COUNCIL OFBrussels, 10 January 2006
THE EUROPEAN UNION
5182/06 ADD 1
ADDENDUM TO COVER NOTE
Secretary-General of the European Commission, signed by Mr Jordi AYET PUIGARNAU, Director
date of receipt: 26 December 2005
to: Mr Javier SOLANA, Secretary-General/High Representative
Subject: Tackling the corporation tax obstacles of small and medium-sized enterprises in the Internal Market outline of a possible Home State Taxation pilot scheme - Impact Assessment
Delegations will find attached Commission document SEC(2005) 1785.
Encl.: SEC(2005) 1785
COMMISSION OF THE EUROPEAN COMMUNITIES
Brussels, 23.12.2005 SEC(2005) 1785
COMMISSION STAFF WORKING DOCUMENT
Annex to the
COMMUNICATION FROM THE COMMISSION TO THE COUNCIL, THE
EUROPEAN PARLIAMENT AND THE ECONOMIC AND SOCIAL COMMITTEE
Tackling the corporation tax obstacles of small and medium-sized enterprises in the
Internal Market outline of a possible Home State Taxation pilot scheme [...]
TABLE OF CONTENTS
1.Introduction ................................................................................................................ 11
2.Procedural Issues and Consultation of Interested Parties .......................................... 12
3.Problem Definition: The Economic Importance of SMEs and their Low Participation in the Internal Market due to Company Taxation Obstacles...................................... 15
3.1. Economic importance of small and medium-sized enterprises in the EU ................. 15
3.2. Participation of SMEs in the Internal Market and internationalisation strategies ..... 17
3.3. The benefits of SMEs internationalisation ................................................................. 25
3.4. Company tax obstacles in the Internal Market and their relevance for SMEs........... 27
3.5. Evaluation of the effects of the company tax obstacles ............................................. 29
4.Policy objectives ........................................................................................................ 31
5.Options for Removing the Internal Market Company Tax Barriers for SMEs.......... 32
5.1. Earlier ideas and initiatives ........................................................................................ 32
5.2. Available options ....................................................................................................... 34
5.3. Initial screening.......................................................................................................... 34
5.4. Conclusion of initial screening of options and policy choice .................................... 39
6.Impact Analysis.......................................................................................................... 39
6.1. Economic impact assessment of the Home State Taxation option ............................ 39
6.1.1. The impact of HST on SMEs ..................................................................................... 40
6.4. Conclusions ................................................................................................................ 62
LIST OF TABLES AND FIGURES
-Table 1: Subsidiaries/branches/joint ventures located abroad (% of SMEs) by age of enterprise
-Table 2: Some basic insights about international groups of SMEs from the AMADEUS database
-Table 3: Distribution of subsidiaries of international groups of SMEs by Member State
-Table 4: Subsidiaries of domestic and foreign SMEs parents in each Member State
-Table 5: Key points of the Home State Taxation pilot scheme for SMEs
-Table 6: Overview of tax treatment of losses in domestic group taxation schemes in Member States
-Table 7: Cross border loss-compensation estimations under HST
-Table 8: Results of possible apportioning mechanisms for the distribution of international SMEs groups' tax bases compared to the actual situation
-Figure 1: Breakdown of main indicators in the EU-25's business economy by enterprise size class, 2001, % share of total
-Figure 2: Frequency of internationalisation by size of enterprise
In its company tax Communications of 20011 and 20032 and its more recent tax and customs3
and modern small and medium-sized enterprises (SMEs)-policy4 Communications, the
Commission, among other things, looked into the potential contribution of EU corporate tax policy for the achievement of the Lisbon goal and into the specific role of SMEs in this respect. It has been established that the cross-border economic activities of all businesses in the EU are hampered by various tax obstacles (such as increased compliance costs, lack of cross-border loss compensation, etc) and that, for various reasons, SMEs are hit particularly hard by them. Consequently, not least due to these tax obstacles, SME participation in the Internal Market is considerably lower than that of larger companies. This results in economic inefficiencies and consequently potential for economic growth and job creation is unrealised. This clearly jeopardises the achievement of the Lisbon objectives. As such appropriate action, to foster the cross-border expansion of SMEs should be taken particularly in the field of taxation.
Against this background, this Impact Assessment first provides information on the consultations carried out in the context of a Home State Taxation pilot project for SMEs. It then describes the problem to be addressed by policy action (i.e. the low participation of SMEs in the Internal Market due to company taxation obstacles) and the policy objectives of the measures under consideration. The Impact Assessment then analyses a variety of policy options and assesses their suitability for removing the tax barriers to the cross-border expansion of SMEs within the Internal Market. It also provides a qualitative and quantitative (as far as possible) assessment of the major economic, social and environmental effects of the Home State Taxation option. Finally, it sets out arrangements for the implementation of this approach and for its monitoring and evaluation.
federations and organisations as well as some academics). Detailed reports on the outcome of these activities are publicly available
6.Most interested parties considered that corporate
taxation was an important obstacle to cross-border expansion of SMEs and acknowledged the potential of the HST approach to make a positive contribution here by helping and encouraging their economic activities in other Member States.
Economic importance of SMEs and their low participation in the Internal Market due to company taxation obstacles
SMEs (generally referred to as enterprises with less than 250 employees) make up a large part of Europe's economy. There are some 23 million of SMEs in the EU-25, accounting for 99.8% of all enterprises and providing around 66% of total private employment. The particular importance of SMEs as job creators is confirmed by their display of higher employment growth patterns than large-sized enterprises. Besides that, the empirical evidence strongly suggests that economic growth corresponds positively with an increased role for SMEs (especially due to the positive externalities that SMEs have on the economy as a whole). For these reasons SMEs are generally considered to play a pre-eminent role in EU economic and employment growth and social cohesion.
European SMEs develop their economic activities mainly in domestic national markets, thus their engagement in cross-border activities across the Internal Market effectively remains low. This is true for all forms of internationalisation, from the simple propensity to export or import from foreign suppliers to more complex forms of internationalisation. Notably, the establishment of a subsidiary, branch or joint venture abroad is only undertaken by 3% of EU- based SMEs. Statistical analysis based on a large dataset
7 provides more insights into the
main features of EU-based "international groups of SMEs"8: it shows an average number of
2.82 majority-owned subsidiaries per SME parent and it shows that neighbouring countries are the main destination of foreign investment of parent SMEs in form of foreign subsidiaries.
Given that, as shown in several studies, engaging in international activities has a positive impact on the competitiveness and performance of SMEs
9 and that the present economic and
business environment emphasizes the role of internationally oriented enterprises in the global economy, the problem of low participation of SMEs in the Internal Market, demonstrated by the statistics shown above, is considered real and concrete and has effects potential economic and social performance of the whole EU.
Particular indicators10 reveal that the participation of SMEs in the Internal Market is, among
other things, hampered by company tax obstacles which companies face when undertaking cross-border activities. In that sense, there are two types of company tax barriers which are of special importance for international SMEs in the Internal Market. First, SMEs have particular difficulties in meeting the compliance costs resulting from the need to deal with up to 25 different taxation systems. Many studies suggest that compliance costs are regressive to size and put a disproportionately higher burden on SMEs (compared with larger companies)
Second, the limited availability or unavailability of a way to offset losses cross-border not only discourages the creation of an establishment abroad, but it also affects the conditions for new start-ups survival and limits the business' access to finance at an essential stage in a company's development life-cycle.
These specific cross-border tax obstacles, along with features of national tax systems that tend to favour domestic over foreign activities, lead SMEs often to refrain from cross-border trade and investments or to prefer purely domestic transactions, even when these are inferior in strict economic terms. When they do develop activities in other Member States, SMEs are systematically subject to higher compliance and finance costs than larger companies and therefore run a higher risk of business failure. In many other policy fields measures of harmonisation or mutual recognition have been taken to assist SMEs with cross-border activities. Taxation remains the single biggest obstacle to these activitieswhich has so far not been addressed at EU level.
Company tax obstacles to the Single Market can impede growth and employment and result in substantial negative economic consequences both for SMEs and for the EU that. Policy action in this area to remove such barriers is therefore urgently required.The general objectives of possible policies in this area should be to encourage and increase investment and cross-border expansion by SMEs in other Member States within an improved EU-wide tax environment and to minimise tax-induced efficiency losses in SMEs investment allocation choices (that is, to render the tax issue as neutral a factor as possible in SMEs' decisions on where to allocate their investments across the EU). The specific objectives of policy action include helping SMEs who wish to set up branch/subsidiary businesses in other Member States to replace or complement national production for export with localisation abroad. This would be a liberalisation policy within the framework of the freedom of establishment (art. 43 of the Treaty). The benefits of attaining these objectives can ultimately be expected to materialize, in sufficiently competitive markets, in further welfare gains to the consumers.
-No policy change: General measures for tackling the tax obstacles faced by all companies, regardless of their size, are under way. It can therefore be argued that no specific action for the tax obstacles for SMEs is necessary. This approach has been followed so far and the result is that SMEs do not fully benefit from the Internal Market. Furthermore the pace of progress with these general measures is slow and their likely impact on SMEs is uncertain.
-Simplification and EU-wide standardisation of company tax filing and bookkeeping rules for international transactions: this would constitute an enormous help for the businesses concerned and reduce their compliance costs. However, this approach falls short of addressing the cross-border company tax obstacles faced by SMEs in a comprehensive manner and could hardly be expected to have a noticeable remedial effect beyond individual cases. It would only address one aspect, of only one of the tax obstacles, that of disproportionate compliance costs (whilst the issue of cross-border loss-offset and the peculiarities of creating foreign establishments would not be addressed).
-Directive on cross-border loss-offset: this initiative would address one of the key issues hampering SMEs expansion in the Internal Market. However, it would do so only in a partial way, because it would still leave other issues such as disproportionate tax compliance costs untouched.
-Direct subsidies by Member States/State Aid: this option would address the tax obstacles for SMEs by using a non-tax instrument. For example, targeted subsidies could encourage cross- border expansion by SMEs. Such a solution would at best compensate for the tax obstacles but not resolve them and could raise 'state aid' or competition issues.
-Home State Taxation pilot project: Under a HST-regime, a SME that does business in more than one country could calculate its taxable profits in all countries according to the well- known tax rules in its 'home country'. The taxable income would then be apportioned between the countries according to some key (e.g. payroll, turnover or other) and each of the countries would apply its own tax rate to its share of the profit. The HST approach is based on the principle of mutual recognition and as such fully respects the principles of subsidiarity and proportionality. In the public consultation held on the pilot scheme idea (see above) a majority of contributions argued in favour of a real-life test approach for the pilot scheme and against a purely theoretical exercise or a limited application to a sample of 'model companies'. However the latter remain possible forms for a pilot.
parent companies established in countries that do not have appropriate group loss compensation rules in their domestic tax legislation (Belgium, Czech Republic, Estonia, Greece, Hungary, Lithuania and Slovakia) will not benefit from cross-border loss compensation possibilities under HST. A quantitative analysis of the loss compensation under HST estimates that the annual total amount that could be compensated cross-border for existing international groups of SMEs is in the order of three billion euros (resulting in estimated immediate savings in tax payments equal to around 860 million euros). This represents on average around 10% of the total losses of EU-based international SMEs groups. Around 30-40% of the existing international SMEs groups could benefit from these HST cross-border loss compensation possibilities.
b)The application of 'home state' tax rules to the foreign activities of a SME reduces
tax-induced compliance costs for not having to deal with up to 25 different national tax systems. The direct cost savings from a HST simplification of the administrative burden for current international groups of SMEs is estimated, under conservative assumptions, to equal approximately 70 million euros per annum for the EU-25. These cost savings for existing international groups of SMEs can be tentatively estimated to increase EU GDP by twice this amount yearly in the long term.
