to manage their economies in pursuit of legitimate national objectives. This argues against the view that the single currency in itself must lead to greater tax co-ordination (paragraphs 78-80).

Is it sensible to consider tax co-ordination limited to European Union Member States?

10. We can see that, particularly in an era of globalisation and increasing electronic commerce, tax co-ordination measures could be genuinely effective only if they applied in third countries as well as in EU Member States. However, although we commend the work of the OECD in this field, we are not optimistic that third countries will soon fall into line with measures adopted in the EU to prevent harmful tax competition, because we cannot see what incentive there is for them to do so. We do not think that this should be used as an excuse for doing nothing within the EU in the meanwhile, but we do underline the need to consider the effect of proposed measures on the position of the EU on the global playing field, when others will be playing by different rules (paragraphs 81-83).

Would tax co-ordination necessitate central control?

11. Enforcement of current tax legislation can require co­operation between Member States and the Commission; so would enforcement of some of the proposals now on the table. Broader ideas which have been floated in relation to corporate tax and VAT might lead towards more centralisation, which in turn could lead to a loss of political control for Member States. National governments will need to keep a watchful eye on that aspect of proposals which come forward (paragraphs 84-89).

Would increased tax co-ordination lead to a higher tax burden?

12. Whether greater co­ordination would lead to a higher tax burden obviously depends on the effect of the actual measures adopted both on tax rates and on tax bases. If the elimination of "tax breaks" enables the base to be broadened, the same total revenue could be derived from lower tax rates. But the most significant point is that while tax decisions remain with Member States, the wish of politicians to be re-elected acts as a restraint. We consider that there would be a danger of upward alignment continuing unchecked if tax decisions were handed over to a supranational body which was not accountable to an electorate (paragraphs 90-92).

Does the present tax system contribute to high levels of unemployment?

13. Within their domestic tax structures, Member States have tended to reduce taxes on income from capital, in order to reduce capital outflow. The Commission argues that this has caused taxes on labour to rise, which in turn has contributed to high levels of unemployment; it concludes that measures to increase the revenue from taxation of income from capital would reduce unemployment. Other witnesses suggested that, although high labour taxes could well have contributed to unemployment in some Member States, there was insufficient evidence to show either that the measures which the Commission was now proposing in relation to taxes on capital income would lead to a reduction in taxes on labour, or that even if they did this would lead to a reduction of unemployment across the European Union. The possible links between the distribution of the tax burden and unemployment are complex, and we do not consider that there is firm enough evidence to support the causal connection which the Commission suggests. It follows that we do not agree with the Commission that employment promotion is an argument which can be used to support the proposed tax co-ordination measures (paragraphs 93-99).

Could tax changes be imposed on the United Kingdom?

14. We note the commitment of the Government to the principles of national competence, subsidiarity and unanimity in tax matters. We also note that the Government is inclined to adopt a pragmatic view on the issue of subsidiarity when it judges measures to be in the interests of British business; we welcome this.

15. We recognise that the concept of national sovereignty in tax matters is subject to market pressures. When tax bases are highly mobile, governments may be unable to set tax rates that differ to any great extent from the rates ruling elsewhere; because capital is so mobile, this applies particularly to taxes on the income from savings. The effect in practice is to reduce the fiscal sovereignty of individual Member States. We recognise that international co-ordination may be a way for Member States collectively to regain some of the fiscal sovereignty which they have lost at a national level as a result of market integration.

16. We consider that there is no case for any departure from the principle of unanimity unless and until such a departure has been openly and explicitly made by a change to the Treaty; such a departure would itself require unanimous approval. We note that this issue is likely to arise at the next IGC. We agree that the principle of unanimity should be maintained for major issues. But we are also agreed that that principle need not necessarily be extended to cover all minor administrative measures dealing with taxation, especially as the number of Member States increases.

17. We note that, like any other European Union measures, tax proposals are the subject of negotiation. The outcome of such bargaining may involve the pooling of sovereignty, which some may see as a reduction of sovereignty. We do not believe that this possible outcome should influence the Government's position on the present tax co-ordination proposals (paragraphs 100-115).

