When states attain membership of the European Union (EU), the governments are in charge of enacting and implementing their local direct taxation policy. The tax framework of the member-states shall not contravene or interfere the laid down policies and directives of the EU institutions; therefore, the sovereignty of member states is extremely safeguarded. Although the EU faces difficulties to come up with results that would be generally accepted by all member states, it has taken every step to integrate all Member States’ corporate direct taxation systems since the 1950s.
EU currently attempts to harmonize the members’ corporate direct taxation scheme via the Common Consolidated Corporate Tax Base (CCCTB). The purpose of this article is to determine the extent to which CCCTB and overpricing policy would affect Cyprus and Malta. To completely investigate that impact, a brief history and the logical basis behind this policy shall be given. An in-depth understanding of this policy requires the identification of the necessity to reform the EU economy. This article highlights the strong objections raised by Malta and Cyprus, which happen to be the smaller Member States. In more detail, the potential effect of CCCTB and overpricing policy on Malta’s and Cyprus economic policies shall be duly assessed. To achieve that, a concise description of Malta’s and Cyprus present corporate tax regime is furnished, which is a prerequisite for the full appreciation of the countries’ standing before this issue.
Transfer Pricing determines the prevailing procedures and methods implemented when physical goods, services, and value are charged between affiliated companies. This policy has affected the cross-border trade and mostly the transactions carried out between related companies. The fundamental reason why entities apply Transfer Pricing policies is to enable them to identify the business divisions that do not operate effectively. This strategy focuses on reducing tax payment and avoidance of double taxation when profits are repatriated. These business practices on profit shifting have resulted in a significant decline in tax revenue and have become a major concern for revenue authorities. Hence, Transfer Pricing rules are currently stringent and affect both multinational enterprises (MNEs) as well as small-medium enterprises (SMEs). Due to the stringent legislation in place, the improper transfer pricing policies among entities will be regarded as tax avoidance actions and attract high penalties.
The Common Consolidated Tax Base
The Common Consolidated Corporate Tax Base (CCCTB) is a notable directive of the European Commission, providing that EU companies and more especially, companies with a large number of subsidiaries, shall comply with the same requirements in determining the tax base of their EU affiliated entities. The CCCTB is applicable to entities incorporated in activities which are subject to corporate income taxation. It should be also noted that non-EU entities, which are liable to EU Member-States’ taxation through a permanent establishment, would also comply with the CCCTB policy.
Under this scheme, all members state tax activities would be overseen by a central body known as Principal Tax Authority (‘PTA’). As a result, all state revenue authorities, responsible for the supervision and management of tax administration, would no longer be effective.
A Brief History of its Development
Although the CCCTB is a recently suggested policy, the potential for harmonization of the corporate taxation has always been a discourse within the EU. Direct corporate tax harmonization among Member-States was the first table in Neumark Committee 1962 Report. The Committee argued that further actions needed to be taken in the European Union community in order to address the current state of affairs in the fields of company and dividend taxation. They supported that differences in the total tax burden levied by Members of the community do not affect the healthy competition in the Community, but the disparity in tax bases and structures used in calculating the effective tax does so. By the 1962 report, it was evident that the Commission’s initial intention was to establish a harmonized corporate tax structure among all Member States.
In 1975, the Commission put forward a mandate to reinforce the harmonization of tax regimes regarding company taxation. This notion suggests that consistent tax rates would be a dire solution. This endeavor was fruitless because the adoption of such measures was never approved. Moreover, this policy continues to hit brick walls on several attempts.
In 1992, the EU Commission issued and released several recommendations positioning its views on corporate taxation in the single market. Nevertheless, the Commission admits to the ideas stated in the earlier Report and opines that some of the Committee’s suggestions on the harmonization of corporation tax rates were above what was needed at the Community level.
The Implications for Malta and Cyprus
Malta’s and Cyprus Corporate Tax System
Companies tend to repatriate income to both Malta and Cyprus, taking advantage of the preferential transfer pricing framework applied in both countries. Malta and Cyprus implemented an attractive corporate tax scheme to be competitive within EU Members-States. This corporate tax regime was meant to attract foreign investors, as well as multinationals entities, into their shores. Both countries adopted the UK tax model which was formulated to favor corporate taxation. In parallel, political parties of both countries agreed on an increase of indirect taxation to generate high revenue. Consequently, the policy adopted by a larger member of EU, which may encourage an increase in direct tax, is not compatible with Malta and Cyprus fiscal policy. In more detail, Malta and Cyprus established a corporate tax rate of 35% and 12.5% accordingly. Cyprus tax rate is considered one of the lowest among the European States. As for Malta, an income tax refund of up to 30% is provided for companies with foreign shareholders, under a holding-trading vehicle. Therefore, the effective tax rate may reach 5%.