*The effect of HST on new start-ups cross-border: the removal of tax barriers by HST measures may also affect the decision of companies to start new cross-border (activities i.e. new cross-border holdings in foreign subsidiaries, new or greater foreign direct investment, new foreign branches, etc). This applies both to companies already operating cross-border wishing to expand to other Member States. More importantly this also applies to companies operating hitherto only in a domestic context, insofar as their decision might be biased by tax considerations. The measures of the HST project could motivate these companies to go international, as the elimination of tax-barriers affects the trade-off between potential benefits and the costs of internationalisation that they face. The cross-border loss-offsetting tax regulation change and reduction of compliance costs should encourage companies to explore physical cross-border investments where companies had not considered these before and boost cross-border SMEs' chances of survival during the first years of business for . The question of how many extra companies are likely to expand cross-border as a result of a more straightforward administration system and the off-setting of losses from other Member States is difficult to answer a priori. Notwithstanding, the increased participation of SMEs in the Internal Market following a voluntary pilot scheme, that would bring about a change in their EU-wide company tax base and compliance costs, could be expected to be limited, because taxation is just one of the obstacles impeding cross-border expansion of SMEs.
dynamic effects are practically impossible to quantify, but they can be considered as the most important ones to the EU economy as a whole.
-The implementation of HST will also have implications for the Member States' national tax administrations. These will include higher spending on administration, control and coordination with other fiscal authorities costs and some revenue consequences following the possibility to offset losses cross-border and the apportioning of tax base results. Quantitative analysis shows the possible effects that apportionment based on factors such as 'payroll', 'turnover' or 'assets' may have on the distribution across the EU Member States of company tax bases of current international groups of SMEs. At any rate, given the proportions of enterprises and the proportions of taxation involved compared to total tax revenues of Member States
12 the tax revenue implications of the HST scheme should be very low and
should not present insurmountable adverse consequences for any Member State. It is important to consider also that the net present value of tax revenues may even increase on the whole, via resulting future tax revenue increases, attributable to improved SME profits/survival and to the expected benefits to the EU economy as a whole.
The assessment has also analysed environmental and notably social aspects of HST, with the conclusion that a HST system would have positive social effects. These include higher employment and higher wages (following increased productivity), especially in host countries. A HST pilot project would have no major environmental impact.
The regional impact assessment suggests that it is reasonable to assume that many SMEs that decide to set up an establishment in another Member State will be located in border regions and will decide to create that establishment on the other side of the frontier. However, it might happen that HST measures also induce relatively more SMEs in remote regions when they need an extra-incentive, to engage in cross-border economic activity (as the propensity to cross-border operations is already higher in border regions). For those countries which do not operate any kind of domestic group loss-relief rules one essential feature of HST is not available and thus it can be expected that less SMEs in the countries concerned (see above)
At the Lisbon European Council of March 2000 the European Union committed itself "...to become the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with more and better jobs and greater social cohesion". This objective was reiterated by the Stockholm European Council of March 2001. Later, the European Council of March 2004 also reaffirmed the commitment of the Lisbon European Council and underlined the need to continue efforts to remove barriers to the Internal Market created through fiscal systems
13.The Commission Communication to the Spring European
Council COM(2005)24 and in particular its companion document SEC(2005)192, the Lisbon Action Plan have provided additional impetus for achieving the Lisbon objective, including in the tax field. Following that line of action, the recent Commission Communication COM(2005)532
14 presents the ongoing and planned Community customs and tax measures,
which are considered key in the attainment of the Lisbon objectives, by explaining "these initiatives would help to renew growth and therefore create more and better jobs". Further on, Commission Communication COM(2005)525
15 emphasizes, in the context of the long-term
sustainability of our social systems, that "there is a need to look closely at making current tax systems perform better across the EU. A more co-ordinated approach at the EU level and more effective administrative co-operation between Member States could significantly improve the performance of tax systems. This could help to keep economic activity and 'mobile' assets (capital, companies) in the EU, while avoiding the risk of concentrating tax on less mobile bases like labour".
Thus, it is now acknowledged that achieving the Lisbon objective requires new impetus and the Commission has made this issue one of its priorities. As small and medium-sized enterprises (SMEs) play a pre-eminent role in the economic development of the European Union and are generally considered to be one of the most important growth and employment creators, their importance for attaining this goal can hardly be overestimated. Accordingly, appropriate action for fostering the cross-border expansion of SMEs has already been called for in the multi-annual programme for enterprise and entrepreneurship, and in particular for SMEs (2001-2005)
16 and in the Commission Communication "Action Plan: The European
In its company tax Communications of 200120 and 200321 the Commission, looked into the
potential contribution of EU corporate tax policy to the achievement of the Lisbon goal and into the specific role of SMEs in this respect. It was shown that the cross-border economic activities of all businesses in the EU are hampered by various tax obstacles but that, for various reasons, SMEs are hit particularly hard by these obstacles. Consequently, not least due to these tax obstacles, SME participation in the Internal Market is considerably lower than for larger companies. This results in economic inefficiencies and a foregone potential of economic growth and job creation which clearly jeopardises also the achievement of the Lisbon objective.
Under the concept of Home State Taxation (HST) the profits of a company or a group of companies active in more than one Member State are computed according to the rules of one company tax system only, that is the system of the Home State of the parent company or head office of the group. This system seemed to holde the most promise for tackling the tax problems that hamper SMEs most when expanding cross-border and that the concept could therefore be usefully tested in a pilot scheme. The European Parliament supported the idea of HST and invited the Commission to take this concept forward
Against this background, this Impact Assessment first provides information on the consultations carried out in the context of a Home State Taxation pilot project for SMEs. It then describes the problem to be addressed (low participation of SMEs in the Internal Market due to company taxation obstacles, which restrict the growth and employment potential of SMEs) and the policy objectives intended by the measures under consideration. It then analyses a variety of policy options and assesses their suitability for removing the company tax barriers to the cross-border expansion of SMEs within the Internal Market. It also provides a qualitative and quantitative (as far as possible) assessment of the major economic, social and environmental effects of the HST pilot project. Finally, it sets out arrangements for the implementation of the HST pilot project and its monitoring and evaluation.
2.PROCEDURAL ISSUES AND CONSULTATION OF INTERESTED PARTIES
which could be taken to remove individual tax obstacles to cross-border trade in the Internal Market and concluded that in the longer term Member States should agree to allow EU companies to use a single consolidated base for computing tax on their EU-wide profits. The Commission considers that the existence of (now) twenty-five separate sets of tax rules for calculating the taxable base within the Internal Market, creates excessive compliance costs and, causes numerous other problems such as the absence of relief for losses in cross-border situations, transfer pricing and double taxation. Home State Taxation was one of the policy options to achieve a single tax base presented in the Commission Communication. Following the discussion of the Communication in the relevant groups and at a conference held in
Brussels in April 200224, the Commission services organised a workshop with all relevant
business and accountancy/tax advisor federations, tax experts and other interested parties which took place on 17 December 2002 in order to consult on the idea of a Home State Taxation pilot scheme for SMEs. The workshop gave support to the Commission project (a summary report is available at the Commission's website
On that basis, the Commission services launched a public on-line consultation in February 2003. The consultation period officially ended on 30 April 2003 but responses were still informally accepted up to the end of May 2003. The consultation paper was first distributed to the participants of the workshop of 17 December 2002 and prior to the on-line publication further disseminated on request. Full information on the consultation (document, summary report, etc) is available at the Commission's website
26 and individual contributions can be
made available upon request.
In the consultation, twenty-four external contributions were received from a variety of national and European federations and organisations as well as some individuals. Almost all contributions were supportive of a HST pilot. Most federations and academics were willing to co-operate on the pilot scheme and most contributors said that their views were subject to a further assessment of the final design of the scheme. The efficiency and simplification gains, which the pilot scheme would bring about for SMEs, were generally acknowledged but many contributions also pointed out that it was too early for a final assessment of these. Moreover, many contributions highlighted the risk of potential discrimination and/or competition problems of the pilot scheme and some even referred to possible constitutional problems in specific Member States. However, it was also frequently maintained that a pilot scheme, which was available to SMEs under a specific definition on an optional basis, could avoid such problems. Most contributions argued in favour of a real-life test approach for the pilot scheme although some considered theoretical simulations on the economic effects could be a useful first step or 'backup'. A few contributions suggested that the pilot scheme should be run as a theoretical simulation only. The view that the existing EU definition of SMEs should be used for the purpose of the pilot scheme was overwhelmingly supported. A majority of contributions considered a relatively long or indefinite period as reasonable for defining the time limit of the scheme (e.g. at least 5 years) and refused other types of limitations (e.g. the exclusion of specific sectors). Some form of EU framework for the pilot scheme was generally welcomed but most contributions remained relatively vague on this point. Some expressed firmer opinions on the details and precise legal form of this framework but these were divided. Almost all contributions maintained that the pilot scheme would be of merit even if not all Member States participated. This should be possible. A majority of respondents wanted to include partnerships in the scheme but considered VAT as too different a tax for inclusion in the scope of the pilot project. On the other technicalities of the possible pilot scheme, a variety of - sometimes conflicting, sometimes complementing - views were presented. These concerned questions like
-which factors should be used for the formula needed for dividing the tax base between participating Member States;
-whether or not existing national tax incentives for SMEs are important for the pilot scheme; etc.
Throughout 2002 and 2003, various contacts were established with appropriate European and national associations representing SMEs and other relevant stakeholders. Bilateral meetings were organised in order to follow up specific issues and participation in conferences and workshops was ensured in order to raise awareness of the project and the consultation process.
In July 2003, the Commission published and distributed, inter alia with the help of the relevant EU federations an "Outline of a possible experimental application of Home State Taxation to small and medium-sized enterprises" and a "Questionnaire on corporate tax as barrier to EU expansion of small and medium-sized enterprises" and called upon interested stakeholders to complete and return the questionnaire in an anonymous form.
The questionnaire was intended to collect some useful information for this pilot project from the EU SME community. There was no intention to draw an EU representative sample in order to conduct a statistical analysis. It should also be noted that numerous replies were incomplete which explains that in the presentation of the results below some figures might at first sight appear to be inconsistent. Moreover, the geographical spread of replies is very uneven. Still the Commission services consider that the replies received in response to the questionnaire provided useful insights also into some of the effects of the scheme. The main results can be summarised as follows:
-177 replies were received in response to the questionnaire: 152 from Germany;
8 from Poland; 6 from Austria; 2 respectively from Belgium, the Czech Republic and Italy and 1 respectively from Denmark, France, Slovakia, the United Kingdom and from an unspecified third country.
A detailed summary of the replies is available on the Commission website27. The Commission
services are mindful of the fact that these results are subject to methodological reservations and do not meet statistical standards of representativeness. On the basis of the replies given to the questionnaire it was nonetheless possible to conclude that
-around one-third of the SMEs in the EU consider corporate taxation as an important obstacle to cross-border expansion;
-around one-half of the SMEs in the EU acknowledge the potential and the positive contribution of the Home State Taxation approach for helping and encouraging their economic activities in other Member States;
-around one-half of the SMEs in the EU show, at least in principle, interest to take part in an appropriately designed pilot scheme;
-the interest to take part in the pilot scheme is, in relative terms, highest among medium-sized enterprises.