THE PROPOSALS ON THE TABLE: DIRECT TAXATION

The Code of Conduct for business taxation

18. The resolution on a Code of Conduct for business taxation was unanimously adopted at ECOFIN in December 1997 as part of a "package to tackle harmful tax competition". The Code concerns "those measures which affect, or which may affect, in a significant way the location of business activity in the Community", which are to be regarded as "potentially harmful" if they "provide for a significantly lower effective level of taxation … than that which generally applies in the Member State in question"; a judgement is then made as to whether they are actually harmful. Member States commit themselves not to introduce new tax measures which are harmful within the meaning of the Code, and to amend their laws and practices as necessary with a view to eliminating any existing harmful measures as soon as possible. Work on the Code of Conduct is being taken forward by a Group chaired by the Paymaster General. We have a number of concerns about the Code of Conduct and the proceedings of the Code of Conduct Group (paragraphs 116-122).

19. We remain unclear about the implications for the United Kingdom of having agreed to this Code, in particular in relation to national sovereignty and to the principle of unanimity in tax matters. However often the Government repeats that the Code is not legally binding, it seems to us that agreeing to it has obviously created a moral if not a legal obligation on the Government to "roll back" tax measures which are ultimately deemed to be "harmful", and not to introduce new measures of the same kind. The actual impact on the United Kingdom will of course depend on which (if any) of our tax measures are deemed harmful. But there remains the risk that the process could lead to the United Kingdom being obliged - in practice if not in law - to adopt tax measures damaging to the interests of the economy or of citizens. This would matter less if all other Member States took the same view as to how binding the Code was, but we are not convinced that they do. This raises the fundamental question of whether a Code of Conduct approach can work, and work equitably, in a body with such diverse styles of government as the European Union. We think that Parliament deserves a much clearer explanation of how the system is supposed to work than the Government has so far provided (paragraphs 123-128).

20. We are left in as much ignorance as anyone else about the way in which the Code of Conduct Group is going about its business. We think that the lack of transparency in the handling of this matter shows both the Council of Ministers and the Government in a very poor light. It leaves the Code of Conduct open to being described as an obnoxious method of inflicting secret taxation, when in fact it may be little more than an innocuous discussion group. We note that the Government has now had some contact with United Kingdom industry about the proposals. We are not aware of the content of these discussions, but they have clearly been insufficient either to elicit a useful response or to calm fears. And contact with industry does nothing to remedy the deplorable lack of accountability to Parliament. We recognise the difficulty of changing the rules of a game which is already in progress, but we consider that given the extent of the leaks which have already occurred (and are likely to continue) there can be no justification for refusing to reveal the facts. We call upon the Government to seek agreement from other Member States that the progress reports which the Code of Conduct Group makes to ECOFIN should be published, and should be subject to Parliamentary scrutiny in the normal way (paragraphs 129-136).

21. We decided not to give detailed consideration to the question of how the Code of Conduct might apply to the United Kingdom's overseas and dependent territories, because the House of Commons Treasury Select Committee had announced its intention of carrying out a short enquiry into this aspect of the proposal. We would only comment that transparency is, if anything, even more important in the handling of matters concerning dependent or associated territories. We hope that they have been kept fully in touch with the Government's position. We fear that this may not have been the case, since rumours fed by continuing uncertainty - and alarmist, in the light of what the Minister told us - have been allowed to remain in currency for so long (paragraphs 137-141).

22. We note that the policy controlling State aid, which the Government accepted as part of the acquis, is not just co-ordinated but unified, and is administered directly by the Commission. We wonder how this chimes with the Government's insistence on unanimity for tax measures, particularly when (at least as far as the United Kingdom is concerned) the Code of Conduct Group appears to be maximising the overlap with the State aid provisions by focusing on sectoral, tightly targeted measures. This causes us to wonder whether the Code of Conduct Group is actually being seen as a method for identifying measures to be tackled by the Commission under the State aid provisions, and whether this explains the Government's apparent lack of concern about the way in which the findings of the Code of Conduct Group will be implemented (paragraphs 142-146).

