COMMISSION STAFF WORKING PAPER EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT
Date: 2011-11-11
Institutions: European Commission
Subjects: EU Member State, corporation tax, deduction at source, double taxation, firm governed by commercial law, interest, transnational corporation

EUROPEAN COMMISSION 

Brussels, 11.11.2011 
SEC(2011) 1333 final 

COMMISSION STAFF WORKING PAPER 

EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT 

Accompanying document to 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 
(recast) 

{COM(2011) 714 final} 
{SEC(2011) 1332 final} 

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EXECUTIVE SUMMARY 

This impact assessment will accompany the proposal to recast Council Directive 2003/49/EC 
on  a  common  system  of  taxation  applicable  to  interest  and  royalty  payments  made  between 
associated  companies  of  different  Member  States  (‘the  Directive’).  Directives  2004/66/EC, 
2004/76/EC and 2006/98/EC and Annexes VI and VII to the Treaty of Accession of Bulgaria 
and Romania have amended the Directive by extending its application to companies and taxes 
in the new Member States and granting some of them temporary derogations from some of its 
provisions1. In order to simplify the applicable rules it is useful to merge all this legislation 
into a single legal text. 

The benefits of the Directive are granted to companies which are subject to corporate tax in 
the  EU,  tax  resident  in  an  EU  Member  State  and  have  one  of  the  legal  forms  listed  in  the 
Annex to the Directive. It covers payments between associated companies, i.e. where one of 
the companies has a direct minimum holding of 25 % in the capital of the other company, or a 
third company has a direct minimum holding of 25 % in the capital of both the payer and the 
recipient company. 

Article 8 of the Directive required the Commission to report to the Council on the operation 
of  the  Directive  with  a  view  to  extending  its  scope.  The  report  was  presented  on  23  April 
2009  (COM(2009)  179)  and  concluded  that  legal  amendments  could  be  made  to  make  the 
Directive function better and thus achieve its objectives more fully. 

Problem description 

The  main  issue  addressed  by  this  legislation  is  the  heavier  taxation  of  cross-border  capital 
flows  than  domestic  transactions.  In  the  case  of  international  payments,  the  recipient  pays 
corporate tax in its State of residence and an additional withholding tax charged by the State 
from which the payment is made (the source State). Tax relations between Member States are 
generally  governed  by  double  taxation  conventions  (DTCs)  that  may  provide  for  the 
exemption or reduction of withholding taxes; also, the residence State may allow the taxpayer 
to  reduce  its  corporate  tax  by  granting  it  a  tax  credit  linked  to  the  withholding  tax.  The 
withholding  taxes  and  the  administrative  procedures  required  for  their  relief  impede  the 
smooth  functioning  of  the  internal  market.  During  the  early  1990s,  the  Parent-Subsidiary 
Directive had harmonised the tax regime applicable to EU profit distributions2. Only in 2003 
did  the  Council  harmonised  the  tax  regime  applicable  to  cross-border  interest  and  royalty 
payments between associated companies with a view to putting them on an equal footing with 
domestic payments by providing for the exemption of withholding taxes at source. Due to the 
different  legislative  procedures  followed  and  the  more  recent  amendment  of  the  Parent-
Subsidiary Directive in 2003, the scopes of the two instruments differ. 

Concerning  the  scale  of  these  problems,  in  82 %  of  cases,  both  the  parent  company  and  the 
subsidiary have a legal form that falls under the scope of the Directive; nearly 95 % of royalty 

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2 

OJ  L  157,  26.6.2003,  p.  49,  OJ  L  168,  1.5.2004,  p.  35,  OJ  L  157,  30.4.2004,  p.  106,  OJ  L  363, 
20.12.2006, p. 129 and OJ L 157, 21.6.2005, p. 278 and p. 311. 
Council  Directive  90/435/EEC  on  the  common  system  of  taxation  applicable  in  the  case  of  parent 
companies  and  subsidiaries  of  different  Member  States,  OJ  L  225,  20.8.1990,  p.  6,  as  amended  by 
Directive 2003/123/EC, OJ L 7, 13.1.2004, p. 41. 

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payments  and  approximately  90 %  of  interest  payments  are  covered  by  the  Directive.  As 
regards the association requirement, non-associated companies (0 to 25 % holding) represent 
12 %  of  holding  links.  This  initiative  tries  to  solve  some  of  the  problems  linked  to  cross-
border payments that fall outside its scope: 

- Cost-minimising firms try to avoid withholding taxes through tax planning: company groups 
may establish an intermediate conduit entity in a different Member State so that the payment 
received  by  it  enjoys  a  tax  exemption  which  would  not  be  applicable  otherwise.  This  can 
result  in  suboptimal  choices  driven  not  by  efficiency  but  by  tax  factors;  on  the  other  hand, 
Member States lose tax revenues. 