3.PROBLEM DEFINITION: THE ECONOMIC IMPORTANCE OF SMES AND THEIR LOW
PARTICIPATION IN THE INTERNAL MARKET DUE TO COMPANY TAXATION
In order to assess the effects of company tax obstacles to SMEs participation in the Internal Market it is first necessary to understand the importance of SMEs for the EU economy.
3.1. Economic importance of small and medium-sized enterprises in the EU
At EU level, SMEs are generally referred to as enterprises with less than 250 employees28.
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 this definition.
The importance of SMEs in driving the European Union's economy can be hardly overemphasized as they make up a large part of Europe's economy. There are some 23 million of SMEs in the EU-25, accounting for 99.8% of all enterprises. As shown in figure 1 below, nearly the totality of SMEs in the EU-25 are micro enterprises (employing less than 10 employees) as they represented 91.3% of the total number of enterprises in 2001. SMEs provide jobs for around 105 million people
employment in EU-25, as shown in figure 1. In turn, large scaled enterprises (LSEs), defined as having more than 250 employees, represent only 0.2% of the total number of enterprises but 34.2% of the total employment in the EU-25.
Figure 1: Breakdown of main indicators in the EU-25's business economy by enterprise size class, 2001, % share of total
Num ber of enteprisesNum ber of persons em ployed
Source: Structural Business Statistics, Eurostat (estimates based on incomplete country data).
Further analysis confirms the particular importance of smaller enterprises and micro- enterprises as job creators. There is evidence of the differing employment growth patterns of the various size-classes
30, indicating that SMEs consistently display higher employment
growth than LSEs, and that the difference is mainly due to micro and small enterprises. The early 1990s recession dip in employment, for example, was less severe in micro and small enterprises and their recovery, in terms of employment total, was swifter. Micro and small enterprises have recovered to employment levels higher than in 1988, whereas by 2001, medium and large enterprises were still below this level. Based on these facts SMEs are generally considered to be a key driver in EU employment levels, and are considered to provide greater employment growth than large-sized enterprises
31.This is all the more
likelysince smaller enterprises account for a greater role in labour intensive sectors than do larger enterprises
role of SMEs, specially due to the three types of positive externalities that SMEs have on the economy as a whole: (i) SMEs serve as vehicles for knowledge spillovers, which may become accessible and commercialised by large enterprises through technology transfer or acquisition;
(ii) SMEs increase the amount of competition in the input market, particularly in terms of the competition for new ideas and human capital embodied in knowledge workers; (iii) SMEs increase diversity in the market, which can spill over to generate productivity increases in existing enterprises. An important implication of the external impact of SMEs is that their contribution to growth is not restricted to the SME sector of the economy, but rather spills over to impact on non-SME enterprises.
In addition, with the indirect impact through taxation of their generated profits and wages, European SMEs are a fundamental pillar of the European welfare state and contribute to economic and social cohesion.
Based on these facts it is not surprising that SMEs are generally considered to be a key driver in EU economic and employment growth and social cohesion. Thus, fostering the development of SMEs can be expected to have greater and more immediate economic and social effects than in other company size classes. These facts increase the relative economic importance of the barriers that these businesses face in their cross-border activities.
3.2. Participation of SMEs in the Internal Market and internationalisation strategies
Despite their economic importance, SMEs participation in the Internal Market effectively remains low, both in absolute terms and relative to that of larger companies. For instance, the propensity to export (percentage of enterprise's turnover abroad) varies strongly with enterprise size: it is 23 % in LSEs as against 12 % in SMEs, and within SMEs, only 7 % in micro enterprises
34.The larger the enterprise, the larger (in a physical sense) the market area
tends to be. As it can be seen from figure 235, size still matters, since the importance of
company size clearly influences the extent and forms of internationalisation.
Micro enterprises are significantly less internationalised than small or medium-sized enterprises. While 64% of micro enterprises are non-internationalised, this is only true for 35% of medium enterprises. The size difference is particularly marked when analysing the share of SMEs with more complex forms of internationalisation such as a subsidiary, branch or joint venture abroad or a combination of more than one form of internationalisation. Thus, the size of the enterprise seems to have a significant impact on the possibilities or choice of internationalisation. Smaller companies create subsidiaries abroad less frequently.
investments), the percentage for medium-sized enterprises is much higher since it amounts to 17%, but medium-sized enterprises account only for 1.2% of the total number of enterprises as shown in figure 1 above.
Figure 2: Frequency of internationalisation by size of enterprise
0-9 (Micro enterprises) 10-49 (Small enterprises) 50-249 (Medium enterprises)
Non-internationalised Foreign supplier - only form
Export-only form Subsidiary abroad or more than 1 form of internationalisation
Source: ENSR Enterprise Survey, 2003.
This essential picture can be developed further to give some insight into the characteristics of SMEs with subsidiaries/branches/joint ventures located abroad. The ENSR Survey 2002
shows the proportion of SMEs in the Europe-19 countries that have
subsidiaries/branches/joint ventures located abroad by country. Typically the proportion is very low, ranging from 1% to only 7%, with the exception of Luxembourg (10%)
higher figure is not surprising given the size of the country and the minimal effort required for any enterprise to expand cross-border compared with the effort needed for the typical SME in the other Member States, not least because of the absence of language barriers. The typical figure for the Europe-19 countries is around 3%, with France, Italy and Portugal only having 1% of their enterprises with subsidiaries/branches/joint ventures located abroad. Although there are no comparable data for the ten 'new' Member States of the EU to our knowledge, it seems reasonable to assume that the relevant proportions are as low or even lower for international groups of SMEs with parent companies based in these countries.
Further on, from table 1 it can be shown that the percentage of SMEs having subsidiaries, branches or joint ventures located abroad is twice as high for young enterprises (less than 5 years) as for the oldest ones (more than 10 years).
Table 1: Subsidiaries/branches/joint ventures located abroad (% of SMEs) by age of enterprise
<=5 years 6-10 years >10 years Total
Yes 4% 3% 2% 3%
No 96% 97% 98% 97%
Source: Weighted data ENSR Survey 2002 among 7669 SMEs in Europe-19 countries
The picture of the main characteristics of existing EU-based international groups of SMEs
39 can be rendered in greater detail using an exercise based on the AMADEUS
database40. Some basic results from this investigation have been compiled and reported in
Tables 2, 3 and 4 below. The main insights from these data can be summarised as follows:
MS) which have at least one majority-owned subsidiary in a Member State other than the parent's one. Subsidiaries have to be owned at least 50% by the SME parent (second or further levels of ownership are allowed as long as indirect ownership is beyond the 50% threshold) and have to fulfil also the SMEs criteria to be considered as part of the SME international group. The table shows that there are 20134 such qualifying subsidiaries in the EU for the 7145 SMEs parent companies, thus a total of 27279 companies are under analysis.
Table 2. Some basic insights about international groups of SMEs from the AMADEUS database
Number number of
SMEs (>50%) of Total Number of Number of
Number parent the SMEs number Average nr domestic subsidiaries Average nr
of SMEs cos. in parent cos. of cos. of subs. subsidiaries Average nr
observed each located in (parents /SME parent subs./SME abroad/SME True
by MS MS each MS + subs) co. (>50%) parent co. (>50%) parent co. Weight
AT 107 12 49 61 4,08 28 2,33 21 1,75 0,0223
BE 145645 1502 3477 4979 2,31 789 0,53 2688 1,79 0,0185
CY 25 2 2 4 1,00 0,00 2 1,00 0,0023
CZ 5430 16 44 60 2,75 11 0,69 33 2,06 0,0185
DK 32018 426 1065 1491 2,50 301 0,71 764 1,79 0,0160
EE 30835 42 58 100 1,38 13 0,31 45 1,07 0,0023
FI 26196 62 130 192 2,10 39 0,63 91 1,47 0,0089
FR 434127 959 2568 3527 2,68 936 0,98 1632 1,70 0,1079
DE 2887 41 82 123 2,00 28 0,68 54 1,32 0,2241
EL 7137 10 28 38 2,80 10 1,00 18 1,80 0,0115
HU 5061 3 4 7 1,33 1 0,33 3 1,00 0,0185
IE 52662 345 830 1175 2,41 182 0,53 648 1,88 0,0089
IT 83330 338 544 882 1,61 84 0,25 460 1,36 0,1252
LV 1599 3 3 6 1,00 0,00 3 1,00 0,0023
LT 701 3 7 10 2,33 1 0,33 6 2,00 0,0046
Table 3. Distribution of subsidiaries of international groups of SMEs by Member State
Nr of subsidiaries Total
(>50% owned) (of subsidiaries
SMEs parent cos) in (>50%
each MS: owned) of
Nr of SMEs parent cos in each MS: AT BE CY CZ DK EE FI FR DE EL HU IE IT LV LT LU NL MA PL PT SK SI ES SE UK SMEs
in each MS
AT 12 28 1 2 12 1 1 1 3 49
BE 1502 13 789 2 34 6 2 4 693 203 9 26 8 84 2 2 107 1053 3 65 15 21 2 100 83 151 3477
CY 2 1 1 2
CZ 16 1 1 11 8 2 4 16 1 44
DK 426 2 11 2 3 301 6 37 51 170 2 7 2 30 18 9 9 64 24 3 4 54 130 126 1065
EE 42 1 13 35 9 58
FI 62 1 2 27 39 1 11 2 9 5 4 6 5 18 130
FR 959 14 149 1 34 8 1 7 936 355 12 25 6 118 3 38 58 2 67 31 7 239 13 444 2568
DE 41 7 2 6 28 2 5 1 1 9 2 2 17 82
EL 10 1 3 10 1 13 28
HU 3 2 1 1 4
IE 345 1 1 3 1 1 2 21 182 16 3 18 581 830
IT 338 11 8 1 1 1 1 137 101 1 4 1 84 1 2 20 13 1 39 1 116 544
LV 3 2 1 3
LT 3 2 2 1 2 7
LU 1 1 1
NL 846 24 146 3 23 26 1 2 100 588 2 22 9 22 2 2 1665 37 8 3 76 7 384 3152
PL 9 2 1 7 1 11
PT 23 4 4 2 38 14 9 71
Table 4. Subsidiaries of domestic and foreign SMEs parents in each Member State
AT BE CY CZ DK EE FI FR DE EL HU IE IT LV LT LU NL MA PL PT SK SI ES SE UK Total
Total Nr of
(>50% owned) 140 1172 25 153 630 131 364 2444 2233 57 130 312 475 119 60 178 3352 6 396 451 58 11 1570 1353 4314 20134
domestic 28 789 11 301 13 39 936 28 10 1 182 84 1 1665 38 888 1101 2009 8124
foreign parent 112 383 25 142 329 118 325 1508 2205 47 129 130 391 119 59 178 1687 6 396 413 58 11 682 252 2305 12010
by foreign 0,93 3,19 0,21 1,18 2,74 0,98 2,71 12,56 18,36 0,39 1,07 1,08 3,26 0,99 0,49 1,48 14,05 0,05 3,30 3,44 0,48 0,09 5,68 2,10 19,19 100
owned by 4,35 2,19 0,46 1,51 1,15 0,79 0,67 12,45 20,38 0,32 1,57 1,37 4,14 1,00 0,64 0,59 9,82 0,03 3,45 3,70 1,42 0,06 6,66 0,95 20,34 100
Table 2 also shows in the first column that nearly data for 2 millions SMEs is recorded in the database. As only 7145 are found to be parent companies with cross-border subsidiaries (i.e. 0.37%), this may seem to contrast with the Observatory of SMEs figure that 3% of SMEs have cross-border subsidiaries, permanent establishments or branches and lead to misleading conclusions of non-representativity of the database. However this may not be the case and the database information is still representative, since the lower observed percentage of SMEs with subsidiaries abroad could be due to the fact that the 3% figure, in addition to subsidiaries, includes also branches and permanent establishments (which are normally much more numerous than subsidiaries) and also to the fact that the threshold fixed to define international groups of SMEs -50% ownership threshold- excludes many of the "subsidiaries abroad" reported in the Observatory figure.
