Opinion on the Commission's Communication to the Council and the European Parliament on the improvement of the fiscal environment of small- and medium-sized enterprises (94/C 397/20)

On 6 June 1994 the Commission decided to consult the Economic and Social Committee, under Article 198 of the Treaty establishing the European Community, on the abovementioned Communication.

The Section for Industry, Commerce, Crafts and Services, which was responsible for preparing the Committee's work on the subject, adopted its Opinion on 30 November 1994. The Rapporteur was Mr E. Müller.

At its 321st Plenary Session (meeting of 21 December 1994), the Economic and Social Committee adopted the following Opinion unanimously.

1. General comments

1.1.

The Community context

1.1.1. Various actions initiated by the Community since the completion of the Single Market deal with the role which SMEs should play in the European Union. The White Paper issued at the end of 1993 specifically stresses their importance for achieving the objectives targeted in the White Paper.

The Economic and Social Committee has issued a number of Opinions fundamentally supporting the Commission's approach, which the Parliament has backed and the Council has generally endorsed, and even carried further on occasions. At the same time, the Economic and Social Committee has identified a number of areas where specific action is required to help SMEs and the craft industries.

It is not enough merely to affirm the real and potential value of SMEs for the economic and social consolidation of the European Union. We should realise that these potential strengths can only be used and exploited if we succeed in a) making the highly diversified SME sectors more dynamic and b) removing as many impediments as possible.

To ensure that current confidence in SMEs' role as 'the bedrock of the Union economy' does not lead to serious disillusionment, action should be taken forthwith at all decision-making levels to pinpoint how SMEs' potential can be brought into play immediately, appropriately and lastingly.

1.1.2. The Commission's Communication under examination can be seen as an attempt to launch concrete action. The Communication is based on the strategic programme for the internal market and, in its own words, on the 'common policy goal that it is in the Community's interest to support small- and medium-sized enterprises'.

Moreover, the Commission's approach is in keeping with the principle set out in its Communication to the Council and the European Parliament of 26 June 1992 () subsequent to the Conclusions of the Ruding Committee indicating company taxation guidelines linked to the further development of the internal market.

1.1.3. The subsidiarity problem warrants examination, insofar as it is necessary to establish whether Commission guidelines and solutions can prompt Member States, acting within the framework of their national powers, to take suitable measures on the basis of 'best practices'; or whether the limited or mandatory measures which are warranted or required go right to the heart of the Single Market's operation and can therefore be dealt with in the Community framework (although some such measures will be more limited or mandatory than others).

Moreover, it should be pointed out that competition distortions in SMEs' cross-frontier trade may have any number of causes; all aspects of such distortion should therefore be examined before concluding that divergences in Member States' direct taxation arrangements impede the Single Market's operation to such an extent as to require mandatory action by the European Union. The Commission could assess such situations.

1.1.4. The Commission is acting in accordance with the principle set out in the abovementioned Communication of 26 June 1992 and stresses that it 'does not intend to harmonize to any extent the purely national tax treatment of small- and medium-sized enterprises'.

Subject to the comments set out below on, inter alia, the various facets of the Communication, the Economic and Social Committee endorses this prudent approach at the current stage of the Union's development and welcomes the initiative taken to improve SMEs' fiscal environment.

This approach should allow a happy medium to be found between, on the one hand, the high expectations pinned on the Union and the possibilities available for helping SMEs, and, on the other, the more restrained attitudes adopted towards Union action in respect of SMEs' tax environment.

1.1.5. The Economic and Social Committee is pleased to note that the Commission, in attempting to define guidelines for improving SMEs' tax arrangements, is following the line taken in the White Paper on Growth, Competitiveness and Employment.

In this respect, reference should be made to the Chapter in the White Paper entitled 'statutory charges on labour' which mentions the 'special case of SMEs' and the major role which they play in matters of employment and indicates several types of tax measures which could assist them.

1.1.6. This yet again highlights the interdependence and direct and indirect links between various national and European policy areas. The Economic and Social Committee therefore feels that its Opinion must reiterate the need for vigorous, sustained, focused and coordinated action in support of the objectives set out in the 'integrated programme in favour of SMEs and the craft sector' [COM(94) 207 final].

