Opinion of the Economic and Social Committee on the 'Proposal for a Council Directive on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States'
Date: 1998-07-01
Institutions: European Economic and Social Committee
Subjects: corporation tax, intra-EU payment, tax harmonisation, tax system, type of business

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In contrast to the Commission’s initial stance, based on its report of 23 July 1998, the regulation of
26 May 1998 abolishes the ‘may contain GMOs’ option.

Moreover, it establishes a list of foodstuffs not subject to labelling (the list is initially empty, and will
gradually be built up on the basis of opinions from the scientific committees) and in the preamble
introduces the concept of a threshold for DNA or protein presence, below which labelling will not be
necessary. No threshold value is set.

Opinion of the Economic and Social Committee on the ‘Proposal for a Council Directive on
a common system of taxation applicable to interest and royalty payments made between
associated companies of different Member States’ (1)

(98/C 284/09)

On 30 March 1998 the Council decided to consult the Economic and Social Committee,
under Article 100 of the Treaty establishing the European Economic Community, on the
above-mentioned proposal.

The Section for Economic, Financial and Monetary Questions, which was responsible for
preparing the Committee’s work on the subject, adopted its opinion on 9 June 1998. The
rapporteur was Mr Pelletier.

At its 356th plenary session on 1 and 2 July 1998 (meeting of 1 July) the Economic and Social
Committee adopted the following opinion by 136 votes to seven, with four abstentions.

1.

Introduction

1.1.
The ESC welcomes the Commission’s move to
rectify a tax discrepancy which is an obstacle to
completion of an integrated single market.

Abolition of the withholding tax levied by some
1.2.
Member States on interest and royalties has long
been recognized as being of major importance for a
Community-wide market.

1.3.
The Commission’s first initiative in this direction
dates back to 20 April 1990. In 1992 the Ruding report
— broadly approved by the ESC (2) — prioritized this
reform. Unfortunately the Commission, in the absence
of consensus within the Council, decided in 1994 to
withdraw its proposal. Eventually, in December 1997,
the Ecofin Council gave the Commission the go-ahead
to draw up the proposal on which the ESC is now
consulted.

displayed concerning the plan — approved by the
Council and referred to in the explanatory memorandum
— for a directive ‘to ensure minimum effective taxation
of income from savings’ while bearing in mind the need
to preserve the competitiveness of European financial
markets at international level, which presupposes exten-
sion to non-EU countries and to the Member States’
dependent or associated territories (3).

1.5.
The purpose of the draft directive is to exempt
interest and royalty payments made by a company of
one Member State to an associated company (in which
the first company has directly or indirectly a minimum
holding of 25 %) of another Member State from any
withholding tax in the Member State from which the
payments are made. Hence tax on revenue deriving from
such payments shall be levied solely by the Member
State in which the beneficial owner is located.

2. Financial justification for the draft directive

1.4.
The ESC acclaims the Commission’s persistence,
not to say obstinacy. The same persistence should be

2.1.
From the financial angle, the aim is to avoid
double taxation — which is undesirable per se — or, at

(1) OJ C 123, 22.4.1998, p. 9.
(2) ESC opinion of 24.11.1992; OJ C 19, 25.1.1993, p. 65.

(3) Conclusions of the Ecofin Council meeting on 1.12.1997

regarding fiscal policy (OJ C 2, 6.1.1998).

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best, cashflow problems resulting from the inevitable
delays sustained by the final beneficiary in recuperating
the amounts withheld.

external payments outstrip their receipts. Conversely,
others are net structural exporters.

2.2.
The proposal for a directive reflects the concern
of the international professional bodies representing
the companies concerned: UNICE, European Banking
Federation, Association of Chambers of Commerce, etc.

2.3.
The tables appended to the draft directive provide
a fairly detailed picture of the nature of the problem, in
tax terms. It can be seen that, in the absence of a bilateral
tax agreement — not the case within the European
Union — withholding tax on interest and royalties can
be harsh in most States, though rates vary widely
(between 45 % and 0 % for interest and between 33 %
and 0 % for royalties).