Taxation of interest and royalty payments between associated companies

23. This proposal provides for the abolition of taxes collected at source on cross-border interest or royalty payments between companies with cross-shareholdings of at least 25 per cent. We recognise that it does not solve the fundamental problems of multinational corporations which operate in a number of Member States, but we consider that it would be a useful step in the right direction. We accept the Government's position that it is not sensible to stand on the letter of subsidiarity when the interests of British business could be furthered by the proposal. Subject to the results of the regulatory impact assessment being satisfactory and to any necessary amendments of detail being made, we therefore urge the Government to press for this proposal to be adopted as soon as possible (paragraphs 147-150).

Taxation of income from savings (the "withholding tax" proposal)

24. This proposal relates to the taxation of interest paid in one Member State to individuals who are resident in another Member State. It actually proposes not simply a withholding tax but a so-called "co-existence model", whereby Member States could choose either to impose a withholding tax at source on such payments at a rate of 20 per cent, or to provide the Member State where the recipient is resident for tax purposes with enough information about the payments to ensure that they can be taxed on receipt according to its legislation. In view of the strength of opposition to this proposal, we looked carefully at why it had aroused such controversy, taking very extensive oral and written evidence from City representatives and others (paragraphs 151-160).

25. Payments on which interest is not deducted at source, and which are not reported to the tax authorities, offer scope for tax avoidance or tax evasion. When this occurs between EU Member States, it affects the pattern of capital flows. It also creates inequities: if people who are unable or unwilling to place their savings abroad pay more tax than those who do, the revenue lost must be raised in other ways. We believe that this must be constantly borne in mind (paragraphs 161-169).

26. Despite claims and counter-claims, we are left with no firm evidence about the likely scale of the effect of a withholding tax on the City of London. There is a genuine fear, reasonably based, that its introduction would damage the City by making Eurobonds issued from a tax haven relatively more attractive to EU investors. We accept that there would be damage as a result of an outflow of business. We tried to collect evidence which would enable us to quantify the likely extent of this damage, but such figures as were forthcoming were insufficiently substantiated and too disparate to be convincing. We expect the long-awaited paper which the Government is producing in conjunction with the City to shed further light on this matter; without it we are not able to reach a conclusion on the likely scale of the effect (paragraphs 170-175).

27. It has been argued that the additional costs and practical problems imposed by the reporting option would have effects just as disastrous as the imposition of the withholding tax. But in the absence of more concrete evidence than we received, we were not persuaded by this argument.

28. However, we have serious doubts that a co-existence model (with some Member States adopting the withholding tax option and others the reporting option) could work in the form currently proposed. The problem of distributing the resulting tax revenue is a major one, which the Commission's proposal does not address. We are puzzled by this, and we wonder whether it results from a wish to press all Member States into adopting the withholding tax rather than the alternative route; if so, we would regard it as disingenuous. We agree with the Government that, if any change is to be made, the adoption of the reporting option on an EU-wide basis would be preferable to the imposition of a withholding tax.

29. Considering whether this would be a practicable way forward, we find it difficult to accept that the insistence of a few Member States on maintaining bank secrecy should force others to adopt a manifestly unsatisfactory solution to the problem of evasion which undoubtedly exists. We were surprised that HM Treasury had needed time to assemble information on banking secrecy in other Member States; we would have thought that the Government would already have this information to hand to formulate its negotiating position on the Directive (and indeed that the Commission would have analysed it as part of the process of considering how to deal with evasion). But we were encouraged to hear the Paymaster General's claim that the German Government—previously one of the main proponents of bank secrecy—now accepted that exchange of information was the best way forward (paragraphs 176-186).

30. In relation to the short term effects if the proposal were to go ahead, we note the view that problems arising from private sector contracts, voluntarily assumed, should not be allowed to affect public policy decisions. Nevertheless, we can see that there is an argument for the adoption of a "grandfathering" arrangement (allowing interest on existing Eurobonds to continue to be paid gross) to avoid massive disruption of the market.

