Communication from the Commission to the Council, the European Parliament and the Economic and Social Committee - Tackling the corporation tax obstacles of small and medium-sized enterprises in the Internal Market - outline of a possible Home State Taxation pilot scheme […] {SEC(2005)1785}
Date: 2005-12-23
Institutions: European Commission
Subjects: European tax cooperation, corporation tax, multinational enterprise, single market, small and medium-sized enterprises, tax harmonisation, tax system

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 23.12.2005 
COM(2005)702 final 

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL, THE 
EUROPEAN PARLIAMENT AND THE ECONOMIC AND SOCIAL COMMITTEE 

Tackling the corporation tax obstacles of small and medium-sized enterprises in the 
Internal Market – outline of a possible Home State Taxation pilot scheme […] 

{SEC(2005)1785} 

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   EN 

 
 
 
 
 
 
TABLE OF CONTENTS 

1. 

1.1. 

1.2. 

2. 

2.1. 

2.2. 

3. 

3.1. 

3.2. 

4. 

Introduction .................................................................................................................. 3 

Purpose of the Communication.................................................................................... 3 

Previous Commission action for improving the fiscal situation of SMEs ................... 3 

The need to improve the fiscal position of small and medium-sized enterprises in the 
Internal Market............................................................................................................. 4 

Company tax obstacles in the Internal Market and their relevance for SMEs............. 4 

Conclusion and need for EU action ............................................................................. 7 

Home State Taxation as a promising approach for tackling the company tax obstacles 
of SMEs........................................................................................................................ 8 

Basic approach and suitability for SMEs ..................................................................... 8 

Development of the idea so far .................................................................................... 9 

Conclusion and Outlook............................................................................................. 11 

ANNEX.................................................................................................................................... 13 

Outline of a possible Home State Taxation pilot scheme for small and medium-sized 

enterprises .................................................................................................................. 13 

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1. 

INTRODUCTION 

1.1. 

Purpose of the Communication 

Achieving the 
Lisbon 
objectives 
requires action 
in the tax area. 

This is true in 
particular for 
small and 
medium-sized 
enterprises. 

"Home State 
Taxation" is a 
possibility 
worth 
exploring. 

in 

and 

particular 

The  Commission  Communication  to  the  Spring  European  Council 
COM(2005)24 
document 
SEC(2005)192,  the  Lisbon  Action  Plan  have  given  a  new  impetus  for 
achieving the Lisbon objective, including in the tax field. In this context 
the conclusions of the Presidency of the European Council of 23 March 
2005 repeatedly highlight the important role of small and medium-sized 
enterprises (SMEs) and call for broad policy actions in favour of SMEs1 

companion 

its 

The underlying problem is that while SMEs play a pre-eminent role in 
the economic development of the European Union, the participation of 
SMEs  in  the  Internal  Market  is  considerably  lower  than  that  of  larger 
companies,  not  least  for  fiscal  reasons.  This  results  in  economic 
inefficiencies and consequently lost potential for economic growth and 
job  creation  which  compromises  the  achievement  of  the  renewed 
Lisbon  objective.  Accordingly,  appropriate  action  for  fostering  the 
cross-border  expansion  of  SMEs  is  called  for  in  the  multiannual 
programme for enterprise and entrepreneurship, and in particular SMEs 
(2001-2005)2  and  in  the  Commission  Action  Plan:  The  European 
Agenda  for  Entrepreneurship3.  Moreover,  the  recent  Commission 
Communication on the contribution of taxation and customs policies to 
the  Lisbon  strategy  and  Communication  on  modern  SME  policy  for 
growth  and  employment4  refer  to  the  need  for  an  appropriate  tax 
framework for SME and mention the Home State Taxation initiative. 

The  purpose  of  this  Communication  is  first  to  set  out  the  particular 
problems  which  SMEs  active  in  more  than  one  Member  State  face  in 
the  company  tax  area  and  to  examine  how  these  undermine  the 
functioning of the Internal Market and, secondly, based on the work of 
recent  years  and  the  Commission's  current  company  tax  strategy,  to 
present a possible, practically viable solution based on the "Home State 
Taxation"  approach.  In  the  Commission's  view,  this  concept  could  be 
usefully  tested  by  interested  Member  States  and  companies  in  an 
experimental  pilot  scheme.  As  demonstrated  in  the  attached  Impact 
Assessment  the  potential  overall  economic  benefit  for  the  Internal 
Market is considerable. 

1.2. 

Previous Commission action for improving the fiscal situation of SMEs 

Previous 
Commission 

So far, Commission actions for improving the fiscal situation of SMEs 
have  focused  on  cross-border  problems  relating  to  taxes  other  than 
corporation tax. In particular the transfer of SMEs, which are frequently 

1 
2 
3 
4 

Presidency Conclusions of the Brussels European Council of 22 and 23 March 2005, e.g. in para. 25 
Council Decision 2000/819/EC of 20 December 2000 
COM(2004)70 dated 11/02/2004 
COM(2005)532 dated 25/10/2005 and COM(2005)551 dated 10/11/2005 

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3 

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action focused 
on the transfer 
of businesses … 

… and current 
efforts so far 
concentrate on 
value added tax. 

family  businesses,  entails  a  number  of  tax  issues  that  are  often  more 
difficult  and  onerous  than  for  large,  publicly  quoted  companies.  Cash-
effective  gift  and  inheritance  taxes  are  an  important  example  in  this 
respect.  The  Commission  has  repeatedly  referred  to  these  issues  and 
presented recommendations on tax problems concerning the transfer of 
small  and  medium-sized  enterprises5  and  a  Communication  on  the 
general improvement of the tax environment of small and medium-sized 
enterprises6.  Most  of  the  recommendations  concern  tax  problems 
relating  to  the  legal  status  of  sole  proprietorships  and  partnerships,  in 
particular the succession of SMEs.  

Moreover,  a  variety  of  measures  are  currently  being  put  in  place  to 
address the particular problems of SMEs in the area of value-added tax. 
In  particular,  the  Commission  initiative  on  the  'one-stop-shop'  concept 
will make it much easier for SMEs to expand in the Internal Market, as 
they will be able to deal with their VAT obligations at one single point 
of  registration  only.  Therefore,  from  an  SME  perspective,  company 
taxation remains one of the biggest Internal Market tax problems, which 
so far is not being properly addressed at EU level. Moreover, progress 
in this field and tax measures favourable to SMEs in other areas would 
be mutually reinforcing. 

2. 

2.1. 

THE  NEED  TO  IMPROVE  THE  FISCAL  POSITION  OF  SMALL  AND  MEDIUM-SIZED 
ENTERPRISES IN THE INTERNAL MARKET 

Companies face 
numerous and 
varied tax 
obstacles in the 
Internal Market 
… 

Company tax obstacles in the Internal Market and their relevance for SMEs 
Recent analysis and research by the Commission services7 subsequently 
confirmed  by  independent  research  institutes8,  reveals  that  the  cross-
border  economic  activities  of  businesses  in  the  EU  are  seriously 
hampered by many different company tax obstacles. In a nutshell, these 
concern  deficiencies 
its 
implementation  in  some  Member  States,  the  general  lack  of  cross-
border  loss-offset  for  subsidiaries,  tax  problems  with  cross-border 
restructuring operations, the application of double taxation treaties and 
transfer  pricing  issues.  The  resulting  higher  or  additional  tax  burden, 
(economic)  double  taxation  and  high  compliance  costs  act  as  a 
disincentive  to  cross-border  economic  activity  within  the  Internal 

in  existing  EU 

legislation  and 

tax 

5 

6 

7 
8 

Commission  Recommendation  of  25  May  1994  concerning  the  taxation  of  small  and  medium-sized 
enterprises, OJ L 177, pp.1-19; Commission Recommendation of 7 December 1994 on the transfer of 
small  and  medium-sized  enterprises,  OJ  L  385,  p.14-17.;  Communication  on  the  Commission 
recommendation of 7 December 1994 on the transfer of small and medium-sized enterprises, OJ C 400, 
pp.1-9. 
Commission  Communication  to  the  Council  and  to  Parliament  on  the  improvement  of  the  tax 
environment of small and medium-sized enterprises, COM(94)206, OJ C187, p.5-10. 
Commission staff working paper "Company Taxation in the Internal Market"[SEC(2001)1681] 
see for instance: Centre for European Policy Studies, "EU Corporate Tax Reform", Report November 
2001  and  "An  EU  Company  without  an  EU  Tax?  A  Corporate  Tax  Action  Plan  for  Advancing  the 
Lisbon Process", Report April 2002, both with further references. 

EN 

4 

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Market. 