-The analysis of SMEs international groups drawn from this database shows an average number of 2.82 subsidiaries (>50% owned) per SME parent in the EU, out of which, 1.14 are domestic subsidiaries and 1.68 are foreign subsidiaries in a different EU Member State to their parent.
-Although not presented in the tables, other analysis have been carried out showing that around 20% of the subsidiaries of the EU-based international groups of SMEs are owned in second or further levels of ownership (ie sub-subsidiaries, etc) for the sample under consideration. Also, group members of this sample of international groups of SMEs have an average of 28 employees per company within the group.
-Tables 3 and 4 in turn show the sample distribution of the subsidiaries of international groups of SMEs by Member State. Thus, the number of domestic and foreign majority-owned subsidiaries (by MS of location) owned by the SME parent companies based in a given MS is presented within Table 3 by rows. The number of subsidiaries established in a given MS (>50%-owned by domestic or foreign parents) is presented in Table 4. Table 3 confirms that in most cases, neighbouring countries are the main destination of foreign investment of parent SMEs in form of foreign subsidiaries. For example, this trend can be seen in the destination of foreign subsidiaries of Nordic countries-SMEs parents (preferably across Sweden, Denmark or Finland), central Europe countries' SMEs parents (for instance SMEs parents in the Netherlands, Belgium, France, etc establish their foreign subsidiaries mainly in the neighbouring countries) or southern countries (for example, cross-border subsidiaries are frequent across Spain and Portugal). On the other hand, Table 4 presents the subsidiaries (foreign or domestically-owned) established in each MS of the EU-25. It shows that UK, Germany and France are the EU countries that receive higher percentages of cross-border investments in the total sample of EU international SMEs parent
by a parent company set in a country other than that of the subsidiary) are established in the first two countries and around 12% in France
All in all, the previous analysis has provided a rather thorough picture of the main features characterising existing EU-based international groups of SMEs with subsidiaries in Member States other than the parent companies' ones.
3.3. The benefits of SMEs internationalisation
The statistics shown above demonstrate that the problem of low participation of SMEs in the Internal Market is real and concrete. Moreover, it is shown that in particular smaller and younger enterprises (which are the main employment creators) need further help and encouragement for expanding across borders and exploiting business opportunities in other Member States.
Why should the low participation of SMEs in the Internal Market be a problem? Firstly, as indicated by several international studies as well as the ENSR 2003 Enterprise Survey, engaging in international activities has a positive impact on the competitiveness and performance of SMEs and thereby on economic growth and social welfare in the EU. The above-mentioned "Internationalisation of SMEs" report investigates in detail how internationalisation affects SMEs competitiveness and shows that internationalised SMEs perform overall better compared to domestic SMEs. Moreover, the more complex forms of internationalisation (ie, the establishment of cross- border subsidiaries) are perceived to have a greater effect on the SMEs' competitiveness.
For example, it shows the effect of foreign subsidiaries on turnover (by enterprise size): Among micro enterprises with subsidiaries abroad, 50% register a positive (or strongly positive) effect on their turnover. For medium-sized enterprises the figure goes up to 68%. Roughly between a quarter and a third of the SMEs register no effect. Very few register a negative effect.
The positive effect of internationalisation is further supported by comparing the turnover of internationalised SMEs versus non-internationalised SMEs. The report shows that non- internationalised SMEs were more likely to experience a decrease in turnover from 2001 to 2002. Similarly, both SMEs with a foreign supplier and those with more complex international activities experienced increases in turnover more frequently than the non- internationalised equivalents. It apprears that SMEs with international activities are more likely to see constant or increased turnover rather than decreased turnover, compared with SMEs that only undertake domestic activities.
The report claims that in addition to quantifiable effects on sales (turnover) international activities can also have an indirect positive impacts on the competitiveness of SMEs in a way that is less easy to measure. The SMEs may for instance improve their cost- efficiency by outsourcing abroad or may develop their know-how and technology competencies. Also, initiating foreign investment or collabouration with partners in other countries may offer new challenges and opportunities to the employees or improve the SMEs' scope of recruitment and their ability to maintain highly skilled employees.
Eventually, foreign direct investments and cross border clustering represent viable ways to facilitate exchanges of knowledge and technology and to strengthen international business strategies of SMEs, resulting in overall better performance. And the tax factor should not be an obstacle to develop such potentiality of growth and improved performance of one of the Internal Market's leading economic agents.
Besides these arguments, the importance of cross-border start-ups by SMEs for the EU economy should also take into account a contextual consideration. It is indisputable that at the moment the current business environment is more favourable for SMEs engaging in cross-border investments than two decades ago. The technologies for communication and management have improved, managers are better educated and more aware of globalizing business, access to information and communication has improved as well as the facilities for managing geographically scattered production. Furthermore, the use of the worldwide web is continuously growing, more efficient, low-priced types of transportation for both goods and personnel have emerged and in general tendencies for increasing specialisation globally are likely to push more SMEs into international business (specially in small open economies). Thus, the importance of cross-border ownership of assets and cross-border establishments continues to increase, mirroring the substantial role of internationally oriented enterprises in the global economy. These considerations support the idea that the present economic and business context in the EU should be supportive of the internationalisation of SMEs by the emergence of horizontal/vertical SMEs' multinationals. Certainly, tax factors should not be allowed to obstruct this trend.
3.4. Company tax obstacles in the Internal Market and their relevance for SMEs
Intense research by the Commission services42 and independent research institutes43 over
the last years have again confirmed that, despite the positive effect on enterprises' performance as described above, the cross-border economic activities of businesses in the EU, are seriously hampered by numerous and varied company tax obstacles. Given progress in many other policy fields where measures of harmonisation or mutual recognition have been taken, the relative importance of these tax obstacles has increased over recent years and now constitutes one of the single biggest problems in the completion of the Internal Market and the fulfilment of its economic potential. The European Commission is therefore currently working on the implementation of a "two- track strategy" which contains both short-term measures that are targeted at resolving specific obstacles to cross-border economic activities in the Internal Market and longer- term comprehensive solutions
In the Commission services' analysis, particular attention was also paid to the specific situation of SMEs
45.Generally, the tax obstacles to cross-border economic activity are
identical for small and medium-sized enterprises and larger companies. The impact of many obstacles on SMEs is however stronger as they have, simply due to their smaller size, less economic and human resources and tax expertise available. In other words, the limited size of the business inherently limits the possibilities to avoid some tax obstacles.
It was nevertheless established that 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
This finding is also endorsed by scientific and quantitative evidence. In addition to the available studies suggesting that compliance cost are regressive to size and put a disproportionately higher
49 or even prohibitively high burden on small and medium-sized
enterprises compared to bigger companies50 the recent European Tax Survey51 which was
obtained from the Commission's European Business Test Panel has, albeit admittedly not in all respects in a statistically reliable way, confirmed the importance of tax-induced compliance costs for SMEs. In particular, it revealed that compliance costs relative to sales are larger for SMEs than for large companies. For instance, econometric regressions provided significant and recurrent evidence that total, VAT and company taxation compliance costs increase with company size but impose a higher relative burden on smaller companies. Moreover, it was established that cross-border activity leads to higher compliance costs for companies. Based on the econometric analysis carried out it was demonstrated that compliance costs are higher for companies with at least one subsidiary in another EU Member State compared to companies without subsidiaries in another Member State and that they increase with the number of subsidiaries abroad.
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 carry back losses.
Obviously, SMEs also face specific cross-border problems relating to taxes other than company taxation. For instance, the transfer of SMEs, often family businesses, entails a number of tax problems that are often more difficult and onerous than for big publicly quoted companies. Cash-effective gift and inheritance taxes are an important example in this respect. The Commission has repeatedly referred to these issues and presented
recommendations on tax problems concerning the transfer of SMEs52 and a
Communication on the general improvement of the tax environment of SMEs53. Most of
the recommendations concern tax problems relating to the legal status of sole proprietorships and partnerships, in particular on the succession of SMEs. The Commission services will soon publish a Communication with updated information regarding the transfer of enterprises and related tax problems in order to prepare the ground for new initiatives in this field. Finally, there are currently a variety of measures under way in order to address the particular problems of SMEs in the area of value-added tax. In particular, the Commission initiative on the 'one-stop-shop' concept will make it much easier for SMEs to expand in the Internal Market as they will be able to deal with their VAT obligations at one single point of registration only
54.It follows that from a
SME perspective company taxation remains the single biggest Internal Market tax problem which is so far not being addressed at EU level.
3.5. Evaluation of the effects of the company tax obstacles
Given the lack of data on SMEs as regards their taxation as well as the limitations of economic modelling, providing a reliable global estimate of the effects of company tax obstacles to SME participation in the Internal Market is difficult. There are nevertheless numerous qualitative and quantitative indicators revealing that the low participation of SMEs in the Internal Market is among other things caused by the tax obstacles which these companies face in the Internal Market. For instance, the replies by interested stakeholders to a "Questionnaire on corporate tax as barrier to EU expansion of SMEs"
published by the Commission services in July 2004 among other things revealed that around one-third of the SMEs in the EU consider corporate taxation as an important obstacle to cross-border expansion
Moreover, the often specific nature of the business activities of SMEs means that they are particularly susceptible to certain cross-border tax obstacles (in particular technology- driven start-up companies). For instance, the limited availability or the unavailability of a
means to offset losses in start-up companies in other Member States not only, as mentioned above, discourages the creation of an establishment abroad, but it also limits the business' access to finance at an essential stage in a company's development life- cycle, which is frequently subject to supply-side constraints imposed by risk-averse financial provision from banks and other financial institutions. This negatively affects the conditions for the survival and the development or cross-border expansion of SMEs. Moreover, due to the smaller business size, high compliance costs are particularly relevant for SMEs and clearly deter many from cross-border expansion.
Furthermore, some features of tax systems tend to favour domestic over foreign activities. For instance, in the domestic context most Member States apply special tax arrangements (fiscal incentives or tax breaks) for self-employed and SMEs that need to be taken into account
56.These arrangements, which are however usually not geared at cross-border
economic activities and the related tax issues, essentially concern the determination of the tax base, flat-rate arrangements and other simplified methods of profit determination. Some Member States also grant specific lower rates. The combination of both effects - the particular importance of cross-border obstacles for SMEs and relief for domestic tax problems - may even increase the hurdle for starting cross-border business for SMEs. Based on an initial qualitative assessment the effects of the tax obstacles can therefore safely be expected to be considerable, with economically relevant impacts.
The consequences of the company tax obstacles and their interplay with other tax and non-tax factors are thus reflected in the above mentioned statistics on the relatively low participation of SMEs in the Internal Market and supported by economic research. In other words, because of the company tax barriers to cross-border EU activity and in particular the problems to compensate for foreign start-up losses and even more so the disproportionately high compliance burdens, SMEs;
Given the overall importance of SMEs as key driver in economic growth their reluctance to Internal Market participation and their poor survival rate is not only very costly to the individual business owner/entrepreneur
57 - it also adversely affects the overall economy
in terms of productivity and job creation to maintain low unemployment levels, or tax revenue creation to support public services, both factors being essential to achieve the final goal of social cohesion stated in the Lisbon Council conclusions.