1.2.

The Member-State context

1.2.1. The Member States' policies on SMEs differ considerably in scope and content. The timing and speed of legislation has varied greatly, depending on the extent to which the problems of establishing, developing and transferring enterprises have been recognized at national, regional or sectoral level. Likewise the economic, social, financial and budgetary policy criteria applied by successive governments will determine the general or specific nature of action to assist SMEs.

1.2.2. It is in this context that it is necessary to stress the need to establish committees for the exchange of information and best practices, and to set up consultation forums in which bodies concerned with SME development will have an appropriate voice. It is also against this background that instruments and machinery most suitable for SMEs, and geared to the situations in the individual Member States, must gradually be established. Other important questions to be resolved in this context are: which tax and non-tax measures to adopt and which criteria to apply, e.g. economic efficiency of measures, fairness, neutrality, social impact, administrative simplicity, budgetary impact.

1.2.3. These questions, whilst interesting, are beyond the scope of the present Opinion. The Committee feels, however, that the problem of the tax environment needs to be dealt with in the broadest possible context, taking account of the situation and trends with regard to overall tax burdens at national, regional and local level in the Member States. As the Committee does not know how, or to what extent, the Member States have been, or are to be, consulted on the proposals contained in the Communication, it feels that it is entitled to ask whether and, to what extent, the proposals are in tune with the Member States' scope for action within the framework of their SME policies.

1.3.

The SME context

1.3.1. As made clear in point 1.1.1 above, SMEs need to be brought into play rapidly if any appreciable improvement in growth, competitiveness and employment is to be achieved. A thorough overhaul of policy is needed to reflect the conditions in which SMEs operate and grow. Firms must be made aware of this policy offensive at EU and national level and see it not only as a message of hope but also and above all as an invitation to participate fully, as equal partners, in future progress.

1.3.2. In order to unlock this potential, the EU and the Member States need to take account of certain features of SMEs, two of which at least are worth mentioning here:

- their great diversity in terms of size and activity;

- the need to involve SME-support organizations in the implementation of programmes and integrated and coordinated actions.

1.4. The action to improve the SMEs' tax environment needs to be carried out at the three levels described above. This will make it easier to deal in depth with the associated problems, including those relating more or less directly to economic and social interest groups in general.

2. Areas of activity proposed in the Communication

2.1. The need to alleviate the tax burden in order to promote the development of SMEs in the EU should be seen in the broader context of SME financing. The Commission should be encouraged, in conjunction with the Member States and SME representative bodies, to look closely into the key problem of financing SMEs; this would involve a systematic follow-up to measures initiated, inter alia, in its Communication on the financial problems experienced by small- and medium-sized enterprises [COM(93) 528 final of 10 November 1993], in order to identify the best arrangements possible for the cost of financing, access to financial sources, credit, etc. ().

In this connection, the question arises as to whether the various funding possibilities, mechanisms and programmes mentioned in this Communication have tax implications. If they do, these should also be examined with a view to improving the tax environment.

2.2. Also, why does the Communication restrict itself to four areas (self-financing; fiscal treatment of venture capital; permanent establishment of SMEs; transfer of businesses) which, whilst not without interest, at first sight appear to lack coherence and to have limited relevance to SMEs in general in the Member States?

This aspect should not be neglected, given the need for an integrated policy and coordinated development programmes which will encourage dynamism and innovation.

2.3.

Self-financing

2.3.1. There are many aspects to the question of internal or external financing of investment by SMEs. The ESC has addressed the problem on various occasions. Although self-financing is usually done by means of the tax-assessment base and net profits, there are various possible approaches to the raising of capital for self-financing. In this connection the Committee stresses the need to improve the tax treatment of the reinvested profits of SMEs. The tax rules applied to such capital, within the framework of each Member State's general tax system, must be neutral in impact.

2.3.2. The Communication highlights the problem of the different tax treatment of companies' profits according to their legal status, with unincorporated businesses (sole proprietorships and partnerships) being taxed at the personal income tax rate and incorporated businesses being taxed at the corporation tax rate. The Communication proposes the elimination of any distortion of competition between firms subject to the same tax treatment.

