Commission has adopted a Communication that presents a possible solution to the
compliance costs and other company tax difficulties that Small and Medium
Enterprises (SMEs) face when doing business across borders. The Commission
suggests that Member States allow SMEs to compute their company tax profits
according to the tax rules of the home state of the parent company or head
An SME wishing to establish a
subsidiary or branch in another Member State would as a result be able to use
tax rules and file tax returns in a country with which it is familiar. The "Home
State Taxation" system would be voluntary for both Member States and companies
and would run for a five-year pilot phase. The Commission's 2004 European Tax
Survey (see IP/04/1091) showed that cross-border activity leads to
higher company tax and VAT compliance costs for companies and that costs are
proportionately higher for SMEs than for large companies.
"Heads of Government and Member
States last March highlighted the important role of SMEs in the economic
development of the European Union" said László Kovács, EU Commissioner for
taxation and customs. "I urge Member States, therefore, to take this opportunity
to eliminate some of the tax complications that inhibit SMEs from participating
in the Internal Market".
The concept of Home State Taxation
presented by the Commission is based on the idea of voluntary mutual recognition
of tax rules by EU Member States. Under this concept, the profits of a group of
companies active in more than one Member State would be computed according to
the rules of one company tax system only, i.e. the system of the Home State of
the parent company or head office of the group.
An SME wishing to establish a
subsidiary or permanent establishment in another Member State would therefore be
able to use only the tax rules with which it is already familiar.
The definition of an SME would be
that commonly used in the EU – companies with less staff than 250, with a
turnover of €50 million or less and/or with a balance sheet total of €43 million
The Home State Taxation scheme
would not mean taxation in the Home State only. It would simply mean that an
SME's tax base (i.e. taxable profits) would be calculated in accordance with the
rules of the Home State. Each participating Member State would then tax at its
own corporate tax rate its share of the profits determined according to its
share of the total payroll and/or turnover.
Introducing the scheme on a pilot,
time-limited, basis would test the practical merits of the concept for SMEs and
its broader economic benefits for the EU while limiting the administrative costs
and potential risks for Member States.
The Commission's Communication
provides detailed elements of such a Home State Taxation pilot
Member States that agreed to
introduce this scheme could do so via a bilateral or multilateral agreement, by
temporarily supplementing existing double taxation treaties or multilateral
conventions, or by concluding a new multilateral convention.
In the Commission's opinion, the
concept of Home State Taxation appears to be a very promising way of tackling
the tax problems that hamper SMEs when they are expanding across borders. The
most common problems are compliance costs and absence of relief for cross-border
The potential overall economic
benefit for the Internal Market from such a measure could be considerable. The
Commission has in its Lisbon Action Plan (see IP/05/973) given a new impetus to achieving the
Lisbon objectives, including in the tax field. It has repeatedly highlighted the
important role of small and medium-sized enterprises in the EU's economic
development and has called for broad policy actions in favour of SMEs. The
European Council of 23 March repeated this call.
For further information see
Home State Taxation pilot project for SMEs – frequently asked
(see also IP/06/11)
Is it not true that more than 95
% of businesses in Europe are SMEs so that this Home State taxation scheme could
have a major impact?
It is indeed true that the vast
majority of businesses in the EU are covered by the EU definition of SMEs.
However, currently on average only
3% of these businesses have establishments abroad.
The share of SMEs in the corporate
tax revenues of Member States is also usually very low.
Moreover, the Commission suggests
if Member States wish to put a strict limit on the potential costs and risk for
their tax administrations, they could restrict the application of the scheme to
small companies (as opposed to small and medium) as defined in Commission
recommendation 2003/361/EC i.e. companies with a number of employees less than
Would the cost for tax
administrations not be disproportionate for a problem that does not really
No. This pilot scheme would be
strictly limited both in time and scope. Therefore, the effective practical
repercussions on national tax administrations concerned would also be limited.
Furthermore, the Commission services will be backing up the running of the pilot
scheme with appropriate research and assistance.
It is very clear that SMEs would
benefit from the scheme. The SME federations have already been consulted on this
idea and they are strongly supportive as they have first hand experience of the
tax obstacles their members face when they want expand abroad. One should not
reject an innovative idea only because it could perhaps result in a slight
additional cost for administrations. It might well be the case that the future
tax revenues increase on the whole, owing to improved SMEs' profits and survival
rate and the expected benefits to the EU economy as a whole.
Would there not be legal
obstacles to applying foreign tax law domestically?
There should not be. In the
Commission's view it would not be necessary to change domestic tax codes in
order to implement the pilot scheme. The Commission suggests using existing
double taxation treaties or concluding an appropriate multilateral convention.