31. Looking at the longer term effects of the proposal, we note that the OECD is seeking a solution on a broader basis than simply the European Union, but we cannot see what small tax-haven countries outside the EU would gain from taking part in such an arrangement. It follows that if the proposal were adopted the danger of driving the Eurobond market out of the City of London - and indeed out of the European Union - would remain. We agree that this potential cost exists, and that the benefits from the Directive to set against those costs might be limited, but we have no basis on which to quantify either.

32. We have not therefore been able to reach agreement on the best way forward. It is argued in some quarters that there are no feasible amendments to the proposal which might make it acceptable, and that unless the proposal is withdrawn the United Kingdom should use its veto, even though this could mean paying a price in negotiating terms. Another view is that it may be possible to find an acceptable version of the proposal, either by making appropriate exemptions from the withholding tax (to limit damage to the Eurobond market, and hence to the City of London), or by ensuring that Member States choosing the reporting option do not thereby lose revenue. Without access to the evidence about the likely scale of impact on the City which the Government has been collecting for the past year, we have no basis on which to reach a conclusion on this proposal (paragraphs 187-199).

THE PROPOSALS ON THE TABLE: INDIRECT TAXATION

Value added tax

33. When the proposal to introduce a maximum standard rate of VAT came before us for scrutiny, we shared the Government's doubts about it. We therefore welcomed the Council's decision to substitute a Minute Statement, which has no legal force (paragraphs 200-204).

34. We do not believe that the proposed experiment to allow Member States to charge reduced rates of VAT on labour-intensive services would have much effect in boosting employment, but equally we do not believe that it would do much harm (paragraphs 205-206).

35. When we first considered the proposal for reform of the VAT committee, we were concerned that differences in interpretation and implementation of the VAT legislation were leading to uncertainty for businesses and governments and to the risk of double taxation or non-taxation. We took the view that if businesses supported the proposal, the Government's opposition to it would not be in the best interests of the full and equitable operation of the Single Market. We remain of that view, particularly if a "safety stage" can be incorporated in the procedure to allow Member States to veto proposals which would have serious budgetary implications for them. But we also commend the Government's pragmatic approach to making the procedures of the VAT committee more effective (paragraphs 207-209).

36. We hope that the Government will not feel obliged to continue to block the proposal for improved mutual assistance for the recovery of cross-border tax debts on the grounds that it should be subject to unanimity not qualified majority voting. It seems to us a useful administrative measure, which could significantly improve recovery rates for indirect and direct taxes, and it is a pity to lose the potential gains because of a point of dogma. We could not understand how the proposal could have an adverse effect on the revenue of the United Kingdom - and if, as HM Customs and Excise suggest, "it would have a direct impact on the taxpayer who is pursued for their debt in another Member State", the Government is surely in favour of its residents paying the taxes due from them wherever they occur (paragraphs 210-212).

37. We consider that it would be desirable to reduce administrative burdens on businesses by simplifying the procedures for reclaiming VAT, and we do not think that this change of itself would be objectionable on subsidiarity grounds. We think that it could be introduced without harmonising the blocking rules, a proposal which we would not wish to accept (paragraph 213-215).

38. In general, we have no objection to proposals tidying up VAT arrangements, provided there are no significant new administrative burdens. Nor would we be concerned if proposals relating purely to the administration of VAT were adopted by qualified majority voting, or provided for subsequent decisions to be taken by qualified majority voting (paragraph 216).

Energy taxation

39. We decided that to cover the proposal for the taxation of energy products would make our enquiry unmanageably broad, not least because the issues on energy taxation are as much environmental as financial (paragraphs 217-218).

Excise duties

40. No acceptable proposals—or even principles—have yet been put forward in respect to excise duties. We share the Government's regret at this situation, but because of it we have not considered excise duties in the course of this enquiry (paragraphs 219-220).