Given  the  progress  in  many  other  policy  fields  where  measures  of 
harmonisation  or  mutual  recognition  have  been  taken,  the  relative 
importance  of  these  tax  obstacles  has  increased  in  recent  years  and  is 
now  one  of  the  biggest  problems  in  the  completion  of  the  Internal 
Market and the fulfilment of its economic potential. The Commission is 
therefore  currently  working  on  the  implementation  of  a  "two-track 
strategy"  which  contains  both  short-term  measures  that  are  targeted  at 
resolving  specific  obstacles  to  cross-border  economic  activities  in  the 
Internal  Market  and  longer-term  comprehensive  solutions.9  In  many 
areas  this  strategy  has  already  resulted  in  tangible  progress.  Good 
progress  is  also  being  made  with  the  technical  work  on  a  Common 
Consolidated  Corporate  Tax  Base  which  will  hopefully  provide  a 
systematic  'solution',  in  the  medium  term,  to  the  Internal  Market 
corporate tax problems of (mostly) the larger companies.10 However, so 
far  no  systematic  remedy  for  the  specific  company  tax  problems  of 
SMEs active in more than one Member State has been put forward. 

Such a remedy is needed, however. In the above-mentioned analysis by 
Commission services,  particular attention  was also paid to the specific 
situation  of  SMEs.11  It  was  found  that,  generally,  the  tax  obstacles  to 
cross-border  economic  activity  are  identical  for  SMEs  and  larger 
companies. However, the impact of many obstacles on SMEs is greater 
as they have, simply because of their smaller size, fewer economic and 
human resources and less tax expertise available. The limited size of the 
business  thus  inherently  limits  the  possibilities  of  avoiding  certain  tax 
obstacles.  The  adverse  effect  of  tax  obstacles  on  SME  participation  in 
the  Internal  Market  is  also  confirmed  by  a  number  of  surveys.  For 
instance,  the  replies  by  interested  stakeholders  to  a  "Questionnaire  on 
corporate tax as a barrier to EU expansion of small and medium-sized 
enterprises"  published  by  the  Commission  services  in  July  2004 
revealed among  other things  that around  one third  of SMEs in the  EU 
consider corporate taxation to be an important obstacle to cross-border 
expansion.12 

… the relative 
importance of 
which is 
continuously 
increasing. 

Small and 
medium-sized 
enterprises are 
hit particularly 
hard by these 
obstacles … 

… in particular 
as regards 
compliance 

Moreover,  it  was  clearly  established  that  there  are  also  two  additional 
areas which are of particular importance for SMEs.13 First, SMEs have 
particular difficulties in meeting the compliance costs resulting from the 

9 

10 

11 
12 

13 

information 

For details see the Commission Communications “Towards an Internal Market without tax obstacles. A 
strategy for providing companies with a consolidated corporate tax base for their EU-wide activities” 
[COM(2001)582]  and  "An  Internal  Market  without  company  tax  obstacles  –  achievements,  ongoing 
initiatives and remaining challenges" [COM(2003)726] 
Detailed 
http://europa.eu.int/comm/taxation_customs/taxation/company_tax/common_tax_base/index_en.htm 
Part III, ch. 8 and part IV, B, ch. 11 of the study [SEC(2001)1682] 
For 
http://europa.eu.int/comm/taxation_customs/taxation/company_tax/home_state_taxation/index_en.htm 
This conclusion by the Commission is also supported by the literature, see for instance: Chittenden F., 
Michaelas  N.  &  Poutziouris  P.  (2000)  ‘Small  Business  Taxation:  An  Agenda  for  Growth’,  Executive 
Development Centre, Manchester Business School and NatWest Bank PLC, p.2 . 

following  website: 

questionnaire 

this  work 

information 

available 

replies 

more 

and 

see 

the 

the 

the 

on 

on 

at 

at 

is 

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costs … 

… and problems 
of cross-border 
loss-offset. 

need  to  deal  with  up  to  25  different  taxation  systems.  This  finding  is 
strongly  supported  by  tax  practitioners  and  business  federations  which 
represent  SME  interests14.  According  to  UEAPME,  the  European 
Association of Craft, Small and Medium-sized Enterprises, "tax-related 
compliance  costs  for  small  businesses  are  up  to  100  times  higher  than 
for large companies"15. There is also relevant scientific and quantitative 
evidence  of  this  phenomenon.  In  addition  to  the  available  general 
studies  suggesting  that  compliance  costs  decrease  with  company  size 
and put a disproportionately higher16 or even prohibitively high burden 
on SMEs compared to bigger companies,17 the European Tax Survey18 
which  was  obtained  from  the  Commission's  European  Business  Test 
Panel has confirmed the importance of tax-induced compliance costs for 
SMEs.  Compliance  costs  in  the  field  of  company  taxation  related  to 
sales  were  estimated  to  be  five  times  higher  for  small  businesses  as 
compared with large businesses. Thus, because of the smaller business 
size,  high  compliance  costs  are  particularly  relevant  for  SMEs  and 
clearly deter many such firms from cross-border expansion. 

Second,  among  the  other  more  specific  tax  obstacles  to  cross-border 
economic activity in the Internal Market, the cross-border offsetting of 
losses  has  been  identified  as  the  most  important  obstacle  from  the 
perspective  of  small  and  medium-sized  businesses.  Losses  often  occur 
at the beginning of an activity in a foreign country, i.e. precisely when 
these  activities  are  typically  still  being  run  in  a  smaller  enterprise. 
Bigger companies are usually in a better position to avail themselves of 
tax  planning  strategies  and  hence  to  obtain  effective  relief  for  cross-
losses.  SMEs  usually  do  not  have  such  optimisation 
border 
opportunities.  Moreover,  given  their  usually  limited  capital  base,  it  is 
particularly  important  for  small  businesses  to  be  able  to  carry  over 
losses. 

For SMEs the 
effect of the 
cross-border 

In  the  domestic  context  most  Member  States  apply  special  tax 
arrangements (fiscal incentives or tax breaks) for the self-employed and 
SMEs.19  These  arrangements,  which  are  usually  not  geared  to  cross-

14 

15 
16 

17 
18 

19 

at 

the 

both 

2004 

(ch.7), 

available 

following 

See for instance the replies given to the Commission consultation in 2003 and a questionnaire launched 
in 
website 
http://europa.eu.int/comm/taxation_customs/taxation/company_tax/home_state_taxation/index_en.htm 
Press release dated 11 June 2004. 
See,  for  instance:  Cressy,  R.  (2000)  ‘Tax,  Assistance,  Compliance  &  the  Performance  of  the  Smaller 
Business’, A Research Report to the Federation of Small Businesses; and: Chittenden F., Michaelas N. 
&  Poutziouris  P.  (2000)  ‘Small  Business  Taxation:  An  Agenda  for  Growth’,  Executive  Development 
Centre, Manchester Business School and NatWest Bank PLC 
See Annex 2 of the Commission services study [SEC(2001)1681] with further references. 
Commission  Staff  Working  Paper  SEC(2004)1128.  In  particular,  it  revealed  that  compliance  costs 
relative to sales are larger for SMEs than for large companies. Moreover, it was established that cross-
border  activity  leads  to  higher  compliance  costs  for  companies.  Based  on  the  econometric  analysis 
carried  out  it  was  demonstrated  that  compliance  costs  are  higher  for  companies  with  at  least  one 
subsidiary  in  another  EU  Member  State  compared  with  companies  without  subsidiaries  in  another 
Member State and that they increase with the number of subsidiaries abroad. 
For a broad overview and an assessment see, for instance OECD, Directorate for Science, Technology 
and  Industry,  STI  Working  Paper  2002/9  "Taxation,  SMEs  and  Entrepreneurship"  by  Duanjie  Chen; 
Frank C. Lee and Jack Mintz. 

EN 

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tax obstacles 
are often 
exacerbated by 
favourable rules 
at the domestic 
level.  

border economic activities and the related tax issues, essentially concern 
the  determination  of  the  tax  base,  flat-rate  arrangements  and  other 
simplified  methods  of  profit  determination.  Some  Member  States  also 
grant  specific  lower  rates.  The  combination  of  these  two  effects  -  the 
particular importance of cross-border obstacles for SMEs and relief for 
domestic  tax  problems  -  may  even  raise  the  bar  in  terms  of  starting 
cross-border business for SMEs. 

2.2. 

Conclusion and need for EU action 

Company tax 
obstacles are 
one of the 
reasons for the 
under-
participation of 
SMEs in the 
Internal Market. 