Maltese-registered limited liability entities are subject to tax on the profit generated globally and are regarded as domiciled in Malta. Dividend received by shareholders is set-off against the tax amount paid by the entities. This means that the dividend is not subject to tax, which inevitably decreases the chance of double taxation. Companies which are not domiciled in Malta or Cyprus can be considered as local tax residents if the effective control and management is exercised in their territories. The foreign income generated from such companies is subject to tax on a remittance basis. This implies that only the profit or capital gains generated in Malta and Cyprus, and any profit that is remitted there, is subject to income taxation. In addition, any profit remitted to Malta or Cyprus is eligible to tax refunds or exemptions, as in the case of a participation holding.
Authorities from both countries believed in transparency when it comes to tax issue and the combat against tax fraud. They recommend that the EU market is not a uniform arena and not all Member-States are challenge with the same economic reality, weather geographical conditions or resources domestic market size. Therefore, direct tax issues should be of national competence.
Malta and Cyprus: A Tax Haven consideration
Malta is considered as a “tax haven” by other Members-States irrespective of the 35% corporate rate imposed on profit. Cyprus however, which offer 12.5% is literally called “tax haven” or jurisdiction governed by a preferential corporate tax regime. In order to reduce companies’ burden, both countries in question offer incentives as well as tax refunds. More specifically, both countries look appealing to companies due to bilateral tax treaties being in force with other EU Member-States. This applicable scheme made both countries successful from a business perspective, as it resulted in a significant increase of capital inflows and foreign direct investments.
Malta and Cyprus low tax rates forced other Member-States to reform their corporate tax framework and reduce the effective rates resulting to a competitive strategy in the EU. This is the reason why the larger Member-States push the harmonization of the corporate taxation. Germany, one of the major critics of Malta and Cyprus tax regime, had always blamed both countries for being the bane behind the unhealthy competition among European states. This rigorous criticism begun when several German large firms formed a Maltese company in order to avoid being subject to German tax regime.
Malta and Cyprus governments refined several of their biased policies to avoid conflicts and be in line with the EU Directives. However, irrespective of the reforms in fiscal policy, both countries still apply the low corporate tax rates. Additionally, the Maltese authorities state that the tax issue no longer exists since there has been a meticulous improvement of the finance sector legislation in line with international best practices.
Cost implication: The Effects of the CCCTB in Malta and Cyprus
The value of losing the capacity to use financial policies as an instrument to entice tax revenue is the principal restraint of the Common Consolidated Corporate Tax Base. Losing this fiscal policy instrument could be an eminent blow to the Maltese and Cyprus economy. The overpricing mechanism would not only significantly decrease but also affect revenue from the tax for both countries. Malta and Cyprus normally seek a competitive advantage over the other Member-States by offering a low effective tax rate to companies. This is one of the fundamental grounds why vast Member States are aggressively pushing for the CCCTB establishment.
If CCCTB comes into force, the larger countries would benefit more from smaller states due to their strong fundamentals and financial stability. Cyprus and Malta will not be able to maintain their effective corporate tax rate and attract foreign investors. Nevertheless, the EU commission assured that such fiscal instruments would not be removed from the action field of member states, should the CCCTB be established.
It is evident for the commission that the distribution mechanism will result in imbalances in favor of larger Member States. In more detail, countries with a high working population will benefit from the ‘labor’ factor, while countries with a high manufacturing segment would benefit from the ‘asset’ factor, thanks to capital intensive industries. For instance, the largest industry in Cyprus or Malta does not require a functional large-scale asset compare to Germany automobile industry. Going by ‘sales factor’ and when apportioned with ‘destination’, the CCCTB will have positive effects only for Member-States featured with a wide consumer base.
The fundamental reason why businesses repatriate their profits to Malta or Cyprus was an outcome of the favorable overpricing policy and effective tax regime. The CCCTB policy is estimated to affect greatly the overpricing policy in both economies under review, as there would be no more incentives for profit shifting. Going by the apportionment mechanism, as suggested, it will definitely have a negative impact on Cyprus and Malta. More specifically, most of the companies registered in Cyprus and Malta are regarded as Small and Medium-Sized Enterprises (SMEs); therefore it will be difficult to operate from more than one state. In this regard, Malta and Cyprus companies would be forced to pay the administrative cost of the CCCTB without being entitled to any refund benefits. The EU Commission accepted the fact that the CCCTB would favor multinational entities and definitely large Member States.
The administrative costs for the tax compliance will definitely increase due to the CCCTB. This policy would bring more activities in-house, which means to an increase in internal costs and reduction in external spending. Putting all these repercussions into thoughts, it is not difficult to conclude that both Malta and Cyprus companies would be negatively affected by response to the CCCTB policy. Malta’s and Cyprus would cease to be attractive as a business hub if their taxation policy is tampered with.
The authors are senior tax advisors and partners of Transfer Pricing Experts’ hub in Cyprus. To contact the authors, please visit www.transferpricing.com.cy or dial +30 210 7245724-5.