Both have to be passed by national Parliaments and thus receive equivalent
status of national laws. There are existing examples for this way of proceeding,
for example as regards the tax treatment of construction works in many tax
treaties. In most of the treaties which Member States have concluded with each
other, construction works are not considered to constitute a taxable permanent
establishment even when they fulfil all the conditions, provided their presence
is limited in time.
Furthermore, Germany and the
Netherlands have recently agreed on a protocol to their double-taxation treaty
that allows companies to be active in border areas on the territory of the other
state while having to comply with their domestic tax law only. So there is no
reason why it should not be possible to use similar mechanisms for a limited
Home State Taxation pilot scheme.
Would applying Home State
Taxation only to small and medium-sized enterprises not discriminate against
companies that are not allowed to benefit from the scheme?
The Commission does not believe so.
Most Member States already have
special advantageous tax rules for SMEs and for these there seems no
discrimination issue at national level. Moreover, the fundamental advantage
provided by Home State Taxation is a reduction of compliance costs, not lowering
of the tax liability. Such a non-monetary advantage is generally not considered
as giving rise to discrimination.
What is the definition of an
The Commission proposes using for
the pilot scheme the general EU definition of SMEs as laid down in Commission
recommendation 2003/361/EC, since this definition is common and familiar in all
Member States. This definition distinguishes between:
- medium-sized enterprises
[headcount < 250 and turnover ≤ € 50 million and / or balance sheet total ≤ €
- small enterprises [headcount <
50 and turnover ≤ € 10 million and / or balance sheet total ≤ € 10
- micro enterprises [headcount <
10 and turnover ≤ € 2 million and / or balance sheet total ≤ € 2
In order to avoid any ambiguity,
this definition should be binding for the purpose of the pilot scheme. Also,
enterprises which are part of a larger grouping and could therefore benefit from
a stronger economic backing than genuine SMEs, do not fall within the scope of
What is the definition of "Home
State" for the purpose of this scheme?
The "Home State" of a participating
SME-group is defined as the country of tax residence of the lead company.
Following the generally accepted tie-breaker rule in bilateral tax treaties,
this would, in case of doubt or of double-residence, be the country in which the
place of effective management (or central management and control) of the lead
company is located and where this company is subject to corporation tax before
entering the pilot scheme. If there are problems with the application of this
rule for the purpose of the pilot scheme, the tax administrations of the Member
States in which the group is active have to reach a common agreement on the Home
State; and otherwise the company cannot take part in the pilot scheme. The
corporate tax base rules of the Home State would then apply to the participating
lead company and its subsidiaries and/or permanent establishments in the
participating Member States, ie to the Home State Group.
How long would the pilot scheme
By definition, the pilot scheme
should de designed as an experimental trial and therefore be limited in time.
For both the participating Member States (tax administrations) and the
participating companies it will be important that the trial period is long
enough so as to allow it to be analysed thoroughly and to justify the changeover
cost. Based on the feedback received, the Commission suggests running the pilot
scheme for a period of five years after which a final evaluation should take
place. The time frame of five years is to be understood to mean that a start
date for the scheme is fixed and that the scheme automatically expires five
years after that date (e.g. 1 January 2007 – 31 December 2011). Qualifying
enterprises could, however, join the scheme at any time during the period and
thus also participate for shorter periods (e.g. 1 January 2009 – 31 December
What specific cross-border tax
problems do SMEs currently face?
Generally, the tax obstacles to
cross-border economic activity are identical for small and medium-sized
enterprises and larger companies. However, the impact of many obstacles on SMEs
is stronger as they have, simply due to their smaller size, less economic and
human resources and tax expertise available. There are two areas which are of
additional, particular importance for SMEs.
First, SMEs have particular
difficulties in meeting the compliance costs resulting from the need to deal
with up to 25 different taxation systems. This finding is strongly supported by
tax practitioners and business federations which represent SMEs' interests.
Available general studies suggest that compliance costs are regressive to size
and put a disproportionately higher or even prohibitively high burden on small
and medium-sized enterprises compared to bigger companies.
Second, among the other more
specific tax obstacles to cross-border economic activity in the Internal Market,
the cross-border offsetting of losses has been identified as the most important
one from the perspective of SMEs. Losses often occur at the beginning of an
activity in a foreign country, i.e., precisely when these activities are
typically still run in a smaller enterprise. Bigger companies are usually in a
position to make sure that all losses are eventually offset against profits,
e.g. by using appropriate transfer pricing strategies. SMEs usually do not have
this possibility. Moreover, given their usually limited capital cover, it is
particularly important for small businesses to be able to set off losses. The
Home State may provide greater access to finance at an essential stage in a
company’s development life-cycle, lessening supply-side constraints imposed by
risk adverse financial provision from banks and other financial
How would the scheme actually be
established, if some Member States are interested?