2.3.3. Some Member States have already adopted measures to limit the distortion arising from the different taxation of profits, thus showing the other Member States the way ahead. The Commission uses these examples to illustrate possible orientations in its Recommendation of 25 May 1994 () attached to the Communication of the same date.

2.3.4. Judging by the Recommendation's Explanatory Memorandum and appendices, the Commission has gone to considerable pains. Here the problem has been dealt with in detail, whereas reading the Communication alone would suggest that a rather broad-brush approach had been adopted.

The Committee wonders, however, whether consultation of the Member States on the possibility of implementing the recommendations has been taken far enough. It therefore calls on the Commission to ensure that the information which the Member States will have to supply before 31 July 1995 on the principal measures taken also explains why the Member States have been unable to follow the Commission's recommendations.

2.3.5. Whilst fully appreciating the efforts made to prevent the unequal taxation of reinvested profits, e.g. via options and/or the introduction of comparable tax rates for incorporated and unincorporated businesses, the Committee would mention the complex problems involved in determining, particularly with regard to small sole proprietorships and partnerships, the amount of profit reinvested, and the related administrative problems. In attempting to alleviate the tax burden on these firms, we must not end up imposing new burdens whilst failing to provide any guarantee that the firms will benefit in practice from the new system.

Experience with some tax systems backs up this warning. Needless to say moves to introduce tax relief for partnerships must not lead to discrimination against incorporated companies.

In this connection, the Committee would alert the Commission to the fact that the Recommendation of 25 May 1994 does not refer to the possibility of changing legal status from incorporated company to a partnership. This omission needs to be rectified, all the more so since the two-way change of status is considered in the Communication on the transfer of businesses of 23 July 1994.

2.3.6. The Commission ought, therefore, to look at the possibility of setting a ceiling at national level on the tax rate applied to industrial and commercial revenues, making no distinction between different legal types of firms. Other approaches, taking into account differences between national systems and policies, could be considered, such as tax treatment similar to that applied to investments in capital.

2.3.7. With a view to improving the financing situation of SMEs and encouraging them to achieve self-financing, Member States should exchange information on the problem of double taxation of income which arises when, first of all, a company's profits are taxed at a proportional rate and secondly, its distributed profits are taxed at progressive income tax rates. Information should also be exchanged on the double taxation of wealth. In this context, the Committee would urge the Commission to press ahead with its endeavours to reach decisions on double taxation.

2.4.

Fiscal treatment of venture capital

2.4.1. In discussing this part of the Communication, the question to be addressed is the suitability of venture capital for SMEs as a whole. In this connection, reference should be made to the Committee's Opinion on the Communication from the Commission on the financial problems experienced by small- and medium-sized enterprises of 6 July 1994 ().

On the one hand, it should be kept in mind that the overwhelming majority of EU SMEs employ fewer than ten workers. This fact, whilst in no way detracting from their ability to create jobs, raises the question, particularly in the light of the nature and scope of their activities, as to how far this form of finance is really suitable for them, especially if they lack the status of incorporated businesses.

On the other hand, however, SMEs' powers of innovation and expansion, sometimes in areas offering little prospect of early profitability, should be borne in mind. In this case, appropriate forms of venture capital financing should be available. Thus, the question of transparency in matters relating to risk capital takes on considerable importance, and, placed in the context of trans-frontier business, could be dealt with in a Recommendation.

2.4.2. The Committee thus agrees that ways of making the best use of venture capital funds should be examined further, bearing in mind the cross-border aspect and the existing systems of taxation in France and the United Kingdom as described in the Communication.

2.5.

Administrative burdens and permanent establishments

2.5.1. The problem of the 'administrative complexity' of taxation is far broader than the administrative and tax burdens of operating across borders. Except for firms which are based in frontier regions and which, as a result of EU integration, are extending their activities to a neighbouring country or countries, the majority of SMEs operate - and will continue to operate - purely within their own local area or region.

2.5.2. In its analysis of the impact of formalities and tax burdens on SMEs operating across borders, the Commission is right to stress the problem of permanent establishment. The various aspects of this, including tax treatment, need elucidation.