The tax barriers faced by SMEs when they undertake international expansion as described above, can be defined as cost-increasing barriers resulting in market-entry restrictions. The removal of such barriers is a liberalisation policy to be analysed within the framework of the freedom of establishment, according to the art. 43 of the Treaty. The manifold, substantial negative economic consequences for SMEs and for the EU that company tax obstacles induce, impeding further potential for growth and employment, calls for policy action in this area to remove such barriers.
The cross-border-specific company tax obstacles mentioned above lead to sub-optimal levels of cross-border investment by SMEs and/or to tax-driven distortions in the allocation of their investments. Thus, tax policy for SMEs in this context should be
In operational terms the specific goals are:
(i) To encourage SMEs in (further) internationalisation of their activities across the Internal Market (both, SMEs that currently operate only in a domestic context and already international SMEs). Internationalisation processes, however, have to be seen nowadays as a much more diversified business activity than just a mere ambition to sell/buy products in/from foreign markets and it has been argued that more complex forms of internationalisation (ie, the establishment of cross-border subsidiaries) lead to overall better performance of SMEs. Thus, the specific objective is to help SMEs wishing to set up branch/subsidiary businesses in other Member States to replace or complement national production for export with localisation abroad.
(ii) to remove SMEs' tax anomalies where they are specific to cross-border economic activity so that such activity can be undertaken in the Internal Market in the same or at least in a broadly comparable way as in national markets, i.e. by not imposing extra tax compliance costs and discriminatory loss compensation rules to international versus purely domestic activities of SMEs.
The achievement of these objectives is subject to several constraints. For instance, any measure taken for achieving these objectives should not at the same time lead to significant revenue shortfalls for Member States, open new major tax fraud or avoidance possibilities and/or compromise tax administrations' control possibilities of SMEs. All these effects would adversely affect the achievement of the overall economic and social benefits sought in the first place.
Market tax problems of SMEs. Given that high compliance costs constitute one of if not the most important SME cross-border tax problem, particular attention was paid to possible Community actions in this area. Among the solutions considered were a simplified and uniform tax return and simplified bookkeeping rules for SMEs which they could file throughout the EU and the standardisation of formal and procedural requirements (similar filing dates, similar penalty regimes and a similar basis for charging interest on late payment, etc). Such action would have been in line with the ideas for moderating the administrative complexity relating to permanent establishments of SMEs (e.g. building sites) of the Commission Communication on the improvement of the tax environment of SMEs
Similarly, thought was also given to the specific approach taken in many double taxation treaties which provides for generous transitional periods under which building and assembling companies can operate abroad without creating a permanent establishment. Such rules could be extended generally to SMEs which would then have more opportunities to familiarise themselves with the tax situation in the foreign country. The underlying idea of such an approach is that SMEs, given the choice, would want to start a new business establishment abroad on the basis of the legislation and tax system of their home country and then find their way gradually around the arrangements in the other country (learning by doing). In an initial phase, companies should thus have the possibility to fulfil their tax obligations, solely vis-ŗ-vis the tax authorities of the Member State in which they have their head office, even if they operate in another Member State. Accounting, declaration and payment obligations would continue to apply solely in the home State.
As regards the issue of loss-compensation and in particular start-up losses, various possibilities to address this problem were considered. Some of the domestic solutions found in Member States were already considered by the Commission in 1994
5.2. Available options
The following policy options have been examined:
No policy change
Simplification and EU-wide standardisation of company tax filing and bookkeeping
rules for international transactions
Directive on cross-border loss-offset
Direct subsidies by Member States/State Aid
Home State Taxation pilot project
5.3. Initial screening
The policy options have been screened in order to determine which of them would be best suited to address the above-described tax obstacles to an economically desirable increased participation of SMEs in the Internal Market and tackling the company tax problems for SMEs to set up establishments in other Member states.
No policy change
If no specific action was taken to remove the specific SMEs tax obstacles in the Internal Market, the existing company-tax induced reluctance of SMEs to participate in the Internal Market would remain and the related economic potential would be continued to be foregone. One could argue that no specific action for the tax problems of SMEs is necessary as general measures for tackling the tax obstacles faced by all companies, regardless of their size, are under way. This is however not convincing. First, this was the approach followed in the past and the result is that larger enterprises benefit at large from the Internal Market while SMEs do not. Second, the pace of progress with these general measures is slow. Many of these are also of particular interest to larger companies, e.g. the improvement of the EU company tax directives on mergers
Simplification and EU-wide standardisation of company tax filing and bookkeeping rules
A simplified and uniform tax return and simplified bookkeeping rules for small and medium-sized enterprises which they could file throughout the EU would constitute an enormous help for the businesses concerned and automatically reduce their compliance costs. Consideration could also be given to the standardisation of formal and procedural requirements (similar filing dates, similar penalty regimes and a similar basis for charging interest on late payment, etc).
However, if one examines the possible simplification and EU-wide standardisation of company tax filing and bookkeeping rules in the light of the preceding analysis of the tax problems of SMEs in the Internal Market and their economic effects, it appears that most of this approach, however useful it could be, falls short of addressing these tax obstacles in a comprehensive manner and could hardly be expected to have a noticeable remedial effect beyond individual cases. It would only address one aspect, that of formalities concerning filing and accounting obligations, of only one of the tax obstacles, that of disproportionate compliance costs.
Moreover, it is extremely doubtful that Member States' tax administrations are prepared, or in a position, to follow this approach as many of these formal obligations follow from national public laws that are not harmonised and fall largely outside the EU's competence. For instance, the issue of cross-border loss-offset and the peculiarities of creating foreign establishments (e.g. a subsidiary) would not be addressed. The simplification and EU-wide standardisation of company tax filing and bookkeeping rules is therefore no acceptable option.
Direct subsidies by Member States/State Aid
Given the unanimity requirement in EU tax matters thought could be given to address the tax obstacles of SMEs by using a non-tax instrument, for instance that of targeted subsidies in order to encourage cross-border expansion of SMEs. Moreover, at EU-level SMEs are subject to specific State Aid rules (exemption regulation
66), which is why
potential competition problems in this respect could probably be avoided in the design of the rules. Apart from this legal issue it must be underlined that such a solution would at best compensate for the tax obstacles but not resolve them. This does not seem to be an efficient way forward. Moreover, it will be difficult to quantify the necessary compensation for the subsidy. Direct subsidies by Member States or the provision of State Aid is therefore no suitable option for tackling the specific company tax problems of SMEs in the Internal Market.
Home State Taxation pilot project
The approach of Home State Taxation (HST), which was originally not particularly targeted at SMEs
67, could be applied specifically for this group of companies in a pilot
project. Under a HST-regime a company that does business in more than one country could calculate its taxable profits in all countries according to the rules in its home country. The taxable income would then be apportioned between the countries according to some key (e.g. turnover, payroll or other) and each of the countries would apply its own tax rate to its apportionment of the profit.
The Home State Taxation approach is based on the principle of mutual recognition and as such fully respects the principles of subsidiarity and proportionality. A Commission Communication to this effect could be taken up by Member States and adapted to possible regional specificities. Moreover, it could be implemented relatively quickly, for instance by using the instrument of tax treaties. Its application to SMEs is supported by the European Parliament
Commission services, independent research institutes and academics71 confirm its
potential to effectively address the tax obstacles of SMEs in the Internal Market. Given that the application of 'home state' tax rules also to foreign activities of a SME reduces tax-induced compliance costs and usually makes sure that losses can be directly offset against profits, Home State Taxation is a suitable, measured and at the same time comprehensive option to tackle the tax obstacles faced by SMEs wishing to expand within the Internal Market.
Definition of pilot scheme
There are various possibilities to define precisely the meaning of 'pilot project'.
-First, 'pilot scheme' could mean a purely theoretical exercise in which some selected businesses and the responsible tax administrations re-calculate the hypothetical effects of applying home state tax rules to international business activities (taxable income, tax liability, revenue effects, etc).
-Second, the tax administrations of the interested Member States could select a sample of appropriate "model companies", perhaps including only those active in border regions and allow them on a reciprocal basis to carry out their business in other Member States or perhaps only the neighbouring country under the tax rules of their home country. This approach would limit the revenue consequences for Member States and allow tax administrations to gather valuable practical experience with the approach in a manageable but not very resource-intensive way. This approach of selecting a sample of "trustworthy"
businesses/model companies for establishing, for instance, information needed for general tax audits (e.g. average profitability figures in specific industries) appears to be common practice. Thus, the experiment would be limited to a handful of sample model companies.
Member State with a business also in the co-operating neighbouring state, identified as an SME according to the special criteria set up, to participate.
The Commission services agree with these views. Only a practical test which is in principle open to all enterprises meeting the relevant conditions and requirements will provide the desired experience with HST which lies at the heart of the pilot scheme idea. Moreover, a restricted pilot would risk creating new discrimination issues.
The basic concepts of Home State Taxation
The basic concept and the fundamental objective of the HST pilot scheme are very
simple: to tackle the tax obstacles encountered by SMEs when they operate in other EU Member States in addition to their own (home state) by granting them the possibility to apply the well-known corporate tax rules of their home state only. The key points of an appropriate pilot scheme as developed over the last years taking into account the contributions from academia, SME federations and individual enterprises as well as tax administrations can be summarised as follows:
Table 5: Key points of the Home State Taxation pilot scheme for SMEs
Basic approach: Under the pilot scheme, SMEs active in more than one Member State can
compute their taxable income (tax base) according to the rules of the system of the Home State of the 'parent company' (lead company or head office) only.
Tax rates: Each participating Member State continues to tax at its own corporate tax rate
its share of the profits of the group's business activities in that State.
Which SMEs: Either small and medium-sized enterprises or, if need be from a Member
Tax assessment and payment: Participating companies will self-assess, report and pay the
local tax but the calculation of the combined profits of the group will only need to be filed by the parent company in the Home State. The other tax administrations concerned receive copies.
Allocation formula for tax base: The tax base as established on the basis of the Home
State rules is apportioned on the basis of a simple formula (e.g. payroll and sales at 50% each) among the Member States concerned. A common allocation mechanism is assumed for all participating SME-groups.
Third country income of group members falls outside the scope of the scheme and is
added to the income of the group member after apportionment.
Tax audits would be carried out by the Home State authorities, if need be jointly with the
partner administration. The general rules for mutual assistance in the EU would apply.
Monitoring: Commission and Member States may create a monitoring group for
supervising the pilot scheme, considering possible practical problems and assessing its success.
5.4. Conclusion of initial screening of options and policy choice
It follows from the foregoing analysis that among the available options for tearing down the specific Internal Market corporate tax barriers for SMEs only the approach of Home State Taxation could achieve the intended result and should therefore be pursued further in a "real-life" pilot scheme which would be open to all qualifying SMEs.
The following analysis sets out the key elements of the HST option and examines its expected economic, social and environmental impacts. The objective is twofold: on the one hand, to explain qualitatively in more details, the channels, both in terms of firms' behaviour and general expected effects, through which the HST may remove the Community's tax barriers faced by SMEs willing to establish their activity in the Internal Market. On the other hand, when possible, quantitative estimates of the various possible effects are presented
domestic context but may be pushed to internationalise their activity, following the reforms.
Second, the transmission of the effects of improved cross-border establishments
into the economic situation of host and home Member States and the indirect effects into consumers' welfare are analysed (the economy-wide impact assessment of HST).
The potential revenue and cost effects of HST measures for the Member States'
national tax administrations.
