International trade has always been a contentious issue. Even those who agree that it is beneficial for all countries involved sometimes succumb to the fallacy that trade is only a good thing if it occurs between countries that have a similar level of economic development. Some even claim that if trade is to bring benefits, it should ideally happen between two identical countries.
But trade happens precisely because of differences between countries. It does not matter whether countries are at a different level of economic development or are endowed with different natural advantages. Take the classical example of Ricardo: trade between England and Portugal was possible precisely because they were different.
Differences between countries can be divided into two broad categories, namely exogenous and endogenous. Exogenous differences such as geographical position, abundance of raw material, etc. cannot be influenced by the government. On the contrary, endogenous differences, i.e. the ease of doing business, bureaucracy, corruption and the like result from public policies. It is pretty obvious that such differences are even recognized in the EU internal market. It is widely admitted that trade is mutually beneficial regardless of exogenous and endogenous factors.
Surely, tax systems in Member States are an endogenous factor. Some countries choose to have higher levels of taxation, while others opt for lower taxes. If companies decide to move to Member States with less onerous tax regimes, it only reflects natural competition among Member States. If some Member States prefer flexible labour laws (and companies invest there), we do not consider this illegal. Quite the opposite, it is one of the fundamental freedoms of the EU.
One can easily predict that proposals to harmonize labor laws, bureaucracy and other endogenous factors would be shot down as violating the principle of subsidiarity as well as for having nothing to do with the functioning of the internal market. So why should we apply double standards when it comes to taxation? The Common Consolidated Corporate Tax Base (CCCTB) initiative and the Anti-Tax Avoidance Directive (ATA) may be seen as a first step towards the tax harmonization. Moreover, this harmonization is presented as an essential factor for the functioning of the single market.
In reality tax competition is no different from the race for investment through the reduction of red tape and bureaucracy and other policies pursued by national governments. In a discussion on tax harmonization one may always ask what we should harmonize. Should all Member States expand their tax base to match the highest existing level or contract them to the lowest one? Unfortunately, harmonization is often used as a synonym of an increase.
Tax harmonization via ATA and CCCTB could have detrimental unintended consequences. It will make companies forego their normal business practices and undermine their competitiveness.
Firstly, the anti-tax avoidance clause is vague and may grant tax authorities excessive rights to interpret business intentions of taxpayers. Due to the General anti-abuse rule (GAAR), local tax authorities might be likely to challenge structures that they deem to be grounded in questionable business rationale. This would cause legal uncertainty and might lead to political interference and even corruption.
Secondly, legal entities with minimum physical presence and few staff might need to allocate more resources and recruit more employees in order to justify themselves as genuine business units. Simply put, some companies might be forced to hire more lawyers to prove their legitimacy in the eyes of tax authorities. This would result in losses in terms of productivity or, in extreme cases, business closures.
Thirdly, large multinational enterprises (MNEs) may be subjected to multiple and uncoordinated audits from various authorities at any time. To prevent this, an extensive cooperation between revenue authorities will be needed. International investigative processes will be costly not only for businesses but Member States too, and this might create an additional tier of bureaucracy and regulatory uncertainty.
Finally, tax revenues might shrink as the implementation of rules under the ATA Directive may have unintended consequences on investments. For example, the Controlled foreign company (CFC) rule treatment significantly changes the taxation of all profits generated by a foreign subsidiary due to a sharp increase in the general cost of capital. Therefore, it may alter in general investment behavior and not only affect investments in passive assets.
Given these pitfalls associated with the ATA Directive, Member States should take precautions against the risks. First, they should ensure that the directive does not extend to transparent entities, sole proprietors and SMEs. Second, they should minimize the transfer of the burden of proof to business entities. An environment where entrepreneurs are constantly forced to justify their legitimacy to tax authorities is unhealthy and unproductive.