2.5.3. The expression 'permanent establishment' is always used in bilateral conventions intended to prevent the double taxation of income and assets. In this case it means the long-term base from which the firm does most or all of its business.

Under the OECD's model convention, a construction or installation site becomes a permanent establishment, subject to tax in the state in which it is located, after twelve months. Some bilateral conventions provide for a shorter period.

2.5.4. Many SMEs, particularly in the construction sector, operate in frontier regions straddling the (theoretically non-existent) frontier, without having a 'permanent establishment'. They keep their headquarters in their country of origin, where they are subject to taxes on profits.

2.5.5. Although the issue of permanent establishments is worth investigating with a view to extending SMEs' activities in other Member States, the various forms of establishment should be examined in detail.

Where a firm establishes a subsidiary or a branch - specific legal concepts - the problems involved in carrying out their activities, inter alia which tax arrangements to apply, should not give rise to difficulties.

When operations are based on the concept of a permanent establishment, it is a different matter, owing to the wide range of situations as regards tax liability arrangements, eligibility for any tax concessions or other benefits granted to firms established in the 'host' country, social security schemes, etc.

The Committee considers that hasty action should be avoided and that a careful examination must be carried out of the actual circumstances in the border and more central regions of the Member States.

2.6.

Transfer of businesses

2.6.1. The problems of transferring businesses doubtless constitute one of the priority areas where there is a case for taking rapid concerted action in the Member States and in the European Union.

It stands to reason that these problems transcend tax issues and that there are more facets to the specific sphere of tax matters than those touched on in the present Communication; all in all, the Communication only deals with inheritance duties and donations.

2.6.2. It should be pointed out that this rather narrow view has been remedied in a new, more recent Communication of 23 July 1994, entitled 'Commission Communication on the transfer of businesses. Action in favour of small- and medium-sized enterprises (94/C 204/01)'.

2.6.3. To date, the ESC has unfortunately not been consulted on this Communication which is the result of a consultation procedure initiated in early 1993. Its objective is fully in line with the objective announced in the present Communication since its intended effects are as follows:

'- to reduce the burden on SMEs and help create a legal and fiscal environment which facilitates the transfer of ownership, the object being to safeguard the fabric of businesses and save jobs; and

'- to eliminate the inequality existing between SMEs and large firms, given that SMEs generally have far fewer owners and the death of one of them can mean more serious financial consequences for the continued existence of the firm.'

2.6.4. Without wanting to analyze the content of this new Communication in detail, the Committee does feel that there are grounds for emphasizing some aspects which are important for improving the tax environment and to which the ESC should devote particular attention in future work.

2.6.5. The range of actions which could be used to achieve the objectives targeted has four main aspects covering around ten operational areas; by way of example, the main features with corporate tax implications should be singled out and addressed in discussions on this issue. The following aspects may be mentioned in this connection:

2.6.5.1. Adequate preparation for transfer via:

- steps relating to the right to change the legal structure;

- steps relating to the structure and operational procedures of public limited company which are best suited to the needs of SMEs;

- steps relating to tax neutrality of operations needed for efficient preparation of transfer of ownership.

2.6.5.2. Taxation of transfer to a third party, where various aspects come into play relating to the sale of the company, to taxation of profits arising from sales and to the transfer of the enterprise to employees; these aspects are not mentioned in the Communication of 25 May 1994, which is currently under discussion.

2.6.5.3. Measures which could facilitate the success of family transfers where inheritance taxes and gift taxes have an important part to play; the impact of these measures on various areas of national law and on basic principles of tax legislation should not be neglected. International double taxation is another of the elements to be taken into account.

2.6.6. While welcoming this discussion/working document on a matter which has a considerable impact on all SMEs and on the economic structures of the European Union, its Member States and the regions, the ESC must stress the need for suitable tax measures to encourage people to set up businesses. In fact, the problem of transfer and continuity of SMEs can only be solved effectively and constructively if established, viable firms attract people who are interested in going into business. There is a wide range of incentives to be taken in this area, including tax incentives. The ESC consequently calls for a specific chapter to be devoted to this subject in the discussion process referred to in the Communication.

3. Proposals for other measures

3.1. In the light of the above comments on the sketchy nature of current Commission guidelines, the ESC would, in turn, like to submit a few additional suggestions as regards taxation areas where the need and scope for action at national and Community level could be studied.