Statistics  show  that  the  effects  of  the  company  tax  obstacles  and  their 
interplay with other tax and non-tax factors, among other reasons, lead 
to  20  relatively  low  participation  of  SMEs  in  the  Internal  Market.  In 
other  words,  SMEs  often  refrain  from  cross-border 
trade  and 
investments  because  they  are  inhibited  by  the  tax  problems  or  prefer 
purely  domestic  transactions,  even  when  these  are  less  lucrative  in 
strictly  economic  terms.  When  they  do  develop  activities  in  other 
Member  States,  SMEs  are  systematically  subject  to  higher  compliance 
and finance costs than larger companies and therefore run a higher risk 
of  business  failure  (altogether  and/or  of  the  newly  created  foreign 
establishment). 

The obstacles 
have negative 
implications 
going beyond 
the pure tax 
problem. 

This 
compromises 
the Lisbon goal 
in various ways. 

In  addition  to  the  barrier  to  participation  in  the  Internal  Market,  the 
SME tax obstacles also have other negative side-effects. For instance, as 
a  result  of  the  problems  of  offsetting  losses  in  start-up  companies  in 
other Member States, not only is the creation of an establishment abroad 
discouraged,  but  these  problems  also  limit  the  business'  access  to 
finance  at  an  essential  stage  in  a  company’s  development  life-cycle, 
which is frequently subject to supply-side constraints imposed by risk- 
averse financial provision from banks and other financial institutions (in 
particular in the case of technology-driven start-up companies). This has 
a  negative  effect  on  the  broader  conditions  for  the  survival  and 
development or cross-border expansion of SMEs. 

Given  the  overall  importance  of  SMEs  as  a  key  driver  of  economic 
growth,  their  reluctance  to  participate  in  the  Internal  Market  and  their 
poor survival rate is not only very costly to the individual businesses; it 
also adversely affects the overall economy in terms of productivity and 
the job creation that is necessary in order to achieve and maintain low 
unemployment levels, or tax revenue creation to support public services 
Both of these factors are essential to achieving the final  goal of  social 
cohesion stated in the Lisbon Council conclusions.  

Addressing the 
SME company 
tax obstacles is 
therefore a 

In order to exploit the full economic potential of the Internal Market and 
contribute  to  higher  growth  and  employment  rates  it  will  therefore  be 
necessary to encourage and increase SME investment and expansion in 
other  Member  States  by  removing  or  at  least  mitigating  the  relevant 
company tax obstacles. This is the fundamental policy objective of the 

20 

For more details see the attached impact assessment. 

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7 

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necessity.  

Counter-
productive side-
effects should 
be avoided. 

pilot  scheme  concept  elaborated  below.  The  operational  goal  is  to 
remove  SME  tax  anomalies  that  are  specific  to  cross-border  economic 
activity so that such activity can be undertaken in the Internal Market in 
the  same  way,  or  at  least  in  a  broadly  comparable  way  to  national 
markets. 

The achievement of this objective is subject to several constraints. Any 
measure taken in order to achieve this objective should not at the same 
time lead to significant revenue shortfalls for Member States, open new 
major tax fraud or avoidance possibilities and/or compromise the ability 
of  tax  administrations  to  oversee  SMEs.  All  these  effects  would 
adversely affect the achievement of the overall economic benefit, which 
was the original purpose of the measure. The design of a possible pilot 
scheme must take this into account. 

3. 

HOME  STATE  TAXATION  AS  A  PROMISING  APPROACH  FOR  TACKLING  THE 
COMPANY TAX OBSTACLES OF SMES 

3.1. 

Basic approach and suitability for SMEs 

'Home State 
Taxation' 
applies the 
mutual 
recognition 
approach of the 
Internal Market 
to company 
taxation. 

This would 
tackle the main 
tax problems of 
SMEs … 

The concept of 'Home State Taxation' is based on the idea of voluntary 
mutual recognition of tax rules. According to this concept the profits of 
a  group  of  companies  active  in  more  than  one  Member  State  are 
computed  according  to  the  rules  of  one  company  tax  system  only,  i.e. 
the system of the Home State of the parent company or head office of 
the  group  (the  "lead  company").  An  SME  wishing  to  establish  a 
subsidiary or permanent establishment in another Member State would 
therefore  be  able  to  use  only  the  tax  rules  with  which  it  is  already 
familiar.  Each  participating  Member  State  would  continue  to  tax  its 
share  of  the  profits  of  the  group  member’s  business  activities  in  that 
State at the corporate tax rate which it has itself defined. This share is 
determined  using  an  apportionment  formula.  No  steps  are  taken  to 
harmonise rules. The Home State Taxation approach therefore preserves 
each Member State's ability to raise revenue through corporate taxation. 

In  the  Commission's  opinion,  the  concept  of  Home  State  Taxation 
appears to be a very promising way of tackling the above-mentioned tax 
problems  that  hamper  SMEs  most  when  they  are  expanding  across 
borders,  in  particular  by  reducing  compliance  costs  and  inherently 
solving  the  problem  of  cross-border  loss-offset.  At  the  same  time, 
however,  given  some  of  its  possible  implications  if  applied  to  all  EU 
companies,  there  is  some  doubt  whether  Home  State  Taxation  may  be 
considered the most suitable tax approach for the Internal Market. The 
concept  could  therefore  be  usefully  tested  in  a  pilot  scheme  only  for 
interested  SMEs  and  Member  States  with  a  similar  tax  base.  The 
attached  annex  describes  in  some  detail  how  this  could  technically  be 
done,  but  obviously  the  details  of  a  possible  pilot  scheme  must  be 
determined  by  interested  Member  States  in  the  light  of  the  national 
framework  conditions.  The  Commission  is,  however,  prepared  to  lend 
technical support to this work, which could also be channelled through 

EN 

8 

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… and is 
therefore worth 
testing in an 
experimental 
pilot scheme. 

the FISCALIS programme21. 

The basic idea of the pilot scheme is to test the practical merits of the 
Home  State  Taxation  concept  for  SMEs  and  its  broader  economic 
benefits for the EU while limiting the administrative costs and potential 
revenue  risks  for  Member  States.  The  pilot  scheme  could  thus  be 
introduced by Member States via appropriate tailor-made arrangements 
with  other  Member  States.  Depending  on  the  actual  situation  on  the 
ground,  there  are  various  possibilities  such  as  via  a  bilateral  or, 
preferably,  multilateral  agreement,  by 
temporarily  supplementing 
existing  double-taxation  treaties  or  multilateral  conventions,  or  by 
concluding a new multilateral convention for this purpose. Appropriate 
suggestions are also presented in the outline of a possible pilot scheme 
in annex. 

3.2. 

Development of the idea so far 

'Home State 
Taxation' is a 
fully developed 
concept that has 
been refined 
over the years. 

This idea of the pilot scheme project has gradually taken shape over the 
last  four  years,  starting  with  the  publications  on  Home  State  Taxation 
by its authors Malcolm Gammie and Sven-Olof Lodin22, and continuing 
with the Commission work on a new company taxation strategy, and the 
reactions  to  these  initiatives.  On  this  basis,  the  Commission  presented 
specific ideas for taking the pilot scheme further and proposed a number 
of  practical  key  points  on  how  such  a  pilot  scheme  could  be  usefully 
designed23.  In  2003  the  Commission  services  carried  out  a  public 
consultation on this idea, and subsequent discussions (both formal and 
informal) with experts from the business community and the academic 
world led to further refinement of the project. Detailed working papers, 
summaries,  official  documents  and  reports  on  all  of  these  preparatory 
works  are  available  (for  instance  on  the  Commission  web-site24).  This 
Communication  completes  this  long-standing  technical  and  political 
preparatory work. 

Testing with 
SMEs is 

The  European  Parliament  supported  the  idea  of  Home  State  Taxation 
and  invited  the  Commission  to  take  this  concept  forward25;  the 

21 

22 
23 

24 
25 

Decision  No  2235/2002/EC  of  the  European  Parliament  and  of  the  Council  of  3  December  2002 
adopting a Community programme to improve the operation of taxation systems in the internal market 
(Fiscalis programme 2003-2007); OJ L 341, 17/12/2002 p. 1-5 
see in particular Gammie, M. and Lodin, S.-O., "Home State Taxation"; IBFD Publications 2001 
E.g. in the above-mentioned Communications [COM(2001)582] and [COM(2003)726]. It is noteworthy 
that,  in  its  1994  Communication  to  the  Council  and  the  Parliament  on  the  improvement  of  the  tax 
environment of small and medium-sized enterprises [COM(94)206 dated 25/05/1994, OJ C 187 dated 
09/07/1994]  the  Commission  had  already  issued  an  orientation  stating  that  "the  foreign  activities  of 
small and medium-sized enterprises could, under certain conditions, be taxed only in the Member state 
of residence of the enterprise. This would imply a major administrative simplification.". However, in its 
current  form  Home  State  Taxation  does  not  go  so  far.  It  does  not  involve  taxation  in  only  the  Home 
State, rather the calculation of the base in accordance with only the Home State rules. 
http://europa.eu.int/comm/taxation_customs/taxation/consultations/home_state_sme.htm 
Report on the Commission communication to the Council, the European Parliament and the Economic 
and  Social  Committee  on  tax  policy  in  the  European  Union    –  Priorities  for  the  years  ahead 
(COM(2001)260 – C5-0597/2001 – 2001/2248(COS))  

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supported by 
the EP, 
ECOSOC … 

European Economic and Social Committee advocates a pilot project on 
"Home State Taxation" as a solution for cross-border activities of SMEs 
which  could  be  tested  on  a  bilateral  basis  before  being  eventually 
widened to the whole of the EU following a positive evaluation26.  