6.1.1. The impact of HST on SMEs
In this section, the possible effects of HST on SMEs are analyzed:
-The HST pilot project directly benefits existing multi-national SMEs: First of all, it is without doubt that HST benefits the SMEs that currently have cross- border establishments in Member States other/s than that of the parent company. The benefits for these enterprises will comprise improved loss compensation and lower tax compliance costs. Sections 22.214.171.124.1 and 126.96.36.199.2 below give a qualitative assessment and a quantitative estimate of the extent of these benefits for currently internationalized SMEs. The final effect of these benefits should be to increase productive investments by international SMEs and to further improve their allocation of resources.
-In addition to benefits for existing multi-national SMEs, the removal of tax barriers by HST measures may also affect the decision by companies to start new activities cross-border (i.e., new cross-border holdings in foreign subsidiaries, foreign direct investment, new foreign branches, etc). This applies both to companies already operating cross-border wishing to expand to other Member States but equally well, and more importantly, to companies so far operating in a domestic context only. Section 188.8.131.52 highlights the main issues that come into play when a company decides whether to start activities cross- border. In particular, the way in which the reaction of these companies may be affected by HST will be discussed.
The report alleges that foreign supply relationships are the most common form of internationalisation, being the case for 30 % of all SMEs. The second most prevailing form of internationalisation is exporting, undertaken by 18% of SMEs. 3% of the surveyed SMEs have collaborative relationships primarily with foreign SMEs, whilst another 3% have established foreign subsidiaries or branches. It is the latter SMEs' group that will be mainly affected by the HST measures and its resulting removal of tax barriers.
The report also shows that there are differences in the likelihood of becoming international within groupings of SMEs according to the size of the enterprise: larger SMEs are more often involved in some form of internationalisation than smaller ones. Also larger SMEs more often have subsidiaries or branches abroad or are involved in more than one form of internationalisation (approximately 12%
of micro, 28% of small and 45% of medium-sized enterprises have forms of internationalisation such as a subsidiary, branch or joint venture abroad or a combination of more than one form of internationalisation). Therefore, in general large SMEs (50-249 employees, of which around 230.000 exist) are the most likely to be affected by the HST measures.
The report also shows that smaller countries are more internationalised: whilst for most European countries a mere 1-4 % of the SMEs have established subsidiaries abroad, in small countries with more open economies (ie, Luxembourg, Austria) this percentage may go up to nearly 10%. Therefore, existing SMEs set in these countries may be relatively more likely to be affected by HST measures (as compared to SMEs in other EU Member States), since a higher proportion of them are parent companies with foreign subsidiaries.
Regarding the sector implications, the form of internationalization of SMEs that may be affected by HST measures (e.g. SMEs with subsidiaries and branches abroad) is most frequent within manufacturing and wholesale (around 30% of SMEs in these sectors have subsidiaries abroad or more than one form of internationalisation). Within these two sectors and transport/communication, the percentage of SMEs that have subsidiaries abroad or more than one form of internationalisation is actually higher than the percentage that merely has a foreign supplier or exports as isolated forms of internationalisation. Thus, these are the sectors more likely to be affected by HST measures, as regards the already operating international groups of SMEs.
for these internationalised SMEs are provided74. The qualitative implications of such
saving measures are also discussed.
184.108.40.206.1. The effects of cross-border loss offsetting
One important feature of the HST method is the proposition that profitable SMEs in one Member State may offset immediately possible losses incurred by other company/ies of the same group, held beyond a certain ownership level
75, in other Member State/s for the
purpose of assessing the total tax base.
The qualitative effects of cross-border loss compensation
Currently, the cross-border loss compensation arrangements that are present in the Member States are applicable mostly to domestic subsidiaries or to foreign permanent establishments, whereas few provisions are available to foreign subsidiaries. This biases investments of parent companies towards the home state, affects the form in which international activities are organized and puts investments by taking a degree of control in foreign companies and foreign direct investment (ie, establishment of foreign subsidiaries) at a disadvantage. In economic terms this means that the dissimilar treatment of loss compensation for the different situations is not neutral for firms' decisions and leads to a less efficient allocation of resources. As HST measures allow for a single system of loss compensation to all members of a given multinational SME group (regardless of the location or form of the group member that incurred the losses), ie, the same system of loss compensation applicable to domestic group taxation, it should lead to a more efficient, non tax-biased, allocation of resources through SMEs investments across the EU.
It is worth at this point providing an overview of the current tax treatment of losses in domestic group taxation schemes in Member States, as these would actually be the loss compensation rules applicable to international members of SMEs groups with a parent company in the corresponding Member State. These are shown in following table.
Table 6: Overview of tax treatment of losses in domestic group taxation schemes in MS
No group relief Intra-group loss transfer "Pooling" of results of a group Full tax consolidation 76
∑ Czech Republic
(∑ Estonia)a) "Group-relief"
∑ United Kingdom b) "intra-group ∑ Denmark
∑ Slovenia ∑ "fiscale eenheid" in
No loss Every group member is taxed separately; losses may be transferred on a definitive basis from one group member to another Each group member determines its tax base which is then pooled at the level of the parent company Legal personality of each group member is disre- garded for tax purposes, the result of the subsidi- aries are treated as if rea- lized
compensation available, i.e. a group
disregarded for tax purposes by the parent
There are seven countries that do not provide any form of group-relief of losses in their domestic cases. As the idea of HST is that the domestic tax rules of the 'home state' of the parent company would apply to EU-wide activities of the group, the international groups of SMEs whose parents are established in those countries will not have access to cross- border loss-offsetting (just as purely domestic groups in those countries do not have group loss compensation available).
intra-group transfer of losses, or 'pooling' of results at the level of the parent company or full tax consolidation (with elimination of all intra-group transactions of all members of the international group). All these methods when applied domestically (and so would be in international cases) provide for a vertical (i.e. between parent and subsidiary) and horizontal (i.e. between subsidiaries) loss-compensation throughout the group.
The possibilities of cross-border loss compensation represent a financial advantage for businesses, which is estimated below. Also, allowing the offsetting of losses in start- ups/early-stage companies outside 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 institutions.
A quantitative estimate of the potential losses that could be compensated by existing international SMEs under HST
The investigation into the potential amount of losses that could be compensated under HST was done through an exercise using the AMADEUS database. In order to quantify the total amount of losses that could be compensated under HST the following steps are taken as part of such an exercise:
(1) Out of the 7145 international groups of SMEs in the database shown in table 2, 2077 of them have parent companies set in 'home states' with appropriate intra- group loss-offsetting rules
78 and present the relevant information for an estimation
of cross-border loss compensation: that is, profits/losses of the parent company and at least one cross-border subsidiary of each group
79.The distribution of this
sample of 2077 international groups of SMEs with actual profits/losses information and with cross-border loss compensation possibilities as available in the 'home state', and their HST-qualifying subsidiaries
of subsidiary/ies located in another Member State or upward when losses of a foreign subsidiary are offset against profits of its parent company, located in another country) and horizontally (ie, compensation across subsidiaries of the same group, respectively located in different Member States)
(3) After mapping subsidiaries to parent SMEs companies' profits/losses of each group of multinational SMEs and analysing the possibilities of cross-border loss compensation for each group up to a maximum of positive profits elsewhere within each group-, the estimates of possible cross-border losses that can be compensated under HST, that would not exist in general without HST measures, are reported aggregated by Member State of the parent companies in the last columns of table 7. In order to handle representativity concerns over the sample, the total amount of cross-border compensated losses is weighted by country by reference to the assumed true weighting factor described above in table 2, in order to replicate the assumed real distribution of international groups of SMEs by country. The seven countries where domestic tax legislation does not provide any form of domestic group loss relief would extend this system to international groups of SMEs with parent companies located in those territories and therefore show no cross-border loss compensation available under HST.
Table 7 reflects the main figures resulting from this exercise calculated for this sample of the database for the years 2003 and 2001, aggregated by Member State. The following insights can be obtained from these results:
The total (weighted) amount of prospect cross-border loss compensation for this sample of international groups of SMEs (with parents set in countries with appropriate loss offsetting rules), which did not exist before HST, is about 190 and 275 million euros for the years 2003 and 2001 respectively. Since the sample represents approximately 8% of total SMEs in the EU (about 2 millions SMEs out of 23 millions) we can estimate, under the assumption of accurate representativity of this sample, the possible total amount of the potential losses that could be compensated under HST for existing international groups of SMEs in the order of 2.4 to 3.4 billion euros per annum (ie 12,5 times the sample size), depending on the years.
with cross-border information of profits/losses and with parent companies set in Member States with appropriate group loss offsetting rules.
The results also show that an average of 30% to 40% (depending on the years) of the existing international SMEs groups could benefit from the HST cross-border loss compensation possibilities (ie, total number of groups in which cross-border loss compensation is actually reported versus total number of groups with cross-border information in the sample).
The estimated amount of immediate savings in tax payments for existing international SMEs in the EU is obtained by multiplying the roughly 3 billion euros by the average effective top statutory tax rate on corporate income in the EU-25 which was 28.7% in 2003
82.This results in estimated immediate savings
in tax payments equal to around 860 million euros which compares with 220 billion euros in corporate tax revenues in the EU-25
This figure should not be understood, however, as a net HST-induced loss of tax revenues for the tax authorities. If the losses that are reported by the subsidiaries with cross-border parents (or by parents with cross-border subsidiaries) can currently be carried forward to future profits -or carried back to profits made in the past-, then this implies that part of these losses can be compensated already in the absence of HST. Thus, HST would only affect the timing in which the offsetting can be made, allowing an immediate compensation, instead of waiting for the conclusion of future potentially profitable fiscal years. This is financially advantageous to the companies, as it implies present savings versus potential future reductions in tax payments (ie it is a financial advantage reducing the tax bill in 1000 euros today instead of reducing it in 1000 euros in say 5 years). For example, an SME company that can currently carry its losses forward would gain by being able to compensate its losses immediately under HST because it could derive interest income from the reduction in tax revenues today instead of tomorrow. Therefore, the real quantitative advantage of HST for the companies that could carry forward their losses should be calculated as the difference between the present savings in tax payments (under HST) and the present value of the stream of future tax reductions (under carried forward of losses provisions).
Table 7. Cross border loss-compensation estimations under HST
thousand euros cross-border loss-compensation for
groups with cross-border information
Nr of groups with cross-
Groups with cross-border information border loss Unweighted Weighted
SMEs subsidiaries of Total nr of cos.
parents cos. the SMEs of groups with
in MS parent cos in cross-border
MS information 2003 2001 2003 2001 2003 2001
AT 6 26 32 2 1 90 221 1115 2739
BE - - - - - - - - -
CY 1 1 2
CZ - - - - - - - - -
DK 160 474 634 58 38 15773 7822 4386 2175
EE - - - - - - - - -
FI 35 72 107 9 9 913 1114 646 788
FR 346 937 1283 133 120 34085 31200 27500 25173
DE 22 44 66 4 7 482 1937 16338 65656
EL - - - - - - - - -
HU - - - - - - - - -
IE 81 274 355 27 25 4492 2399 1518 810
220.127.116.11.2 The effects of HST on the compliance costs/administrative tax burden of
Another important direct effect of the HST proposal is the reduction of tax compliance costs for the SMEs that are already operating cross-border (and for those SMEs that might decide to start up cross-border establishments in the future).
The implications of extra cross-border compliance costs
The above-mentioned "Internationalisation of SMEs" report shows that the most frequently cited internal barrier by SMEs to internationalisation is the 'high costs of the internationalisation process'. These costs may include purchasing legal consulting services, the translation of documents, greater travel expenses and higher business and financial risks. By facilitating tax compliance on cross-border activities, some of these costs may be clearly addressed by HST measures, especially as the report also shows that these costs are mostly felt by SMEs with the most complex international activities such as establishments abroad (24%), ie the main group of SMEs targeted by the HST project.