The Commission suggests using the
existing mechanism of double-taxation treaties to implement the pilot scheme.
Interested Member States should thus enter into appropriate negotiations,
prepare and conclude a bilateral or, preferably, multilateral agreement allowing
interested companies to participate in the Home State Taxation pilot scheme. If
they so wish, support and assistance for these efforts would be available from
the Commission services, possibly via the Commission's FISCALIS programme of
training for tax officials. The Member States concerned should then implement
the agreement domestically, in accordance with their national laws and
practices. A bilateral agreement could usefully take the form of a protocol
supplementing the relevant double-taxation treaty, and multilateral agreements
should be concluded in an intergovernmental convention. This way of proceeding
would make sure that the pilot scheme could be introduced relatively quickly and
in a flexible manner, while fully respecting the principle of legality of
taxation. It is important to recall that Home State Taxation is based on the
idea of voluntary mutual recognition of tax rules.
How could companies volunteer to
On the basis of their agreement
with other Member States, the tax administrations of participating Member States
should, for instance via appropriate internal procedures (e.g. circular letters
or publication of a call for 'expression of interest'), establish the
possibility for companies to volunteer to participate in the 'pilot scheme'.
Interested companies (both the lead company and subsidiaries) would have to
notify their interest in taking part in the pilot scheme to their usual
counterparts in the tax administrations of their respective residence States and
these would be obliged to inform and consult without delay the tax
administrations of the other Member States concerned. A decision on the
application should be given by the two or more administrations concerned within
a reasonable period of time, e.g. two to three months after the notification of
interest by the company. As with other administrative decisions a possible
refusal should be accompanied by reasons and could only be justified if the
applying company does not meet the requirements set out in the relevant
agreement (for which there is no discretion for the authorities).
Would SMEs with head offices in
third countries or indirect ownership via third countries be allowed to
Given the narrow scope of the pilot
scheme it is unlikely that SMEs with head offices in third countries would want
to take part in the scheme in respect of their EU-wide activities in an EU
group, as this would involve attributing the parent/head office function to one
subsidiary for the sub-subsidiaries. Equally it appears to be improbable that
SMEs with indirect ownership via third countries, i.e. a parent company in a
Member State with a subsidiary in third country which holds a (sub-) subsidiary
in another Member State, could qualify for the pilot scheme. While there is no
need to systematically exclude companies of the first type systematically from
access to the pilot scheme if they fulfil the basic requirements set out in the
relevant agreement, and in particular comply with the definition of a small and
medium-sized enterprise, there are good reasons to believe that the second
situation would be too complicated to handle for the purposes of a pilot scheme.
In the Commission’s services' opinion, indirect ownership via third countries or
non-participating Member States should therefore disqualify a group of companies
from participation taking part in the pilot scheme.
Would the scheme apply to
corporation taxes only or to all taxes?
It seems sensible that the scheme
should apply to corporation taxes only. Taxes other than corporation taxes
should not be included in the scope of the scheme. This concerns in particular
value added tax, excise duties, wealth tax, inheritance tax, land tax and land
transfer tax. If they so wish, Member States could nevertheless continue to
apply national or local profit-related surcharges on the corporate tax as
established under the conditions of the pilot scheme (i.e. on that Member
State’s share of the overall tax base). Non-profit related local or regional
taxes could also continue to be levied under the rules of each of the Member
The pilot scheme should not
indirectly influence the levying of taxes other than corporation tax. Insofar as
the determination of the taxable income for corporation tax interacts with or
impacts on the assessment of other taxes or social security contributions, and
insofar as this link cannot be technically established on the basis of the Home
State tax base rules, specific accounts should be kept on the basis of the Host
Would the scheme apply to SMEs
in all sectors?
Several sectors of the economy are
usually subject to specific corporate tax rules. For the purpose of an SME pilot
scheme this might lead to additional complications that are hard to justify,
either because very few, if any, SMEs are active in these sectors or because the
sectors in question are often still national. Therefore, Member States might
give some thought to the idea of stipulating that, for instance, 'Home State
groups' with more than 10% of their turnover in the sectors of shipping,
financial services, banking and insurance, oil and gas trade and exploitation,
and agricultural activities (including forestry and fishery) should not be
allowed to participate in the pilot scheme.