2.4.
In the European Union, bilateral agreements
reduce such taxation to far lower levels but they do not
always make it possible to avoid double taxation
completely and the relevant schemes for levying with-
holding tax in the countries of the beneficial owners of
the payments are complicated.

3. Why has it taken so long to frame a directive?

3.6.
These difficulties may explain the Commission’s
cautious, wait-and-see, pragmatic approach; it is regret-
table that this attitude is ultimately akin to being afraid
to act.

4. A cautious approach

The draft directive hedges implementation with

4.1.
impressive precautions.

4.2.
Interest and royalty payments may serve as device
for evasion and fraud in the form, for instance, of unduly
large payments made by the subsidiary to the parent
company in the guise of interest or royalties. This
practice, which corresponds to transfer of profits, usually
occurs within a group with the intention of ensuring
that profits will be taxed in a country where company
income tax is low.

4.3. Here the draft directive draws logical conclusions
as regards the option allowing Member States to readjust
transfer charges when interest or royalties exceed ‘arm’s
length’ prices.

3.1.
For a long time it has been generally recognized
that rules are needed on such an apparently simple
matter.

4.4.
As the financial cost of exemption from withhold-
ing tax will hit Greece and Portugal hard, these countries
are granted a five-year transition period during which
taxes will be scaled down.

3.2.
The difficulties stem from with the complexity
of tax rules in the European Union and poor harmo-
nization — except in the VAT sphere.

5. An over-wary approach

3.3.
In addition, taxation falls within the sphere of
national sovereignty because of its vital contribution to
national budgetary resources. Hence the Treaty of Rome
designated this area as one in which decisions must be
taken unanimously.

3.4.
The strict financial constraints imposed by the
Maastricht Treaty or the Stability Pact make States
particularly vigilant when there is any likelihood of loss
of revenue, as in this particular instance.

The Member States’ interests differ: some are
3.5.
net importers of capital and technology, viz. their

The scope of the proposed directive seems too

5.1.
restricted.

5.2.
It limits exemption from withholding tax to
payments between associated companies, despite the
fact that this measure is fully justified where such
payments are made between companies which are not
in a dependent relationship.

5.3.
The status of associated company is recognized
only in the case of companies with a minimum sharehold-
ing of 25 % in another company although, under bilateral
tax agreements, the preferential rules applicable to
associated companies usually require a shareholding of
10 %.

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6. General comments

ings outside its scope may not be delayed beyond the
transitional period of five years (possibly extended)
stipulated in Article 8(1).’

6.1.
The Commission reserves the right to propose at
a later stage, as work progresses on the single market,
an extension of this exemption to royalty and interest
payments between non-associated companies.

6.2.
The Committee does not grasp the logic of this
restriction, which is designed to alleviate the proposal’s
financial impact on Member States that are net importers
of capital and technology, when it is proposed in the
case of the countries concerned (Greece and Portugal)
to introduce a five-year transitional period over which
the tax rate will be gradually scaled down. The general
principle is that interest and royalty payments eligible
for exemption from withholding tax must be ‘arm’s
length’ payments made between independent companies.
When payments are made between associated compa-
nies, application of the ‘arm’s length’ principle results
in any surplus component being regarded as a distri-
bution of profits eligible to benefit under Directive
90/435/EEC.

6.3.
The general rule is therefore that interest and
royalty payments are made between independent parties;
in such circumstances, there are no particular grounds,
as in the case of intra-group dividends (where the aim is
to ensure tax neutrality, so as to avoid penalizing offices
set up within the EU in the form of subsidiaries
or controlled companies compared with permanent
establishments), by restricting the scope of exemption
from withholding tax solely to interest and royalty
payments made between associated companies. On the
contrary, it is vital to extend such exemption to all
payments made between independent undertakings so
as to avoid distorting terms of competition in such a
way that national suppliers enjoy an unfair advantage.