… and the SME 
Community. 

Member States 
are sceptical. 

Nevertheless, 
there is an 
actual 
precedent… 

The public consultation on the idea of a Home State Taxation pilot for 
small and medium-sized enterprises held by the Commission services in 
2003 and a questionnaire distributed in 2004 showed support among EU 
small  and  medium-sized  enterprises  for  the  Home  State  Taxation 
approach  and  high  interest  for  taking  part  in  a  possible  pilot  scheme. 
However, due to the low response rate to the questionnaire, the results 
cannot be considered as being statistically significant. 

that 

Obviously,  the  Commission  has  also  consulted  Member  States  on  the 
prospect  of  such  a  pilot  scheme,  among  other  things  in  2004  in  a 
working group meeting and at the Informal ECOFIN Council. It has to 
be  admitted 
these  consultations  revealed  considerable  and 
widespread  scepticism.  The  essential  arguments  presented  to  the 
Commission in this context were, first, that claims about specific cross-
border  tax  obstacles  for  SMEs  were  misleading  and,  second,  that  any 
such  pilot  scheme  would  give  rise  to  serious  administrative  and  legal 
problems,  including  discrimination27.  The  Commission  considers, 
however, that  there  is clear evidence of the need to improve the  fiscal 
position  of  SMEs  in  the  Internal  Market  and  that  the  potential 
administrative  and  legal  problems  can  be  addressed  and  should  not  be 
exaggerated. Moreover, as the scheme would be entirely voluntary, it is 
difficult  to  see  any  rational  justification  for  preventing  those  Member 
States  that  wish  to  do  so  from  entering  in  a  bilateral  or  multilateral 
agreement to conduct a pragmatic trial of an innovative tax scheme for 
SMEs. 

Moreover,  notwithstanding  their  reservations  towards  Home  State 
Taxation, two Member States recently agreed a protocol to their double-
taxation  treaty  under  which  an  exception  is  made,  in  certain  border 
regions,  to  the  rules  on  permanent  establishments.  In  the  regions 
concerned,  establishments  of  companies  from  the  other  Member  State 
are  not  treated  for  tax  purposes  as  "permanent  establishments"  even 
though  the  normally  applicable  criteria  are  met.  Consequently  no 
taxation  on  the  territory  of  the  country  where  the  establishment  is 
located is triggered – in contrast to normal rules. The main differences 
between this approach and Home State Taxation are that it is limited to 

26 
27 

Opinion ECO/127 
While an independent "Study on analysis of potential competition and discrimination issues relating to a 
pilot  project  for  an  EU  tax  consolidation  scheme  for  the  European  Company  statute  (Societas 
Europaea)" also ascertains the existence of such problems there are various, legal and practical, counter-
arguments  against  the  supposed  discrimination  claims.  Most  importantly  the  scheme  does  not 
systematically reduce the tax burden of the participating companies; the benefit is reduced compliance 
costs. Moreover, there are broadly comparable initiatives based on the country of origin principle and 
mutual recognition both in the tax arena and in other public law areas where the argument is apparently 
not being made. 

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a narrowly defined border area and the two Member States have agreed 
that  no  further  allocation  of  the  tax  base  between  the  two  countries  is 
needed..  However,  the  inherent  logic  of  the  approach  -  mutual 
recognition  -  is  identical  to  that  of  the  pilot  scheme,  and  its  practical 
implementation via the double-taxation treaty mechanism confirms that 
such  arrangements  are  perfectly  feasible  and  can  be  introduced  in  a 
relatively short period of time. 

Finally, the Home State Taxation approach has also been simulated with 
actual  data  from  a  relatively  large  Swedish  group  of  companies,  in  a 
project  led  by  the  Stockholm  School  of  Economics.  No  technical 
difficulties  were  encountered  and  only  a  few  adjustments  to  the 
companies’  accounts  were  required.  There  was  a  reduction  in  tax 
payable, but this was explained by the better loss-offset possibilities (a 
desired result) which means that negative revenue will automatically be 
clawed  back.  That  is  to  say,  group  relief  under  domestic  Swedish  law 
would become available to companies participating in the HST scheme. 
However, any deductions in respect of subsidiaries in another Member 
State would be reversed in subsequent profit years. There would thus be 
no reduction in tax in the longer term. 

… and real life 
simulations 
have also 
confirmed its 
practical 
feasibility. 

4. 

CONCLUSION AND OUTLOOK  

In  the  light  of  the  renewed  Lisbon  agenda,  and  bearing  in  mind  the 
economic importance  of EU  company tax  reform for  the  improvement 
of  the  EU  Internal  Market  as  a  whole  and  for  promoting  economic 
growth  and  employment  creation,  specific  action  in  favour  of  SME 
participation in the Internal Market is more necessary than ever before. 
The  field  of  corporate  taxation  deserves  particularly  close  attention  in 
this respect.  

In this regard, the Commission considers that the Home State Taxation 
concept provides a realistic and effective means to address the specific 
tax problems of SMEs in the Internal Market, in particular the problems 
of  high  compliance  costs.  It  may  be  considered  that  Home  State 
Taxation does not provide a systematic long-term "tax solution" for the 
Internal  Market  (in  the  way  that  the  Common  Consolidated  Corporate 
Tax  Base  -CCCTB  -  does),  but  its  potential  benefits  for  SMEs  and 
consequently  for  the  broader  EU  economy  should  not  be  left 
unexploited,  particularly  as  it  will  no  doubt  be  some  years  before  the 
CCCTB is implemented. Furthermore, in case the common consolidated 
tax  base  would  only  be  optional,  it  will  be  more  attractive  for  bigger 
companies  than  SMEs.  The  approach  could  thus  be  usefully  explored 
relatively  quickly  and  in  a  straightforward  manner  by  interested 
Member  States  and  businesses  in  an  experimental  pilot  scheme.  The 
attached  outline  of  such  a  possible  pilot  scheme  presents  the  relevant 
technical and legal issues in some detail. 

Interested  Member  States  are  invited  to  involve  the  Commission 

The economic 
reasons for 
testing a new 
concept for 
taxing SMEs in 
the Internal 
Market are 
compelling. 

It is hoped that 
Member States 

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will examine the 
possibility and 
the 
technicalities of 
a pilot scheme 
constructively. 

Services at an early stage when preparing a pilot project along the lines 
set out in this Communication and to inform them of any legislative or 
regulatory  initiatives,  not  least  in  order  to  ensure  compatibility  with 
Community law, notably in the field of competition rules. 

The  Commission  is  aware  of  the  fact  that  a  large  majority  of  Member 
States  currently  view  this  idea  with  degree  of  scepticism.  In  the 
Commission's  view  the  concerns  underlying  this  critical  stance  can, 
however,  be  dealt  with  effectively.  Moreover,  in  all  likelihood  only 
Member States with a broadly similar tax base would enter into such an 
agreement. The suggested approach ultimately constitutes no more than 
a  pragmatic  and  modest  initiative  aimed  at  the  mobilisation  of  the 
growth  potential  of  SMEs  -  it  should  not  be  hampered  by  purely 
administrative considerations. 

It is hoped that Member States will examine the possibility of a Home 
State Taxation pilot scheme for SMEs and the detailed arrangement set 
out  in  annex  in  a  constructive  and  open  spirit.  The  Commission  is 
prepared to provide support and advice to any interested Member States 
on specific projects. 

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ANNEX  

OUTLINE OF A POSSIBLE HOME STATE TAXATION PILOT SCHEME FOR SMALL AND MEDIUM-

SIZED ENTERPRISES 

Introduction 

1. 

2. 

3. 

4. 