IDEAS FOR THE LONGER TERM

Reform of the system of corporate taxation

41. In view of the increasing integration of business within the EU and increasing globalisation, there are some attractions for both companies and tax authorities in the idea of harmonised corporate taxation. The only comprehensive solution suggested to us was a system where companies would pay tax to, and by the rules of, their chosen "home State". But such a system presents various problems. It would in our view require a considerable degree of harmonisation of effective tax rates, to avoid businesses seeking out low-tax Member States in what some might regard as harmful tax competition. Because existing corporate tax structures are so diverse, we find it hard to envisage how agreement on a common system could be reached (even if the political will were there) and how the transition could be made. And the attribution of revenue to the various Member States in which businesses operated would require a centralised bureaucracy. Businesses may ultimately come to feel that to be a price worth paying for greater certainty, and we would well understand their wish to see Member States adopt policies to that end.

42. Meanwhile, failing a comprehensive solution, there would in our judgement be a case for an optional single European corporation tax along the lines suggested by the CBI, which would help multinational companies by simplifying their tax accounting and cutting out battles over which tax jurisdiction was applicable. However, it too would result in problems of revenue allocation for EU governments and potential bureaucratic burdens (paragraphs 221-231).

Reform of the system of value added tax

43. We have considered whether we should welcome or deplore the apparent loss of momentum on the issue of VAT. There seemed to be two main arguments for changing to the system proposed by the Commission in 1996, whereby each business in the EU would have a single place of registration, taxation and deduction of input tax.

44. First, the single place of taxation system is presented as having significant advantages for businesses - in particular for small firms wishing to export, which would have to grapple with the bureaucracy of only one Member State. We were initially attracted to it for this reason, but we then found that in fact small firms would benefit only in rare circumstances, and the proposed system for redistributing revenue might well lead to more rather than less bureaucracy.

45. The other main reason for considering a new VAT system would be if it offered a real likelihood of reducing the scope for fraud on goods traded between Member States. This is a matter of considerable concern to us, particularly in the context of enlargement. Unfortunately, it does not seem that changing the VAT treatment of traded goods would eliminate the scope for fraud. We note that changing from the present destination-based system to the origin-based system previously proposed by the Commission would merely have changed the method of operation of fraudsters, and we fear that the same might be true of the single place of taxation system.

46. Moreover, we note other major drawbacks to the single place of taxation system. Without considerable convergence of national VAT bases and rates, businesses would have an interest in establishing themselves where VAT rates were lowest (because they could then sell their products more cheaply all over the European Union). This would erode overall VAT revenues. In addition, we think that the concentration of business registration in low tax Member States would create enforcement problems, because enforcement is likely to be more difficult if revenue authorities have to tax business activities which are occurring well outside their territory.

47. We conclude that there seems to be no compelling argument for a completely new system of VAT. A change to a system based on a single place of taxation would impose comprehensive new restrictions on the VAT policies of Member States, as far as we can see to no particular benefit. We judge that if the Commission were to bring forward such a proposal it would fail the test of proportionality (paragraphs 232-248).

CONCLUDING COMMENTS

48. Taxation, whether direct or indirect, is a highly sensitive issue, and there is a clear need to ensure that proposals on tax matters emanating from the institutions of the European Union are properly publicised and accurately reported. We conclude that recent scare headlines about a European Union tax take-over were unjustified, and ill served a British public insufficiently informed of the facts to judge the validity of the reporting.

49. This Report, in examining carefully those tax proposals already placed on the table by the Commission and some which are as yet only mooted, seeks to measure their appropriateness and the impact they are likely to have on the United Kingdom. Three principal conclusions are drawn:

• that there are certain areas where some sensible, well-justified co-ordination—in particular to reduce fraudulent tax evasion and to help create conditions in which tax competition can be pursued harmlessly—could serve both United Kingdom and EU-wide interests, and ought therefore to be pursued in a spirit of pragmatism rather than being dismissed out of hand on purely dogmatic grounds;
• that as long as the Government maintains its insistence on the unanimity rule in decision-making (except for purely administrative matters) and on the principle, shared by all Member States, that national taxes raising revenue from domestic taxpayers are a strictly national matter, such proposals as are already on the table can pose little or no threat to the interests of the United Kingdom; and
• that the Government must nonetheless remain permanently vigilant to ensure that undesirable tax measures are not smuggled through the back door.