3.2. This study should, of course, be carried out in keeping with (a) Member States' tax and other policies on firms and (b) the general principles and basic guidelines underlying Member States' tax, economic and social policy.

3.3. The ESC recognizes that the present Communication and the appended Recommendation constitute an initial step towards the objective. It is also aware that Member States have a broad range of mechanisms, programmes and measures to promote the creation and development of SMEs in various sectors. In general, these measures fall into three categories:

a)

reduction of financial and administrative burdens and obstacles;

b)

encouragement for the creation of new firms, takeover of existing firms and start-up of activity on a viable basis;

c)

promotion of SME development by creating a favourable environment on the financial, economic, social, and technological fronts.

3.4. In actual fact, only a few of the measures mentioned by the Communication fall directly within the abovementioned categories. Thus, the ESC feels it would be valuable to expand the range of possible intervention on the tax front.

Whilst specifying that it intends to restrict its comments to the sphere of direct taxation, where the European Union's powers and scope for intervention are limited, the ESC therefore calls on the Commission to envisage studies, analyses and consultations in areas such as:

3.4.1. Partial or total initial exemption from taxes on profits for start-ups and firms changing ownership - possibly subject to conditions on professional qualifications or job creation.

3.4.2. Possibility of tax relief on investments in SMEs for small and medium-sized private investors, who are a potential source of finance for such firms [see ESC Opinion on the Communication from the Commission on the financial problems experienced by small and mediumsized enterprises ()]; general tax incentives for investment in SMEs.

3.4.3. Differences between the tax treatment of institutional and private investors, and between quoted and non-quoted companies.

3.4.4. The extension to all the Member States of the system operating in some, at the instigation of the EC, whereby single-member limited companies may opt to pay either personal income tax or corporation tax.

3.4.5. A system (details to be worked out) whereby SMEs could establish special reserves earmarked for investment in physical assets or for other purposes.

3.4.6. Deductibility from taxable revenue of the cost of management training and business start-up advice.

3.4.7. Depreciation arrangements designed to eliminate any SME disadvantages vis-à-vis large companies.

3.4.8. The Member States' tax arrangements in connection with certain national and Community action programmes and aid to SMEs.

3.4.9. The introduction of certain abatements or exemptions for spouses working as assistants in SMEs.

3.4.10. The various issues raised in the Communication of 23 July 1994 on the transfer of businesses.

4. Consultation of the ESC

4.1. In conclusion, the ESC endorses the Commission's moves to improve the tax environment of SMEs. The Committee hopes that these efforts will be appropriately reflected at the various levels where the principles and objectives of the Integrated Programme in favour of SMEs and the craft sector are put into effect.

4.2. One of the basic problems arising in connection with this complex issue is that of the legal basis for the instruments and measures which the Commission would do well to draw up, when the guidelines established in the various areas, including the tax environment, are being translated into action.

4.3. Faced with the challenge of the coherent development of the European Union, the Committee must, to the best of its ability, support the Commission and the economic and social players concerned by the initiative in favour of SMEs.

It should be stressed once again that the ESC's membership enables it to operate as a consultation platform and a forum for the exchange of views in the exercise of its consultative role. Thus, whenever the Commission plans broadly-based consultation on an action programme, in order to define realistic objectives and guidelines at an early stage of drafting, input from the economic and social interest groups via the ESC could prove useful in more than one respect, and particularly in ensuring that all relevant points of view are taken into account and that problems are swiftly identified. This approach could be envisaged for certain action programmes and guidelines, in accordance with procedures to be agreed and without prejudice to the normal consultation procedure. The additional work and consultations envisaged in connection with the Communication would lend themselves well to such an exercise.

Done at Brussels, 21 December 1994.

The President

of the Economic and Social Committee

Carlos FERRER

() SEC(92) 1118 final.

() Committee Opinion on the Communication from the Commission on the financial problems experienced by small- and medium-sized enterprises of 6. 7. 1994 (CES 850/94).

() OJ No L 177, 9. 7. 1994.

() CES 850/94.

() CES 850/94, 6. 7. 1994.