The  basic  concept  and  the  fundamental  objective  of  the  Home  State  Taxation  pilot 
scheme  are  very  simple:  to  tackle  the  tax  obstacles  encountered  by  small  and 
medium-sized enterprises (SMEs) when they operate in other EU Member States in 
addition to their own, by giving them the possibility to apply, in certain respects, the 
corporate  tax  rules  of  their  home  state,  with  which  they  are  familiar.  Thus,  a  SME 
would  be  allowed  to  calculate  the  taxable  profits  for  the  parent  company  together 
with  all 
in  other 
its  qualifying  subsidiaries  and  permanent  establishments 
participating Member States according to the tax base rules of its home state. The tax 
base  thus  established  would  then  be  allocated  to  the  Member  States  concerned  in 
accordance  with  their  respective  share  in  the  total  payroll  and/or  turnover.  Each 
Member State would subsequently apply its national tax rate.  

This  document  explains  the  technical  features  of  this  concept  in  the  form  of  an 
experimental pilot scheme for interested SMEs. The purpose is to provide interested 
Member States with as detailed a basis as possible for working out the practicalities 
and  the  legal  content  of  a  concrete  bilateral  or  multilateral  pilot  scheme  and  to 
demonstrate  practical  solutions  to  problems  that  might  occur.  The  following 
explanation does not seek to cover every possible situation and potentially complex 
issue in relation to the pilot scheme. However, the application of the scheme should 
in practice be easy and straightforward for the vast majority of participating SMEs. 

Obviously, this 'template' cannot replace an actual tailor-made agreement that takes 
into  account  the  precise  features  of  the  tax  laws  and  other  relevant  framework 
conditions  in  participating  Member  States.  The  Commission  services  are,  however, 
prepared  to  provide  additional  support  and  advice  in  practical  preparations  if  the 
relevant Member States so wish. Such support could, for instance, also take the form 
of common FISCALIS seminars and project groups. 

It  goes  without  saying  that  insofar  as  a  possible  pilot  scheme  refers  to  existing 
national  tax  laws  and  practices  this  does  not  involve  any  assessment  of  whether 
individual rules are compatible with the EU Treaty. The application of such rules in 
the  context  of  the  pilot  scheme  would  in  no  case  and  by  no  means  prejudge  any 
position  or  decision  to  be  taken  by  the  Commission  or  any  other  institution  in  this 
respect. 

Basic approach and procedures 

Definitions 

5. 

The  fundamental  approach  of  "Home  State  Taxation"  is  based  on  the  idea  of 
voluntary  mutual  recognition  of  tax  rules.  The  taxable  income  of  the  'Home  State 
group'  is  computed  according to  the  rules  of  one  company  tax  system  only,  that  of 
the Home State of the lead company. Each participating Member State continues to 

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13 

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tax  at  its  own  corporate  tax  rate  its  share  of  the  profits  of  the  group  member’s 
business  activities  in  that  State.  This  share  is  determined  by  applying  a  formulary 
apportionment  mechanism.  For  the  purpose  of  a  pilot  scheme  the  relevant  new 
concepts and terms, i.e. those which do not follow standard practice in international 
taxation,  must  all  be  carefully  defined.  The  following  definitions  are  useful  in  this 
regard: 

– 

– 

– 

– 

"Home State" means the country of tax residence of the direct or indirect parent 
company,  or  of  the  company  to  which  the  permanent  establishment  belongs 
(head office), as appropriate.  

"Host state" means the country of tax residence of the subsidiary or the country 
in which the permanent establishment is situated, as appropriate. 

"Home  State  Group"  means  the  group  of  companies,  or  the  company  with 
permanent establishments, participating in the pilot scheme, as appropriate. 

"Lead  company"  means  the  company  at  the  head  of  the  Home  State  Group 
(parent  company  or  head  office),  which  is  resident  in  the  Home  State,  and 
which is ultimately accountable for the operation of the pilot scheme. 

6. 

There  is  no  need  for  a  separate  definition  of  SMEs  –  on  the  contrary,  it  seems 
advisable  to  use  the  general  EU  definition  of  SMEs  as  laid  down  in  Commission 
recommendation 2003/361/EC28, since this definition is common and familiar in all 
Member States. This definition distinguishes between: 

– 

– 

– 

medium-sized enterprises [headcount < 250 and turnover ≤ € 50 million and / 
or balance sheet total ≤ € 43 million] 

small enterprises [headcount < 50 and turnover ≤ € 10 million and / or balance 
sheet total ≤ € 10 million] 

micro enterprises [headcount < 10 and turnover ≤ € 2 million and / or balance 
sheet total ≤ € 2 million] 

In order to avoid any ambiguity, this definition should be binding for the purpose of the pilot 
scheme. This also concerns in particular the definition of terms used for the SME definition 
and the types of enterprises taken into consideration in calculating staff numbers and financial 
amounts. 

7. 

The  following  diagram  illustrates  the  basic  functioning  of  the  scheme  under 
consideration  and  the  definition  of  the  related  technical  terms  as  used  in  the 
remainder of this document. 

28 

Commission Recommendation of 6 May 2003 concerning the definition of micro, small and medium-
sized enterprises (2003/361/EC); OJ L 124 of 20.5.2003, p.36-41. 

EN 

14 

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___________________________________________________________________________ 

Description of facts 

A group of companies has the following structure: 

–  Parent company PA, located in Member State A  
–  Subsidiary DB, located in Member State B 
–  Subsidiary DC, located in Member State C 
–  Sub-Subsidiary DDC, located in Member State C 

Member State A 

Member State C 

PA 

↓ 

↓ 

DB 

→ 

→ 

DC 

↓ 

↓ 

DDC 

Member State B 

Definition of terms: 
–  Company PA is the lead company 
–  Companies PA, DB, DC and DDC can form a "Home State Group" 
–  Member State A is the "Home State" 
–  Member State B is "Host State" for DB 
–  Member State C is "Host State" for DC and DDC 
–  Member States A, B and C will formalise their cooperation in the pilot scheme by appropriate legal 

instruments, e.g. via a multilateral "Home State Convention" or "Home State agreement" 

Functioning of the scheme:  
–  PA  establishes  the  taxable  income  of  PA,  DB,  DC  and  DDC  according  to  the  tax  legislation  of 

Member State A 

–  The  tax  base  so  established  is  apportioned  among  Member  States  A,  B  and  C  following  for 

instance the proportions of payroll and turnover in each jurisdiction 

–  PA files a group/comprehensive tax return in Member State A and pays tax (on its share) 
–  DB self-assesses and pays their individual tax liability in Member State B 
–  DC and DDC self-assess and pay their individual tax liability in Member State C 

___________________________________________________________________________ 

Qualifying enterprises 

8. 

It seems strongly advisable to apply the pilot scheme only to small and medium-sized 
enterprises  which  are  subject  to  corporate  income  tax.  Moreover,  it  should  in 
principle  be  open  to  all  such  small  and  medium-sized  enterprises.  However,  ,in 
order,  on  the  one  hand,  to  target  the  pilot  scheme  more  effectively  at  the  first 
expansion cross-border of enterprises which have not yet reached a size which would 
allow them to support the additional costs caused by the application of the unfamiliar 
tax laws of another Member State and, on the other hand, to put a strict limit on the 
potential  costs  and  risk  for  tax  administrations,  Member  States  could,  if  they  so 
wished,  include  only  small  companies  as  defined  in  Commission  recommendation 
2003/361/EC  in  the  pilot  scheme.  Further  restricting  the  pilot  scheme  to  micro 

EN 

15 

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9. 

10. 

11. 

12. 

enterprises only would call the economic objectives of the pilot scheme into question 
and is therefore not a viable option. 

The definition laid down in Commission recommendation 2003/361/EC also contains 
rules  for  the  categorisation  of  'autonomous  enterprises',  'partner  enterprises'  and 
'linked  enterprises'  and  explains  how  these  are  taken  into  consideration  for 
determining the data used for the required staff headcount and the financial amounts. 
It  seems  sensible  for  these  rules  to  be  applied  in  order  to  determine  whether  a 
company  fulfils  the  criteria  of  a  small  and  medium-sized  enterprise  and  thus 
qualifies, in this respect, for participation in the pilot scheme. At the same time, these 
rules should be used for defining the Home State group.29 

Given the narrow scope of the pilot scheme it is unlikely that SMEs with head offices 
in third countries would want to take part in the scheme in respect of their EU-wide 
activities  in  an  EU  group,  as  this  would  involve  attributing  the  parent/head  office 
function  to  one  subsidiary  for  the  sub-subsidiaries.  Equally  it  appears  to  be 
improbable  that  SMEs  with  indirect  ownership  via  third  countries,  i.e.  a  parent 
company in a Member State with a subsidiary in third country which holds a (sub-) 
subsidiary in another Member State, could qualify for the pilot scheme. While there 
is  no  need  to  systematically  exclude  the  first  type  of  companies  from  access  to  the 
pilot scheme if  they  fulfil the basic requirements set out  in the relevant agreement, 
and in particular comply with the definition of a small and medium-sized enterprise, 
there are good reasons to believe that the second situation would be too complicated 
to  handle  for  the  purposes  of  a  pilot  scheme.  In  the  opinion  of  the  Commission’s 
services' opinion, indirect ownership via third countries or non-participating Member 
States  should  therefore  disqualify  a  group  of  companies  from  participation  taking 
part in the pilot scheme. 