In turn, the most cited external barrier to internationalisation cited in this report is 'existing laws and regulations', typically of the target countries, mentioned by 29% of SMEs with foreign subsidiaries/branches or several forms of internationalisation.It can not, on the basis of this report be concluded to what extent this barrier is related to the differences in national regulations (lack of harmonisation) or to a general lack of knowledge on legal regimes and to what extent it is due to specific difficulties created by existing national regulations. It seems that, in any case, HST measures may provide a relief to the sort of external barriers perceived by SMEs, by providing a single set of rules for the calculation of an international group of SMEs' corporate tax base, which should reduce their total compliance costs.
parent companies with a subsidiary, branch or permanent establishment in the home State and companies without a subsidiary, branch or permanent establishments. Therefore there is a cross-border element to compliance costs, which the HST proposals may eliminate.
In summary, the preceding analysis suggests that HST, by reducing the tax compliance costs of international groups of SMEs, may affect the costs' structure of firms and may help to remove deterrent factors to the exploitation of the investment possibilities in the Internal Market by SMEs. This reduction of firms' costs should eventually encourage further cross-border investments and allow a better allocation of resources by these enterprises.
A quantitative estimate of the compliance costs reduction due to HST in terms of GDP
Below it is estimated the direct savings in tax compliance costs for existing international groups of SMEs in the EU, attributable to the HST scheme measures are estimated.These estimates have to be taken only with great caution, as the aggregation of data and the simplifying assumptions made, may distort the estimations.
The basis of the quantitative assessment will be the available information from various sources (mentioned below) on cross-border compliance costs, compliance costs as proportion of total corporate tax payments by SMEs, total corporate income tax revenues,
The approach takes as a starting point the possible reduction in compliance costs for cross-border situations that HST may induce. It then estimates the amount of compliance costs as a percentage of taxes paid by SMEs. Combining these figures with the corporate income taxes paid by international SMEs (with subsidiaries abroad) as a fraction of GDP provides an estimate of the direct compliance costs savings as a fraction of GDP for existing multinational SMEs with subsidiaries/branches abroad.
for these enterprises following the application of HST. Balancing the different arguments we assume that on average the HST proposal reduces total compliance costs of existing international SMEs by 20% (ie, 20% is the percentage of total compliance costs born by international SMEs assumed to be potentially saved due to the reduction in company taxation compliance costs abroad granted by HST).
2)Estimate the percentage of total compliance costs as a proportion of the corporate tax bills for SMEs: Relatively few estimates are available for the percentage of compliance costs as a proportion of corporate tax payments for SMEs
88.Based on the available evidence, compliance cost-to-tax payments of
15% to 30% can be considered. The estimations carried out for a prudent 15% assumption on this figure are reported below.
3)Estimate the percentage of the corporate tax bills of international SMEs as a proportion of EU GDP: To derive an estimation of this figure, several sub- percentages are used:
The average percentage of corporate income taxes on EU-25 GDP, which
amounted to 2.7% in 200389.
The percentage of total taxes on profits attributable to SMEs (versus large
companies). This figure is estimated from the taxes on profits in the BACH Database, which collects data for six industrial sectors and seven countries (Austria, Belgium, France, Italy, Netherlands, Portugal and Spain). According to this database SMEs contribute 33% of the total taxes on profits (compared to 67% for large companies). Thus, the figure of 33% is taken as approximating the percentage of revenues obtained from taxing SMEs' profits in the EU-25, which combined with the figure of the previous point implies that around 0.9% (= 2.7% * 33%) of EU GDP are revenues from corporate income taxes paid by SMEs.
corporate tax payments (which is, admittedly a rather simplistic assumption). Combined with the previous figure, this implies that 0.027% (= 0.9% * 3%)
of EU GDP are revenues from corporate income taxes of international SMEs with subsidiaries abroad.
With all this information, the direct costs savings due to the HST simplification of the administrative burden for current international SMEs with cross-border subsidiaries is calculated as a percentage of EU GDP. The quantitative compliance costs savings estimate, under the most conservative assumptions, equals 0.00081%
90 in terms of
EU GDP, which amounts to approximately 70 million euros per annum for the EU- 25. By varying the assumptions on the percentages used to more pessimistic or optimistic approaches, it is easy to carry out a sensitivity analysis for the quantitative estimate presented.
In addition to these direct effects on cost savings, medium term effects of the HST proposal can be tentatively estimated. A Dutch study on administrative burdens
on a general equilibrium model, shows that a reduction of the administrative burden on companies by 0.9% expressed in terms of GDP increases GDP by 1.7% in the long term (when taking R&D spillovers into account). Under the given assumptions and if the same ratio of transmission effects could be translated to the EU-wide economy, this would mean a non-negligible increase in EU GDP equal to 0.00153% in the long term due to the HST-driven tax compliance costs reduction of existing international groups of SMEs.
18.104.22.168. The effects of HST on the decision of domestic SMEs to start new cross-border
Besides existing multinational SMEs, the HST project should also benefit the SMEs that currently operate only in a domestic context and push them to internationalise their activity. Internationalisation processes, however, have to be seen nowadays as a much more diversified business activity than just a mere ambition to sell/buy products in/from foreign markets. Thus, this policy proposal is in particular directed at SMEs wishing to start new cross-border investments by, for instance, setting up branch/subsidiary businesses in other Member States to replace or complement national production for export with localisation abroad
Despite the benefits that may be obtained from international activities, almost 60% of the non-internationalised SMEs in the ENSR 2003 Enterprise Survey
93 have not even
considered internationalising. That is, a large number of SMEs operate only in the local market. Possibly, in a considerable number of cases, these non-international SMEs have no wish whatsoever to engage in international activities: their decision may be based on their belief that the domestic demand is sufficient, their consideration that internationalisation is irrelevant for their line of business, or a lack of ambition to grow beyond a certain size or beyond the domestic market, etc. However, in other cases their hesitation might be based on existing barriers and not a lack of interest or opportunities. It is the business conditions of this latter group of SMEs, with stated aims of expanding into other EU States, which is targeted by the HST project, in particular insofar as their decision might be biased by tax considerations.
The measures of the HST project may motivate these companies to go international, as the elimination of tax-barriers affects the trade-off between the benefits and costs of internationalisation they face. The costs and benefits of setting up establishments abroad, which companies balance when considering changing their domestic setting into an international one, are briefly revised below, as well as the possible impact of the HST scheme on them.
The benefits may consist, in the first place, of increased access to markets which can involve trade costs savings. Other benefits lie in the strategic advantages offered by establishing cross-border activities
94.A SME could decide to locate establishments close
to cross-border competitors to have easier access to information and technologies. The decision to become international is therefore not merely motivated by a potential to increase sales, but it is an important means of gaining know-how and insight into new useful technologies
95.Other important benefits that cross-border establishments can
may also permit access to additional production capacity with the result of lower average costs from a better exploitation of scale and scope economies.
To benefit from cross-border investments there are also costs to incur by SMEs:
-The possible costs of multi-nationalization include costs of disintegration of the domestic company and foregone economies of scale, for example in case of substitution of exports with production abroad. If production activities are split across a border (i.e., horizontal differentiation of investments), disintegration costs can arise. For example a SME can decide to duplicate part of its production by setting up an assembly plant cross-border to serve a foreign market in addition to a home plant. In this case of horizontal investment some economies of scale are lost due to the duplication of activities. For vertical cross-border investment the disintegration costs consist of packaging and freight costs or the time it takes to ship products between plants
-Another key parameter in many investment decisions is the installation costs of the investment. The relatively high fixed cost of investing abroad makes it easier for large companies to invest cross-border. It explains why SMEs that are internationalized are relatively large
97.Various methods have been used to study
the implication of the irreversibility of a fixed investment and a general conclusion in recent literature is that increased uncertainty leads to lower investment rates
98.These results underline the role of transparency in tax rules.
liabilities which have deterred foreign direct investment by increasing transaction costs) the implementation of HST should reduce some production costs associated with the instalment and development of an investment abroad. HST may therefore ease the costs of internationalisation for SMEs and increase the probability of successful and profitable cross-border expansion
Having said all that, what is the expected number of companies that may decide to become international following the implementation of HST? Ideally it would be desirable to know the numbers of companies that will be affected most profoundly by HST. That is to say, how many eligible SMEs are presently hesitant about developing their activities in other Member States via branches and/or subsidiaries and will be encouraged to do so when HST is in place? How many extra companies are likely to expand cross-border given a more straightforward administration system and the off- setting losses in other Member States possibilities? How will the start-up/early-stage survival rate of the extra companies that decide to expand will be affected by the cross- state loss-offsetting measures introduced by HST? All these questions are difficult, if not impossible, to answer a priori and the most reliable answers can only be gained by the implementation and monitoring of the pilot scheme. Notwithstanding this, the increased participation of SMEs in the Internal Market following a voluntary pilot scheme that would bring about a change in their EU-wide company tax base and compliance costs, can be expected to be limited, all the more because the tax factor is just one of the obstacles impeding cross-border expansion of SMEs. So overall, the proportion of new SMEs willing or able to participate in the scheme would be expected to be low. An optimistic scenario could be increased foreign investment within the EU by SMEs of up to 6% following HST implementation. Interestingly, an admittedly not representative - questionnaire launched by the Commission services (see Chapter 2 above) reveals a much higher interest of around half of the respondents indicating that they were interested in taking part in a possible pilot scheme.
6.1.2. The economy-wide effects of HST: transmission of effects into home and host countries
Now that the impact of HST measures on SMEs (either already multinational or potentially so) has been assessed, this section will show how the effects of cross-border investments by SMEs would translate to home and host Member States and thereby what the economy-wide impact of the proposed policy would be.
22.214.171.124. Host Countries effects
The impact of the implementation of HST on the host Member State depends on a number of different elements.
First, the removed barriers to entry could lead to more companies entering markets in the host state. This reduces the price-cost marks and less efficient companies tend to be replaced by the more efficient ones, thus resulting in gains in the allocation of resources.
As empirical evidence shows that foreign companies are often more productive and competitive than domestic ones
100 this might imply some crowding-out of local SMEs.
In addition, further productivity efficiency gains may be expected because management and workers of companies in the host Member State need to improve the organisation of their work in order to withstand increased competition effects. Moreover, recent evidence also shows productivity gains as a result of reductions in entry barriers and reduction of technology gaps as a consequence of lowering administrative barriers
On the other hand, other studies point at important positive effects of increased competition on host Member States on local companies, especially through the market for input factors. Foreign investments, in the form of subsidiaries or production plants, represent important clients for small locally-based suppliers and sub-contractors and they secure the transfer of technology and management skills to domestic SMEs. Other theoretical
Other positive results may arise from the spillover effects that multi-national companies have on the local companies in the host Member State. Two types of spillover effects are possible. First technological spillovers occur if the cross-border activities of a SME transfer technology to local companies. In addition, local companies could learn about the market in which they are operating and acquire skills unknown to them before their contact with foreign affiliate. For technological spillovers to occur the evidence shows that the host country needs to have a minimum level of capacity to absorb the skills and technology that a foreign affiliate uses
104.The other type of spillover occurs when
domestic companies benefit from the interactions with foreign affiliate if the activity of the foreign affiliate, which buys intermediate products from a local supplier, leads to a product quality improvement of the local supplier which will benefit other domestic buyers.
In summary, there are reasons to believe that the increased competition effects may benefit local companies of the host countries. In addition, in order to have technological spillovers the host Member State needs to have a minimum level of capacity to absorb the technologies that foreign affiliates use.
