Tax Avoidance and Abuse in the EU: With a Focus on the Impact of the Corporate Tax Rate

Abstract

As aggressive tax planning is not defined in more detail in the EU legislation, the boundary between tax planning and aggressive tax planning cannot be unambiguously defined. According to a corporate law decision (the Centros case) there is no abuse of the free movement of establishment as long as the company is founded in accordance with the law of host country. On the other hand, the boundary seems to be different in tax law. In order to assess the presence of a artificial arrangement, the court uses a proportionality test based on the objective and subjective relationship. In order for an establishment not to be artificial, it must be subject to an actual activity with a physical presence. Based on the Merger Directive, it is assumed that a transaction takes place as part of tax avoidance if the company's restructuring transaction is not based on valid business reasons, and the purpose is only conditional on taxation. Based on the Parent-Subsidiary Directive, the subsidiary must have economic realities, be a part of the host country's economy, and the purpose must not be to create a deduction for the parent company in order to assume that this action is not a part of tax avoidance.
As cross-border barriers have been removed and companies have become more mobile, a tax competition between Member States has emerged. Tax competition is asymmetric, i.e. some countries gain an advantage at the expense of others. However, tax competition can be harmful and contribute to the creation of a "race to the bottom" in which the Member States are competing for delivering the lowest tax rate. Thus, a "free rider" behavior by companies may arise, thereby enabling them to become more aggressive in their tax planning and thus engage in tax avoidance activities. Corporate tax harmonization among the EU countries results in the creation of a tax cartel. If the tax rate is set too high, countries outside the EU will "free ride" on the agreement and they will be able to attract investors from the EU, as they can offer better tax rates. This could potentially undermine the EU economy.
Companies should consider how far they will go to minimize their tax obligations. If the public does not regard their tax payments as fair, it may potentially give the company a bad reputation. If companies are associated with tax avoidance, some stakeholders may opt out such companies. This causes the stock market to decline and affect the company's revenues in the long run. In this context, it may be beneficial to involve CSR as this could potentially lead to a better reputation and a stronger brand as well as a number of business benefits.