Member  States  may  opt  to  exclude  internationally  active  partnerships,  single 
entrepreneurs and sole proprietorships or other tax-transparent or hybrid entities from 
the pilot scheme, even though they are partly covered by the definition of small and 
medium-sized  enterprises.  Their  inclusion  would  drastically  complicate  the  pilot 
scheme  and  offer  no  prospect  of  major  economic  benefits.  For  this  purpose  the 
assessment e.g. of the 'hybrid' character of an entity (i.e. one which is considered to 
be tax-transparent by one State and opaque by another) can of course only be made 
from the perspective of those Member States taking part in the pilot scheme and not 
by a Member State which is not that of any of the entities in the 'Home State Group'. 

the  example  of 

incorporated  companies, 

The  potential  complications  and  additional  technical  problems  can  be  illustrated  as 
follows.  Unlike 
inclusion  of 
internationally active partnerships and other tax-transparent or hybrid entities within 
the scope of the scheme could, for instance, lead to diverging opinions on the correct 
application  of  existing  double-taxation  treaties,  especially  when  the  partners  are 
residents of other Member States other than that in which the partnership is located. 
An  example  of  this  type  of  problem  is  the  situation  where  one  Member  State 
considers  the  interest  on  a  loan  by  the  partner  to  the  partnership  as  normal  interest 
and another regards it as a form of hidden profit distribution. The scheme would thus 

the 

29 

see  "The  new  SME  definition  -  user's  guide  and  model  declaration",  available  under: 
http://europa.eu.int/comm/enterprise/enterprise_policy/sme_definition/sme_user_guide.pdf 

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in  some  respects  effectively  extend  into  personal  income  taxation.  It  is  therefore 
conceivable that, if Member States wish to include partnerships, these would only be 
accepted into the scheme in exceptional cases, which have to be analysed by the tax 
administrations of the Member States involved on an individual basis. In any event, 
only  commercially  active  partnerships  with  business  income  should  be  allowed  to 
apply to take part in the scheme.  

Determination of the Home State and the Home State Group 

13. 

14. 

15. 

The  "Home  State"  of  a  participating  SME-group  is  defined  as  the  country  of  tax 
residence of the lead company. Following the generally accepted tie-breaker rule this 
is, in case of doubt or of double-residence, the country in which the place of effective 
management (or central management and control) of the lead company is located and 
where this company is subject to corporation tax before entering the pilot scheme. If 
there  are  problems  with  the  application  of  this  rule  for  the  purpose  of  the  pilot 
scheme,  the  tax  administrations  of  the  Member  States  in  which  the  group  is  active 
have  to  reach  a  common  agreement  on  the  Home  State;  otherwise  the  company 
cannot take part in the pilot scheme.  

The  corporate  tax  base  rules  of  the  Home  State  will  therefore  apply  to  the 
participating  lead  company  and  its  subsidiaries  and/or  permanent  establishments  in 
the participating Member States. Whether or not these activities of the participating 
company are included in the 'Home State group' for the purpose of the pilot scheme 
depends on the domestic group taxation rules of the Home State and the conditions 
defined  therein.  It  seems  that  world-wide  consolidation  schemes  are  extremely 
difficult, or evenimpossible, to apply in the context of the pilot scheme 

Under  no  circumstances  should  a  company  (parent  or  subsidiary)  be  allowed  to  be 
part  of  two  different  "Home  State  groups".  Therefore,  Member  States  should  set  a 
generally  applicable  majority  ownership  requirement  in  the  relevant  bilateral  or 
multilateral agreement. This additional threshold would, for the purpose of the pilot 
scheme, supplement and replace existing national thresholds if these are lower 

Coverage of taxes 

16. 

17. 

It seems sensible that the scheme should apply to corporation taxes only. Taxes other 
than  corporation  taxes  should  not  be  included  in  the  scope  of  the  scheme.  This 
concerns in particular value added tax, excise duties; wealth tax, inheritance tax, land 
tax and land transfer tax. If they so wish, Member States could nevertheless continue 
to apply national or local profit-related surcharges on the corporate tax as established 
under  the  conditions  of  the  pilot  scheme  (i.e.  on  that  Member  State’s  share  of  the 
overall tax base). Non-profit related local or regional taxes could also continue to be 
levied under the rules of each of the Member States involved. 

The  pilot  scheme  should  not  indirectly  influence  the  levying  of  taxes  other  than 
corporation  tax.  Insofar  as  the  determination  of  the  taxable  income  for  corporation 
tax  interacts  with  or  impacts  on  the  assessment  of  other  taxes  or  social  security 
contributions, and insofar as this link cannot be technically established on the basis 
of the Home State tax base rules, specific accounts should be kept on the basis of the 
Host  State  rules.  An  example  of  this  would  be  the  treatment  of  fringe  benefits  in 
many Member States' income or wage tax laws. Applying different tax rules for the 

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calculation and treatment of benefits in kind under corporation tax law at company 
level and  under personal income tax law  at staff level may result in an undesirable 
mismatch  and  thus  lead  to  over-  or  under-taxation.  The  only  way  to  address  this 
mismatch is to re-calculate the benefit, either in the Home State for the income of the 
Home State group or in the Host State for the personal income tax treatment of the 
recipient.  Given  the  variety  of  rules  on  fringe  benefits  and  comparable  issues  in 
Member  States,  no  general  solution  can  be  suggested;  appropriate  arrangements 
would need to be worked out in the specific situation in the light of the laws of the 
Member States concerned. 

Coverage of sectors 

18. 

19. 

Several sectors of the economy are usually subject to specific corporate tax rules. For 
the purpose of an SME pilot scheme this might lead to additional complications that 
are hard to justify, either because very few, if any, SMEs are active in these sectors 
or because the sectors in question are often still national. Therefore, Member States 
might  give  some  thought  to  the  idea  of  stipulating  that,  for  instance,  'Home  State 
groups'  with  more  than  10%  of  their  turnover  in  the  sectors  of  shipping,  financial 
services, banking and insurance, oil and gas trade and exploitation, and agricultural 
activities  (including  forestry  and  fishery)  shall  not  be  allowed  to  participate  in  the 
pilot scheme.  

The definition of the sector should be based on the domestic taxation rules applied in 
the  'home  state'  concerned,  but  the  tax  administrations  of  the  Member  States 
concerned  must  in  any  event  approve  the  sector  allocation  on  a  case-by-case  basis. 
Alternatively, common EU definitions should be employed or, if need be, developed 
for the purpose of the scheme. The Commission services would be prepared to assist 
interested Member States with this task, where necessary. 

Provisions for specific cases and anti-avoidance rules 

20. 

It goes almost without saying that the pilot scheme has to include rules for dealing 
with  exceptional  cases  and  anti-avoidance  provisions.  The  following  possible 
arrangements seem to make sense from the Commission’s point of view and should 
be  considered  as  possibilities  by  interested Member States. These rules also should 
provide certainty for participating companies. 

(a) 

(b) 

(c) 

(d) 

A  lead  company  which  takes  part  in  the  pilot  scheme  cannot  choose  which 
qualifying  subsidiaries  or  permanent  establishments  in  participating  Member 
States will form part of the Home State Group ("all in/all out" approach). 

Only existing enterprises which have been tax resident in the 'Home State' for 
at least two years should be allowed to participate in the scheme.  

A  business  which,  while  participating  in  the  pilot  project,  by  performing  its 
normal commercial activities grows organically beyond the limits set out in the 
SME definition should not for this reason be excluded from the project. 

A  change  of  ownership  does  not  automatically  lead  to  an  exclusion  of  the 
participating company, unless it breaches the definition of small and medium-
sized enterprise. 

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(e) 

One-off  transactions  and  'abnormal'  business  fluctuations  in  turnover  should 
not  automatically  lead  to  exclusion  of  the  participating  company  (or  the 
disposal  of  a  large  capital  asset  should  be  excluded  from  the  turnover 
requirements). 

(f)  Mergers  and  acquisitions  which  do  not  affect  the  constituent  elements  of  the 
pilot  scheme  (SME  definition;  determination  of  Home  State,  etc.)  should  not 
automatically  lead  to  the  exclusion  of  the  participating  company.  The 
responsible  tax  administrations  will,  however,  have  to  re-assess  whether  the 
prerequisites for participating in the scheme are still met under the new group 
structure. 