6.4.
The reasons given in paragraphs 6.2 and 6.3
above justify — once the five-year transitional period
(possibly extended) has expired — the automatic exten-
sion of exemption provisions to interest and royalty
payments between associated companies. The Com-
mittee therefore calls for Article 10 to be worded as
follows:

Under Article 7 of the draft directive, Member
6.5.
States may choose not to apply the exemption from
withholding tax where interest or royalties paid are
subject to preferential corporation tax arrangements
in the Member State in which the beneficiaries are
registered. On this point Article 10 provides that the
report to be made to the Council within three years of
the Directive’s entry into force shall particularly review
the application of Article 7. The Commission specifies
that it will be easier at that stage, especially in the light
of progress on the code of conduct for business taxation,
to ascertain whether it is necessary to continue to grant
Member States the derogation provided under Article 7.

6.6.
As the Commission points out in the explanatory
memorandum accompanying the draft Directive, the
Ecofin Council of 1 December 1997 gave its agreement
to the framing of a code of conduct on company
taxation, to provide for the freezing and dismantling of
detrimental tax measures on the part of States. Zero
taxation, or substantially lower tax rates than those
normally applied in the Member State concerned, come
into the above category.

6.7.
The Committee would point to the importance
of ensuring consistency between the common action
envisaged under the code and the derogation provided
for in Article 7 of the draft directive, viz. not to apply
exemption from withholding tax when interest or royalty
payments in the State where the beneficiary company is
established are not normally taxed and hence are covered
by the above code. Member States may not be authorized
to take unilaterally new steps such as levying withholding
tax on interest and royalty payments in retaliation
against prejudicial tax measures subject to the code of
conduct without compromising the consensus on which
this code is founded and thereby seriously undermining
it.

The beginning of the first sentence of Article 7(1)

6.8.
must therefore read:

‘Three years after the date referred to in Article 9(1),
the Commission shall report to the Council on the
operation of this Directive, in particular with a view
to reviewing the application of Article 7. Extension
of the directive’s coverage to companies or undertak-

‘1. In addition to the situations covered by Article 6,
Member States shall be authorized to retain any
existing taxes specified in Article 1 which are
applicable to any payments of interest or royalties ...’

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and Article 7(2) as follows:

‘2. If the circumstances referred to in either of points
a) or b) of paragraph 1 apply only to a part of the
interest or royalties referred to in paragraph 1, the
authorization for which the said paragraph provides
shall be applicable to that part of the interest or
royalties.’

7. Specific comments

7.1. Level of holding (%) required for the status of

associated company

Since the aim is ultimately to do away with any
withholding tax on interest and royalty payments made
within the EU between companies, a reduction in the
level of holding from 25 % to 10 % is recommended,
which would tally with the limit set in most bilateral
agreements for purposes of eligibility to benefit from
the reduced rate of withholding tax applicable to
dividends paid between associated companies.

Accordingly, in Article 3(1)(b), ‘25 %’ should be replaced
by ‘10 %’.

7.2. Timespan for maintaining the level of holding

two-year timespan for maintaining the level of holding
expires, ‘subsequently’ should be inserted before ‘with-
draw’ in Article 3(2).

7.3. Definition of ‘royalties’

Payments made by way of contributions to a group’s
central research expenditure must specifically be covered
by the exemption from withholding tax. The OECD
Fiscal Affairs Committee has clearly stated that no
withholding tax should be levied on payments that do
not represent royalties but result from agreements on
contribution to a group’s central expenditure. Hence
Article 2(1)(b) should read:
‘... or for information
concerning industrial, commercial or scientific expe-
rience which has been, or is in the process of being,
acquired. Variable ...’

7.4.

Interest or
Article 5

royalties within the meaning of

Insert the following sentence under Article 5:

‘The provisions of Council Directive 90/435/EEC
therefore apply to interest or royalty payments
reclassified as distribution of profits if these are
made between companies covered by the present
directive.’

To highlight the fact that Member States may not delay
application of the directive until such time as the

Reason: this clarification, and the attendant explanation,
are the same as for Article 4.

Brussels, 1 July 1998.

The President

of the Economic and Social Committee

Tom JENKINS