RSM Resources

From America to Austria, corporate taxes are a universally hot topicfor all types and sizes of businesses — but for very different reasons.While U.S. companies are on constant guard against rising state andfederal tax rates, European Union (EU) businesses have seen their taxobligations plummet in recent years, dropping to an EU average of 25.8percent from 33.9 percent since 2000. This long-term trend creates arich opportunity for U.S. companies to invest in EU markets and takeadvantage of a very business-friendly environment.

The drop inEU corporate taxes started in the mid-1980s, when then-Prime MinisterMargaret Thatcher championed lowering the United Kingdom tax rate to 35percent from 52 percent. Other European countries quickly jumped on thebandwagon to match these more attractive rates, and a low tax structuresoon became a competitive advantage for EU nations.

Sincethen, the largest tax-rate reduction among the original EU countrieshas been in Ireland, which cut its rate to 12.5 percent in 2006 from 40percent in 1993 — a 68.8 percent reduction. The second-largestreductions have occurred in Austria and Germany, each cutting its rateby 36 percent, followed by Portugal and Italy, which have reduced theirrates by 31 percent and 29 percent, respectively.

When the EUadded 10 countries in 2004, those new members lowered their tax ratesto match the rest of the alliance. With an average corporate income taxrate of 18 percent, the Eastern European states that joined the EU thatyear have some of the lowest tax rates in Europe, along withcompetitive labor rates and active programs designed to encourageforeign investment.

In his June 2006 testimony before the U.S.Senate Finance Committee, Martin A. Sullivan of Tax Analysts, anot-for-profit, nonpartisan tax-policy group, said, "As transportationand communications costs have dropped, and trade barriers and currencycontrols have also declined, there is more cross-border investment thanever." More than a decade ago, economists focused on tax policy as away to boost domestic investment on the margin, Sullivan said. Today,with increased capital mobility and countries competing moreaggressively to attract multinational corporations, tax rates weigheven more heavily on major investment decisions, according to Sullivan.

Irelandis one of the most powerful examples of how the EU’s tax structure hasbenefited both individual countries and the companies that do businessthere. When Ireland joined the EU in 1973, its gross domestic product(GDP) was 60 percent of the average European GDP; in 2006, its GDP wasoff the charts at 110 percent. Although Ireland is only 1 percent ofthe EU market, with its 12.5 percent corporate tax rate it lures nearlyone-third of the U.S. foreign investment in the European Union and isthe world’s largest exporter per capita.

Germany is a recentexample of how EU nations continue to adjust their rates to attractinternational businesses. In November 2006, the German governmentannounced that it would lower the country’s corporate tax rate to about29 percent from 38.7 percent beginning Jan. 1, 2008. The new taxstructure is a "tremendous step for medium-sized companies, for smallcompanies and business partnerships," says Roland Koch, prime ministerof the German state of Hesse. "Today, we’re exposed to internationaland European tax competition. We have to tax companies differently thanin past decades."

Other countries, newer to the EU, promotethemselves for foreign investment via similarly bargain-basement taxrates. Cyprus, for example, has a corporate tax rate of 10 percent,Latvia and Lithuania have rates of 15 percent, and Hungary’s rate is 16percent. Some have criticized these low rates as representing a "raceto the bottom" that could potentially undermine the tax base everynation needs to support its infrastructure. However, many EU countriesare tweaking their tax codes to ensure they protect their fiscal healthwhile still remaining pro-foreign investment. Germany is the latest toimplement this approach, working to combine its favorable corporate taxrates with a broadening of its overall tax collection system, much likethe model of Scandinavian countries and Ireland.

Of course,analyzing corporate income tax rates doesn’t tell the whole story ofEuropean tax burdens. Yes, corporate income tax rates have declined.But rates for the value-added tax (VAT) on transactions in goods andservices supplied in European countries have largely remainedunchanged. The VAT remains a more significant source of revenue forEuropean economies than corporate or individual income taxes.

Beyond lower rates

Inaddition to the general reduction of corporate income tax rates,European countries are also adding incentives to their internal taxlaws to encourage formation of holding companies within membercountries. In 2006 alone, Belgium, the Netherlands and Switzerland allchanged laws to attract international investment by reducing taxes onspecial types of income and by lowering withholding taxes onrepatriation of income to foreign investors. This caps off an EU trendthat began in 2000.

Other EU tax reforms on the horizon aredesigned to promote foreign investment while simplifying the alliance’stax system. The European Commission has proposed a common consolidatedcorporate tax base (CCCTB) that would create a uniform set of rules forcalculating a company’s aggregated EU-wide profits. This, in turn,would reduce the costs of maintaining different national tax systems aswell as a company’s compliance expenses. The CCCTB, which could be inforce as early as 2008, would allow member countries to still set theirown corporate tax rates. Given the strategy of EU nations to attractforeign businesses through low corporate taxes, and that the CCCTBrequires unanimous approval from the commission, there is stillsignificant debate over whether the CCCTB will ultimately come tofruition.

Any U.S. business contemplating doing business in theEU should also be aware of possible changes in international taxtreaties. For example, treaties with several EU countries await U.S.Senate ratification, and others are in various stages of negotiation.Yet even with trade relations in flux and the ongoing streamlining ofthe EU’s corporate tax system, most experts predict the EU willcontinue to provide excellent markets for U.S. trade, investment andoperations.

"As mobile as capital may be, profits are moremobile," Sullivan said. "In deciding where to channel profits, tax-ratedifferentials are all-important. Without increasing the deficit andwithout changing the overall tax burden on the corporate sector, agovernment can protect its revenue base, increase investment andincrease competitiveness."

European Union

Average Corporate Tax Rate, 2000–2006

Year Average rate

2000 33.9

2001 32.0

2002 30.9

2003 29.7

2004 28.3

2005 26.1

2006 25.8