(g) 

The  change  of  the  Home  State  of  a  participating  company  during  the  pilot 
scheme  could  be  deemed  impossible.  The  transfer  of  the  lead  company's  tax 
residence  to  another  Member  State  should  then  lead  to  the  termination  of  the 
pilot scheme. The same holds for a merger leading to a change of tax residence 
of  the  lead  company.  Alternatively,  in  the  case  of  change  of  residence  to 
another Member State, the group could, in principle, continue to benefit from 
Home State taxation, albeit under the rules of a new Home State. The transition 
from one Home State regime to another should then be seamless; although this 
appears to be technically complicated, it is not impossible.  

(h)  Where the tax years of the lead company and the Home State group member do 
not coincide, it falls to the lead company to keep corresponding accounts which 
allow the tax administrations concerned to assess the application. 

(i) 

(j) 

(k) 

The  transfer  of  assets  between  the  lead  company  (parent  company  or  head 
office) and the subsidiary and/or permanent establishment in another Member 
State under the pilot scheme is possible in keeping with the domestic taxation 
rules of the Home State. However, the participating lead company is required 
to  establish,  in  collaboration  with  the  responsible  tax  authorities,  the  book 
value and the market value of the transferred asset so that the transfer can be 
taxed  according  to  the  current  'normal'  rules  if  the  pilot  scheme  is  not 
prolonged or if the asset is sold (i.e. "freezing" of the position and tax deferral). 
Insofar as the transaction is covered by the fiscal Merger Directive30, the rules 
of the Directive apply. 

Unless  otherwise  stipulated,  all  transactions  within  the  Home  State  group 
between  lead  company  and  subsidiaries  or  permanent  establishments  or 
between  group  members  should  be  dealt  with  according  to  the  domestic  tax 
rules of the Home State. 

The  general  anti-abuse  rules  of  the  State  of  residence  apply  for  every  group 
unit in relation to non-participating Member States and third countries, in order 
to forestall "rule shopping". 

Application of existing double-taxation treaties 

30 

Council  Directive  2005/19/EC  of  17  February  2005  amending  Directive  90/434/EEC  1990  on  the 
common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares 
concerning companies of different Member States; OJ L 58/19; 04/03/2005 

EN 

19 

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21. 

22. 

23. 

24. 

It follows from the very concept of Home State Taxation that the relations between 
'Home  State  group'  members  under  the  pilot  scheme  during  the  application  of  the 
scheme  fall  outside  the  scope  of  the  relevant  double-taxation  treaties.  The  bilateral 
double-taxation  treaty  between  two  participating  Member  States  should  not  be 
applicable  for  transactions  between  members  of  the  Home  State  group.  The  treaty 
should, however, continue to be applied to those aspects of the tax treatment which 
are not affected by the pilot scheme. 

The  pilot  scheme  does  not  involve  any  change  in  the  remit  of  the  tax  treaties.  The 
various group members should remain subject to the same tax treaty as before joining 
the pilot scheme. In other words, the tax treaty of the 'Host' or residence State should 
apply  to  a  member  of  a  piloting  Home  State  Group,  but  to  the  taxable  income  as 
established under Home State rules. Accordingly, the pilot scheme does not require 
changes  to  Member  States'  double  taxation  treaties  with  third  countries.  As  each 
member of the 'Home State Group' remains a taxpayer in its country of residence, the 
respective treaties should continue to apply. 

As  regards  foreign  source  income  of  the  group  members  (dividends,  interests, 
royalties,  income  from  immovable  property  etc.)  from  third  countries  or  non-
participating Member States, it seems sensible that this should generally fall outside 
the scope of the pilot scheme and be accounted for under the normal rules. Foreign 
source  income  should  thus  be  added  to  the  income  of  the  group  member  after 
apportionment.  This  procedure  avoids  problems  that  might  otherwise  arise  if  the 
Home  State  and  the  Host  State  had  agreed  on  different  arrangements  in  their 
respective  treaties  with  a  third  state,  e.g.  on  the  use  of  the  credit  method  and  the 
exemption  method  for  certain  income  items.  Where  the  participating  enterprise  has 
such  income,  it  will  therefore  be  required  to  file  two  tax  returns,  one  in  the  Home 
State and one in the Host State for specific income items. 

In  specific  circumstances,  double  taxation  treaty  non-discrimination  issues  could 
occur, both within the EU in relation to non-participating Member States and vis-à-
vis third countries, as enterprises in the same State are treated differently under the 
pilot  scheme.  While  the  available  research31  suggests  that  the  comparison  between 
enterprises participating in the pilot scheme and those outside the pilot scheme may 
no longer be the relevant reference point, these issues would ideally require a formal 
common  understanding  with  the  respective  Treaty  partners  on  the  interpretation  of 
this clause under the conditions of the pilot scheme.  

Transfer pricing issues 

25. 

26. 

31 

It  follows  from  the  very  concept  of  Home  State  Taxation  that  national  transfer 
pricing rules should cease to be applied within the Home State Group under the pilot 
scheme.  In  the  framework  of  the  'Home  State  Group'  the  rules  of  the  Home  State 
should be equally applied in the other Member States concerned. 

As regards transfer pricing adjustments, e.g. concerning affiliated companies, related 
parties or sub-subsidiaries in non-participating Member States or third countries, the 

International  Bureau of  Fiscal  Documentation  (IBFD);  The  compatibility  of  the  Home  State  Taxation 
system  with  double  taxation  agreements  based  on  the  OECD  Model:  a  study",  reproduced  in 
Lodin/Gammie, op.cit, p. 77-104, p.99. 

EN 

20 

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competent authority should be the Home State tax authorities (unless the adjustment 
arises from a transaction between a third country and a member of the Home State 
group resident outside the Home State). This seems to be the only practically feasible 
way  of  proceeding.  Moreover,  the  available  research32  suggests  that  a  careful 
distinction  should  be  made  between  primary  and  secondary  corresponding 
adjustments.  In  particular,  it  seems  advisable  to  make  corresponding  adjustments 
after  the  tax  base  allocation  is  carried  out  and  not  before.  This  is  because  only  the 
(foreign-sourced) income of that affiliate and only the Member State responsible for 
the negotiation should be affected. 

27. 

Consultation  between  the  administrations  of  the  Home  State  and  the  Host  State 
would  in  any  event  seem  prudent.  Such  consultations  are  probably  imperative  in 
relations  between  the  Host  State  and  a  third  country  not  having  a  double-taxation 
treaty with the Home State. 

Other technical issues 

28. 

29. 

30. 

As  regards  withholding  taxes,  dividend  payments  and  the  related  procedures 
concerning  transactions  between  members  of  the  Home  State  Group,  the  domestic 
rules  of  the  Home  State  should  apply  to  all  members  of  the  'Home  State  Group'. 
Again, this way of proceeding follows logically from the very concept of Home State 
Taxation. 

As regards payments between two enterprises established in the same Member State 
but subject to the tax rules of different Home States, following the suggestion of the 
authors  of  Home  State  Taxation33,  this  transaction  could  usefully  be  considered  a 
domestic  transaction  rather  than  a  cross-border  payment,  and  consequently  the 
domestic rules of the residence (Host) State should be applied. This would avoid any 
complications  of  introducing  new  rules  for  what  is  a  straight  forward  domestic 
transaction within one State. 

As  far  as  dividend  payments  to  possible  minority  shareholders  are  concerned, 
although this might to some extent require additional book-keeping, these payments 
should be dealt with by applying the domestic rules of the residence (Host) State, as 
this approach appears to be the only practically feasible way of proceeding. 

Procedural and administrative aspects of the pilot scheme 

Practical implementation of the pilot scheme 

31. 

In addition to the tax treatment of SMEs under the possible pilot scheme, a method 
of for access to the scheme and its procedural operation need to be laid down. It is 
suggested  to  use  the  mechanism  of  double-taxation  treaties  for  implementing  the 
pilot  scheme.  Interested  Member  States  should  thus  enter  into  appropriate 
negotiations, prepare and conclude a bilateral or, preferably, multilateral agreement 
allowing  interested  companies  to  participate  in  the  Home  State  Taxation  pilot 
scheme. If they so wish, support and assistance for these efforts would be available 
from  the  Commission  services,  possibly  via  the  FISCALIS  programme  (seminars 

32 
33 

Lodin/Gammie, op.cit., p.57; IBFD, op.cit, p. 95f. 
see Lodin/Gammie, op.cit, p. 37 

EN 

21 

   EN 

 
                                                 
32. 

and/or  project  groups).  The  Member  States  concerned  should  then  implement  the 
agreement  domestically,  in  accordance  with  their  national  laws  and  practices.  The 
bilateral  agreement  could  usefully  take  the  form  of  a  protocol  supplementing  the 
relevant double-taxation treaty, and multilateral agreements should be concluded in 
an intergovernmental convention. This way of proceeding would make sure that the 
pilot  scheme  could  be  introduced  and  relatively  quickly  and  in  a  flexible  manner, 
while fully respecting the principle of legality of taxation. 