The definition of the sector should
be based on the domestic taxation rules applied in the 'home state' concerned,
but the tax administrations of the Member States concerned must in any event
approve the sector allocation on a case-by-case basis. Alternatively, common EU
definitions should be employed or, if need be, developed for the purpose of the
scheme. The Commission services would be prepared to assist interested Member
States with this task, where necessary.
What provisions would be
established to prevent abuse?
The pilot scheme has to include
rules for dealing with exceptional cases and anti-avoidance provisions. The
Commission suggests a variety of possible arrangements to ensure this, including
that only existing enterprises that have been tax resident in the 'Home State'
for at least two years should be allowed to participate in the scheme and that a
participating SME that moves its lead company's tax residence from one Home
State to another during the pilot scheme would have to terminate its
participation in the scheme. The Commission also proposes that the general
anti-abuse rules of the State of residence apply for every group unit in
relation to non-participating Member States and third countries, in order to
forestall "rule shopping". A final point to note is that, generally speaking
smaller companies are seldom audited at present so there should be no dramatic
change for tax administrations as regards resources needed to combat tax fraud
or evasion if some SMEs participate in the pilot scheme.
Would Member States conduct
joint audits of participating SMEs?
The general rules for mutual
assistance and administrative co-operation between EU Member States should apply
and should be used. Moreover, the tax authorities of the interested Member
States should, if this is considered necessary, form joint audit teams for
auditing the lead company and group members. The audits should be allowed to be
carried out by the joint team in all premises covered by the Home State group,
but be strictly limited to those aspects governed by the pilot scheme. In the
event of litigation it would be logical, in the Commission's view, to apply, in
principle, the rules of the residence state of a "Home State group" member
company. It seems difficult to envisage another solution that does not infringe
the Member States' respective national laws.
Could an SME opt out of the
pilot scheme before its expiry?
The decision by a company to take
part in the pilot scheme should be binding for the entire five-year period or
for a shorter period until the pre-determined end of the pilot scheme. If a
company insists on ending the application of the scheme before the expiry of the
five-year period, this could be made possible subject to a re-assessment of the
tax years under the pilot scheme and retroactive application of the
What factors would be taken into
account in apportioning the tax base between Member States?
For the purpose of this narrow
pilot scheme it should be sufficient to use a simple but economically robust
formula for apportioning the tax base between the participating Member States.
This is because the tax revenue 'at stake' is limited by various factors: the
restriction of the scheme to small or small and medium-sized companies; the
limited number of small and medium-sized companies with establishments in other
Member States; the optional character of the scheme; the strict monitoring that
would apply; the generally low tax liabilities of SMEs etc. Moreover, a simple
formula is easy to administer and operate.
The Commission recommends using the
respective share in the total payroll (50%) and overall turnover (50%) of the
participating business in each Member State concerned as apportionment formula.
These figures are easy to identify in the company's accounting and tax
declarations. Moreover, the combination of an input-related factor (payroll)
with an output-related factor (sales) also reduces the possible
At any rate, the following economic
factors may also be used for devising the allocation formula: payroll; number of
employees; sales (turnover); assets. Combining these factors would make the
formula more economically representative but also more complex. Depending on the
formula chosen by Member States it would be necessary for them to agree on
commonly accepted and practically operational definitions of the factors
How would the effectiveness of
the scheme be monitored?
The Commission considers it
advisable that, together with interested Member States, it should create a
monitoring group to supervise the pilot scheme. The members of
this group would consult one another, consider possible practical problems and
assess the scheme's success. Moreover, it would make sense for those Member
States implementing the pilot scheme to draw up, by 31 December 2009, a detailed
report containing an overall assessment of the pilot scheme's effects. This
would allow the Commission and the monitoring group to consider the possible
prolongation or termination of the scheme and decide on the relevant procedures.
Have Member States, businesses
and the European Institutions been consulted on this Home State Taxation idea?
Yes. The Commission services
initiated a public consultation process on this idea in 2004. The consultation
process included the organisation of a workshop, a public on-line consultation,
bilateral meetings and the distribution of a questionnaire, all of them with the
relevant stakeholders (i.e. business and accountancy/tax experts, national and
European federations and organisations as well as some academics). Most
interested parties considered corporate taxation as an important obstacle to
cross-border expansion of SMEs and acknowledged the potential and positive
contribution of the HST approach for helping and encouraging their economic
activities in other Member States. The European Parliament and Economic and
Social Committee also supported the idea of Home State Taxation for SMEs on a
pilot basis and invited the Commission to take this concept forward.