Finally, increased competition in the host country may eventually have a positive effect on consumers' welfare (throughout the whole EU). The degree of competition of the markets will determine the relative distribution of the benefits between producers (higher profits) and consumers (lower prices). The higher the degree of competition in the market, the higher the reduction of cost translating into lower price. Considering the ever increasing degree of competition in the EU products market, the implementation of HST, should result in a relatively (to profit) important increase of benefits in favour of consumers, thus permitting a corresponding increase in their welfare. Obviously, a complete translation of the cost reduction into price reduction is only a theoretical option associated with the hypothetical situation of perfect competition.
benefits for home Member States can be expected to consist of skill-upgrading and the use of new technologies after cross-border investments
6.1.3. The effects of HST on Member States' tax administrations
This section finally assesses the impact that the implementation of HST will have on the national tax administrations of Member States.
In the first place, they may be affected by the possibility of immediate cross-border loss compensation between members of the same group of SMEs. While it has been argued that such a measure is, without doubt, financially advantageous for groups of EU SMEs, it also may have an impact on Member States' revenues. Those Member States where members of a particular SME group have positive profits against which cross-border losses can now be immediately offset may suffer some costs, as they might see some of their potential corporate tax revenues from SMEs income foregone, when other group members incur losses elsewhere. However, the net effect of the HST system on the revenues of these Member States, compared with the present situation -that allocates the SMEs groups' income according to separate accounting standards- is not necessarily
negative: it will depend on the shares that these Member States receive from the groups'
tax bases following the application of the agreed allocation mechanism. These shares could allocate higher or lower tax bases than they would have had otherwise (before cross-border loss compensation and HST). In turn, Member States where the loss-making firms within the groups are located can on the whole benefit from an immediate cross- border loss compensation effect and the mechanics of HST: this would be the case when the apportioning mechanism allocated to them positive shares of the total group tax base in a given year (regardless of the non-profitability of the business in that territory in that year). That would normally be the case (ie, all Member States where SMEs groups are active receive positive shares of their respective total tax bases) when allocation was based on factors such as labour costs, number of employees, turnover or assets, as these factors always have positive values for any firm, also the non-profitable ones. As the same Member State can be both "loser" and "winner" for different SMEs groups (compared to the present situation) the net effect on national tax revenues of the cross- border loss-offseting introduced by HST is largely undetermined for particular Member States.
the case under the current profit-based distribution of international SMEs' tax bases, where losses accumulate in some countries.
The application of HST will also increase costs to fiscal administrations, due to an increased administrative burden and the need to coordinate with other fiscal authorities.
On the other hand, it is important to consider also that the net present value of tax revenues may well increase, due to resulting future tax revenue increases, attributable to improved SME profits/survival and to the expected benefits to the EU economy as a whole.
This analysis helps to answer the question of whether HST could lead to substantive changes in revenue yield to some Member States. Corporate tax revenue constitutes a small proportion of national GDP in EU economies. In fact, corporate tax typically constitutes less than 4% of GDP and less than 10% of total tax receipts for each EU-25 country
107.A further breakdown of this data to show the proportion of corporate income
tax received from SMEs and especially, from internationalised groups of SMEs (ie with foreign investments), would clearly indicate that the proportions of GDP 'at risk' in individual Member States due to the HST scheme are extremely low
108.This lends weight
Table 8: Results of possible apportioning mechanisms for the distribution of international groups of SMEs' tax bases compared to the actual situation
Distribution of Distribution of
Unweighted Weighted (by
nr. of cos.) Distribution of international groups international groups
international groups of SMEs tax bases of SMEs tax bases
current of SMEs tax bases when when apportionment
distribution when apportionment apportionment is is based on 'payroll'
of the sample
of the sample is based on 'payroll' based on 'payroll' (1/3), 'turnover' (1/3)
MS of (1/2) and 'turnover'
international of (1/2) and 'assets' (1/3)
groups of international
SMEs groups of
SMEs % Change % Change % Change
wrt current wrt current
tax bases(*) % wrt current
tax bases(*) (weighted) %
situation situation situation
AT 3,65% 58,48% 1,49% -56,99% 2,38% -56,10% 3,59% -54,89%
BE 31,35% 1,86% 0,85% -1,01% 0,79% -1,07% 0,90% -0,95%
CY -1,11% -11,00% 0,50% 11,50% 0,41% 11,42% 0,52% 11,53%
CZ 0,34% 3,85% 5,66% 1,81% 3,90% 0,05% 2,87% -0,98%
DK 2,11% 0,38% 0,81% 0,44% 0,58% 0,20% 0,65% 0,27%
EE 3,21% 0,29% 0,18% -0,11% 0,12% -0,16% 0,10% -0,19%
FI 3,89% 0,99% 0,56% -0,43% 0,47% -0,51% 0,45% -0,54%
FR 2,30% 0,74% 9,21% 8,47% 8,13% 7,39% 8,07% 7,34%
DE 0,20% 8,20% 20,99% 12,79% 32,2624,06% 32,44% 24,24%
EL 0,31% 3,05% 0,87% -2,18% 0,74% -2,31% 0,75% -2,30%
HU -0,16% -1,41% 0,00% 1,41% 0,31% 1,72% 0,52% 1,93%
Finally, given the limited character of the pilot scheme, its strict anti-avoidance rules and the tight control and monitoring process (see below), the impact of the pilot on national tax administrations will be limited to the re-allocation of tasks and staff as necessary to introduce and manage the scheme. In particular, the potential risk of more fraud, delocalisation, "pilot scheme shopping" and similar risks have been fully taken into account in the design of the scheme and can be expected to be minimal. A certain additional costs for tax administrations could be caused by the need to control and monitor the experiment but there is no reason whatsoever to believe that it would be very high or disproporationate in view of the potential economic gains. Currently, smaller companies are anyway hardly audited by Member States. Moreover, it should not be forgotten that the proposed scheme would be optional for enterprises and Member States.
6.2 Social and environmental impact assessment of the Home State Taxation option
HST measures would also have some environmental and notably social effects.
The social effects can be assessed by analyzing the impact of this policy on the labour markets of the host and home countries:
Regarding the host countries, evidence on anticompetitive regulation in the product market suggests that positive effects on employment can be expected from the fact that HST reduces the compliance burden for cross-border companies
indicates that multi-national companies pay higher wages than local companies in the host countries
110.With respect to the skill of workers the impact will depend on the skill
requirements of the cross-border activities vis-ŗ-vis those of the local companies in the host country. There is not much empirical evidence available on this issue but skilled workers appear to be concentrated in multi-national companies. In addition, multi- national companies appear to adjust employment relatively quickly compared with domestic companies. Studies investigating whether employment is more volatile in multi- national companies compared with domestic companies do not confirm this hypothesis. The evidence suggests that multi-national companies preserve employment when labour demand shocks occur
In summary, the available empirical evidence on differences between multi-national companies and domestic companies suggests that productivity, skills of workers and wages are higher in multi-national companies whilst job-insecurity of workers in multi- national companies is not necessarily higher.
As regards the home country, one of the key issues is how low labour costs in other countries affect employment in the home Member State. Do low labour costs in host countries where affiliates are located increase or decrease employment in the home country? The available empirical evidence indicates that given cross-border investments an increase in the wage costs of affiliates increases (decreases) employment in the parent company if the activities in the parent and cross-border affiliate are substitutes (complements). Concerning the start-up of cross-border activities, a recent study suggests that there are no differences in employment dynamics between companies that start investing cross-border and non-investing companies
112.In addition to the number of
workers in the home country other evidence suggests that the skill-intensity increases in the parent company especially where it concerns vertical cross-border investments in cheap labour locations
In summary, HST measures can be assessed as having a positive social impact, namely higher employment.
Concerning the environmental impacts, in view of the nature of the measure no direct impacts are to be expected. It is nevertheless obvious that if the expected efficiency gains of HST materialise, this will indirectly imply increasing some environmental costs following increased activity.
Under the HST approach, the domestic group taxation, consolidation or loss-offset rules would apply to all activities of the SMEs within interested Member States. This implies that for those countries which do not operate such domestic rules (that is, Belgium, Czech Republic, Estonia, Greece, Hungary, Lithuania and Slovakia) one essential feature of HST from a business perspective is not available. Whether or not the compliance cost reduction is sufficient to attract business interest to the scheme is difficult to assess but ceteris paribus it can be expected that fewer SMEs in the countries concerned will participate than in countries with appropriate loss-offset rules.
HST is designed to improve the business conditions in the Internal Market for SMEs, which constitute one of the key drivers in economic growth. Current tax provisions in the EU penalise SMEs willing to internationalise their activities because they de facto impose supplementary compliance costs and offer few provisions to foreign subsidiaries to compensate for cross-border losses. This encourages SMEs to internalise activities and discourages their investing in a degree of control in foreign companies and their establishment of foreign subsidiaries.
The implementation of HST, through the removal of these tax barriers, is a measure aimed at promoting SMEs' investments in the Internal Market, by contributing to the process of costs optimisation of firms
114, and at a better allocation of the resources,
notably physical capital investment. In fact, such a measure allows business to make sounder economic choices based on the productivity of factors and less distorted by the influence of (some) taxation costs.
The present impact assessment has analyzed (some of) the effects of HST on the main economic agents and driving forces of the economy. First, this measure will automatically benefit the SMEs already installed abroad. This first benefit derives from the increased possibilities of cross-border loss compensation, which remove an important distortion to the efficient allocation of resources. The second benefit is that removed compliance burden due to dealing with several tax administrations, which will improve the structure of costs of these firms and possibly encourage them make to further investments.
have appropriate group loss compensation rules in their domestic tax legislation. Also the lighter compliance burden due to dealing with several tax administrations may act as an incentive to start up a cross-border establishment. The economic benefits of the scheme could be recognised in the medium- to long-term as sufficient levels of greater cross- border expansion and survival become realised. Due to technological developments, the global business environment is also increasingly likely to favour SMEs engaging in cross-border activity and neighbouring countries will most likely constitute the easiest and most frequent business partners.
Besides the direct effects on SMEs, HST measures also provide gains to the markets of the home and host Member States, for example for companies associated with foreign subsidiaries such as suppliers or collabourating business partners or by the improved transfers of technology and know-how. By increasing the openness of the Internal Market the HST scheme increases the potential efficiency and output of the EU economy. The efficiency gains offered will benefit consumers in the form of lower prices for products, improved quality and a greater variety of products.
To conclude, the implementation of HST will bring the economic benefits associated with a liberalisation policy within the framework of the freedom of establishment.
The implementation of HST will also have implications for tax administrations. These will include higher administration and control costs and some revenue consequences following the possibility to offset losses cross-border and the apportioning of tax bases results. Nevertheless, there are reasons to think that all these effects will be rather reduced. Of course, the precise short-term risks to individual MS' tax revenues and the possible benefits/losses are impossible to assess a priori. However given the proportions of enterprises and of taxation revenue involved, the risks are not sufficient to bring the scheme into question, especially given the expected benefits to the EU economy as a whole.
7.IMPLEMENTATION, MONITORING AND EX-POST EVALUATION
It is suggested that the pilot scheme is implemented via a multilateral agreement or, in bilateral relations, via a supplementing protocol to the applicable double-taxation treaty. The Commission and interested Member States will create a monitoring group for supervising the functioning of the pilot scheme, considering possible practical problems and assessing its success. This will ensure, but only to the extent that there is a real practical need for it, a continuous evaluation and reports. After the proposed five year period an ex-post evaluation will be carried out jointly by the responsible Member States and transmitted to the Commission and the monitoring group.