On the basis of their agreement with other Member States, the tax administrations of 
participating Member States should, for instance via appropriate internal procedures 
(e.g. circular letters or publication of a call for 'expression of interest'), establish the 
possibility for companies to volunteer to participate in the 'pilot scheme'. Interested 
companies  (both  the  lead  company  and  subsidiaries)  would  have  to  notify  their 
interest  in  taking  part  in  the  pilot  scheme  to  their  usual  counterparts  in  the  tax 
administrations  of  their  respective  residence  States  and  these  would  be  obliged  to 
inform and consult without delay the tax administrations of the other Member States 
concerned.  A  decision  on  the  application  should  be  given  by  the  two  or  more 
administrations  concerned  within  a  reasonable  period  of  time,  e.g.  two  to  three 
months after the notification of interest by the company. As with other administrative 
decisions  a  possible  refusal  should  be  accompanied  by  reasons  and  can  only  be 
justified  if  the  applying  company  does  not  meet  the  requirements  set  out  in  the 
relevant agreement (no discretion for the authorities). 

Filing and payment requirements 

33. 

34. 

As far as the filing and payment requirements are concerned, it is suggested that in 
principle the lead company should be obliged to file a tax return for the Home State 
group only in the Home State. The responsible tax administrations of the other states 
concerned  should  receive  copies  of  this  tax  return  and  the  relevant  annexes  (e.g. 
balance sheets, profit/loss account etc. – as required under local Home State laws and 
practices).  The  information  provided  must  be  sufficient  to  allow  additional  profit-
related taxes or surcharges or other inter-related features of personal income tax to be 
assessed.  In  the  view  of  the  Commission's  services,  in  order  to  limit  the  cost  there 
should  not  be  any  systematic 
tax 
requirement 
administrations could ask for key documents to be provided in the national language 
or another appropriate language at the expense of the taxpayer. 

translation;  however, 

for 

The  very  concept  of  the  pilot  scheme  makes  it  inevitable  that  most  of  the  actual 
administrative  burden  falls  on  the  lead  company.  The  lead  company  should  thus 
compute  the  combined  profits  of  the  group  according  to  the  rules  of  its  residence 
'Home  State'  and  allocate  those  profits  among  the  group  members  according  to  the 
pre-established  formula  (see  below).  The  figures  of  the  various  allocation  criteria 
should be reported to the tax authorities of all Member States involved. The payment 
of  the  tax  will,  however,  be  made  by  the  respective  group  member  in  its  residence 
(Host) State. 

Control and supervision issues 

35. 

As  regards  the  supervision  of  the  pilot  scheme,  the  general  rules  for  mutual 
assistance  and  administrative  co-operation  in  the  EU  apply  and  should  be  used. 
Moreover,  the  tax  authorities  of  the  interested  Member  States  should,  if  this  is 

EN 

22 

   EN 

 
considered  necessary,  form  joint  audit  teams  for  auditing  the  lead  company  and 
group members. The audits should be allowed to be carried out by the joint team in 
all premises covered by the Home State group, but be strictly limited to those aspects 
governed  by  the  pilot  scheme.  In  the  event  of  litigation  it  would  be  logical,  in  the 
Commission services' view, to apply, in principle, the rules of the residence state of a 
"Home  State  group"  member  company,  e.g.  the  host  state  for  a  subsidiary  and  the 
home state for a lead company. It seems difficult to envisage another solution which 
does not infringe the Member States' respective national laws. 

36. 

In  the  bilateral  or  multilateral  agreement  it  will  be  necessary  for  Member  States  to 
agree on appropriate arrangements for the termination of the pilot scheme(s). These 
'exit provisions' must determine the valuation of assets and liabilities as well as the 
treatment of expenditure after the end of the pilot scheme, assuming the latter is not 
prolonged, without imposing on participating enterprises the systematic need to keep 
two sets of accounts under the rules of the Home State and the Host State throughout 
the pilot scheme test phase. 

Time frame 

37. 

38. 

By  definition,  the  pilot  scheme  should  de  designed  as  an  experimental  trial  and 
therefore  be  limited  in  time.  For  both  the  participating  Member  States  (tax 
administrations)  and  the  participating  companies  it  will  be  important  that  the  trial 
period is long enough so as to allow it to be analysed thoroughly and to justify the 
changeover  cost.  Based  on  the  feedback  received,  it  is  suggested  to  run  the  pilot 
scheme  for  a  period  of  five  years  after  which  a  final  evaluation  should  take  place. 
The  time  frame  of  five  years  is  to  be  understood  to  mean  that  a  start  date  for  the 
scheme is fixed and that the scheme automatically expires five years after that date 
(e.g. 1 January 2007 – 31 December 2011). Qualifying enterprises could, however, 
join  the  scheme  at  any  time  during  the  period  and  thus  also  participate  for  shorter 
periods (e.g. 1 January 2009 – 31 December 2011) 

The decision by a company to take part in the pilot scheme should be binding for the 
entire five-year period or for a shorter period until the pre-determined end of the pilot 
scheme.  If  a  company  insists  on  ending  the  application  of  the  scheme  before  the 
expiry  of  the  five-year  period,  this  shall  be  possible,  but  may  be  subject  to  a  re-
assessment of the tax years under the pilot scheme and retroactive application of the 
"traditional" rules.  

Apportionment formula 

39. 

For the purpose of this narrow pilot scheme it should be sufficient to use a simple but 
economically robust formula for apportioning the tax base between the participating 
Member  States.  This  is  because  the  tax  revenue  'at  stake'  is  limited  by  various 
factors:  the  restriction  to  small  or  small  and  medium-sized  companies;  the  limited 
number of small and medium-sized companies with establishments in other Member 
States;  the  optional  character;  strict  monitoring;  the  generally  low  tax  liabilities  of 
SMEs etc. Moreover, a simple formula is easy to administer and operate 

40. 

The  following  economic  factors  may  be  used  for  devising  the  allocation  formula: 
payroll; number of employees; sales (turnover); assets. Combining these factors will 
increase  the  economic  representativeness  but  render  the  application  of  the  formula 

EN 

23 

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41. 

42. 

43. 

more  complex.  Depending  on  the  formula  chosen  by  Member  States  it  will  be 
necessary  for  them  to  agree  on  commonly  accepted  and  practically  operational 
definitions of the factors used. 

It is recommended to use the respective share in the total payroll (50%) and overall 
turnover  (50%)  of  the  participating  business  in  each  Member  State  concerned  as 
apportionment  formula.  These  figures  are  easy  to  identify  in  the  company's 
accounting  and  tax  declarations.  Moreover,  the  combination  of  an  input-related 
factor  (payroll)  with  an  output-related  factor  (sales)  also  reduces  the  possible 
arbitrariness 

Following  the  inherent  logic  of  the  Home  State  Taxation  concept  and  the  pilot 
scheme,  both  profits  and  losses  should  be  subject  to  the  formulary  apportionment. 
Any losses allocated to the group units will be subject to the carry-forward and carry-
back  rules  of  the  State  of  residence  of  the  unit,  i.e.  the  home  state  for  the  lead 
company  (parent  company  or  head  office)  and  the  host  state  for  subsidiaries  and 
permanent establishments 

Under the Home State Taxation system the lead company uses the tax return forms 
of  the  Home  State  for  combining  and  reporting  its  taxable  activities  in  all  Member 
States  concerned  (see  above).  These  do  not  necessarily  include  the  required 
information on the apportionment factors. An appropriate, simple form for declaring 
these in an annex to the tax return should therefore be devised. 

Evaluation 

44. 

It  seems  advisable  that  the  Commission  and  participating  Member  States  should 
create a monitoring group to supervise the pilot scheme; the members of this group 
would  consul  one  another,  consider  possible  practical  problems  and  assess  the 
scheme's  success.  Moreover,  it  would  make  sense  for  those  Member  States 
implementing the pilot scheme to draw up, by 31 December 2009, a detailed report 
containing  an  overall  assessment  of  the  pilot  scheme's  effects,  so  as  to  allow  the 
Commission  and  the  monitoring  group  to  consider  the  possible  prolongation  or 
termination of the scheme and decide on the relevant procedures.  

EN 

24 

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