From America to Austria, corporate taxes are a universally hot topic for all types and sizes of businesses—but for very different reasons. While U.S. companies are on constant guard against rising state and federal tax rates, European Union (EU) businesses have seen their tax obligations plummet in recent years, dropping to an EU average of 25.8 percent from 33.9 percent since 2000. This long-term trend creates a rich opportunity for U.S. companies to invest in EU markets and take advantage of a very business-friendly environment.
The drop in EU corporate taxes started in the mid-1980s, when then-Prime Minister Margaret Thatcher championed lowering the United Kingdom tax rate to 35 percent from 52 percent. Other European countries quickly jumped on the bandwagon to match these more attractive rates, and a low tax structure soon became a competitive advantage for EU nations.
Since then, the largest tax-rate reduction among the original EU countries has been in Ireland, which cut its rate to 12.5 percent in 2006 from 40 percent in 1993—a 68.8-percent reduction. The second-largest reductions have occurred in Austria and Germany, each cutting its rate by 36 percent, followed by Portugal and Italy, which have reduced their rates by 31 percent and 29 percent, respectively.
When the EU added 10 countries in 2004, those new members lowered their tax rates to match the rest of the alliance. With an average corporate income tax rate of 18 percent, the Eastern European states that joined the EU that year have some of the lowest tax rates in Europe, along with competitive labor rates and active programs designed to encourage foreign investment.
In his June 2006 testimony before the U.S. Senate Finance Committee, Martin A. Sullivan of Tax Analysts, a not-for-profit, nonpartisan tax-policy group, said, “As transportation and communications costs have dropped, and trade barriers and currency controls have also declined, there is more cross-border investment than ever.” More than a decade ago, economists focused on tax policy as a way to boost domestic investment on the margin, Sullivan said. Today, with increased capital mobility and countries competing more aggressively to attract multinational corporations, tax rates weigh even more heavily on major investment decisions, according to Sullivan.
Ireland is one of the most powerful examples of how the EU’s tax structure has benefited both individual countries and the companies that do business there. When Ireland joined the EU in 1973, its gross domestic product (GDP) was 60 percent of the average European GDP; in 2006, its GDP was off the charts at 110 percent. Although Ireland is just one percent of the EU market, with its 12.5 percent corporate tax rate, it lures nearly one-third of U.S. foreign investment in the European Union and is the world’s largest exporter per capita.
Germany is a recent example of how EU nations continue to adjust their rates to attract international businesses. In November 2006, the German government announced that it would lower the country’s corporate tax rate to about 29 percent from 38.7 percent beginning January 1, 2008. The new tax structure is a “tremendous step for medium-sized companies, for small companies and business partnerships,” says Roland Koch, prime minister of the German state of Hesse. “Today, we’re exposed to international and European tax competition. We have to tax companies differently than in past decades.”
Other countries, newer to the EU, promote themselves for foreign investment via similarly bargain-basement tax rates. Cyprus, for example, has a corporate tax rate of 10 percent, Latvia and Lithuania have rates of 15 percent, and Hungary’s rate is 16 percent. Some have criticized these low rates as representing a “race to the bottom” that could potentially undermine the tax base every nation needs to support its infrastructure. But many EU countries are tweaking their tax codes to ensure they protect their fiscal health while still remaining pro-foreign investment. Germany is the latest to implement this approach, working to combine its favorable corporate tax rates with a broadening of its overall tax collection system, much like the model of Scandinavian countries and Ireland.
Of course, analyzing corporate income tax rates doesn’t tell the whole story of European tax burdens. Yes, corporate income tax rates have declined. But rates for the value-added tax (VAT) on transactions in goods and services supplied in European countries have largely remained unchanged. The VAT remains a more significant source of revenue for European economies than corporate or individual income taxes.
Beyond Lower Rates
In addition to the general reduction of corporate income tax rates, European countries are also adding incentives to their internal tax laws to encourage the formation of holding companies within member countries. In 2006 alone, Belgium, the Netherlands and Switzerland all changed laws to attract international investment by reducing taxes on special types of income and by lowering withholding taxes on repatriation of income to foreign investors. This caps off an EU trend that began in 2000.
Other EU tax reforms on the horizon are designed to promote foreign investment while simplifying the alliance’s tax system. On March 16, 2011, the European Commission proposed a common consolidated corporate tax base (CCCTB) that would create a uniform set of rules for calculating a company’s aggregated EU-wide profits. This, in turn, would reduce the costs of maintaining different national tax systems as well as a company’s compliance expenses. The CCCTB, which could be in force as early as 2013, would allow member countries to still set their own corporate tax rates. Given the strategy of EU nations to attract foreign businesses through low corporate taxes, and that the CCCTB requires unanimous approval from the commission, there is still significant debate over whether the CCCTB will ultimately come to fruition.
Any U.S. business contemplating doing business in the EU should also be aware of possible changes in international tax treaties. For example, treaties with several EU countries await U.S. Senate ratification, and others are in various stages of negotiation. Yet even with trade relations in flux and the ongoing streamlining of the EU’s corporate tax system, most experts predict the EU will continue to provide excellent markets for U.S. trade, investment and operations.
“As mobile as capital may be, profits are more mobile,” Sullivan said. “In deciding where to channel profits, tax-rate differentials are all-important. Without increasing the deficit and without changing the overall tax burden on the corporate sector, a government can protect its revenue base, increase investment and increase competitiveness.” iBi