- Withholding rates vary in the different bilateral relations between Member States. Different 
DTCs  may  provide  for  different  rates.  This  may  distort  economic  decisions  attracting 
investment to low tax countries. 

- The conditions for enjoying withholding tax exemption under the  Directive  relating to the 
organisational form, the relations between the parties to the transaction, the ownership shares, 
minimum holding periods, etc. induce firms to choose options driven by tax factors instead of 
by efficiency criteria. 

- The requirements to obtain the Directive’s benefits are stricter than those established in the 
Parent-Subsidiary  Directive  for  the  exemption  of  dividends.  The  different  tax  regime  for 
dividends,  interest  and  royalties  may  distort  the  capital  structure  of  companies  and  the 
allocation of intangibles. 

-  The  application  of  withholding  tax  relief  at  source  provided  by  DTCs  involves 
administrative procedures imposing heavy administrative burdens and costs on firms. In many 
cases, it is provided only later via a refund. This results in liquidity costs. Also, if it is granted 
through tax credits in the residence State, there is a delay between the withholding charge and 
the deduction in the tax return. This also generates liquidity costs. These compliance costs for 
EU companies are estimated at €

 126 million each year. 

- Companies will be subject to double taxation: they bear a levy at source and corporate tax in 
their  State  of  residence.  This  latter  State  may  provide  for  double  taxation  relief  either  by 
exempting such income or by allowing deduction of the tax charged at source. However, if the 
withholding tax charged on the gross payment is higher than the corporate tax (low nominal 
rates) calculated on the net income derived from such payment, the companies suffer higher 
taxation than that charged on equivalent domestic payments. 

Another problem has to do with the conditions imposed for exemption from withholding tax 
when the payment is made by a company through a permanent establishment, i.e. a branch: 
such payment has to be a tax-deductible expense for this taxpayer. As it is currently worded, 
the Directive would not apply to cases where deduction is denied on grounds such as failure 
to comply with all the formal requirements, while the transaction is effectively connected to 
the activity of the permanent establishment. 

Finally, the Directive does not require the exemption at source to be linked to taxation of the 
payment in the residence State of the recipient. This may lead to payments free of tax. At the 

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time the Directive was agreed, the Council invited the Commission to propose the necessary 
amendments.  The  Commission  adopted  an  amending  proposal,  COM(2003)  841,  to  exclude 
from  the  withholding  tax  exemption  companies  already  exempted  from  tax  on  interest  and 
royalties  received  in  their  residence  State.  While  there  was  general  consensus  on  a 
compromise text, the discussions in the Council working groups between 2004 and 2006 did 
not  result  in  a  unanimous  agreement.  The  Commission  withdrew  this  proposal  when  it 
adopted  the  Communication  ‘Commission  Work  Programme  2010  —  Time  to  act’, 
COM(2010) 135 final, because it planned to propose this new recast of the Directive. 

Maintaining  the  current  scenario  would  perpetuate  distortions  of  business  behaviour, 
compliance  costs  for  companies  and  the  risk  of  double  taxation.  As  a  consequence,  there 
would  be  less  cross-border  capital  flows,  reducing  capital  and  technology  transfers.  The 
process  of  cross-border  allocation  of  resources  would  be  adversely  affected.  In  sum,  the 
potential of the internal market would not be achieved. 

In  principle,  this  situation  affects  companies  of  all  sectors  and  sizes,  although  compliance 
costs  constitute  a  larger  share  of  the  total  cost  for  smaller  firms.  Concerning  interest,  the 
problems  addressed  here  affect  mainly  the  financial  sector.  Still,  the  capital  structure  of 
corporate groups in any sector of activity is composed of equity and debt. This means that all 
sectors  of  activity  are  affected.  Concerning  royalties,  sectors  intensive  in  the  use  of 
technology and intellectual rights face these tax burdens more frequently. 

Tax  administrations  are  also  affected  since  they  receive  income  from  withholding  taxes  or 
their  tax  revenues  are  reduced  by  the  tax  credits  used  by  taxpayers  to  eliminate  double 
taxation. 

Subsidiarity 

This initiative is necessary since Member States tax cross-border activities according to their 
bilateral  tax  agreements,  which  are  the  result  of  bilateral  negotiations.  Each  country  pair 
arrives  at  a  different  solution.  When  there  is  no  DTC  applicable,  withholding  taxes  are 
charged in accordance with unilateral rules decided in line with national tax policies. There is 
no spontaneous coordinated action to eliminate these obstacles to the internal market. Thus, 
action  at  EU  level  is  required  to  guarantee  harmonised  and  coordinated  tax  policies  in  this 
particular area of taxation. 

The rationale for European action stems from the cross-border nature of the problem and the 
impossibility for each individual Member State to establish a single tax policy for itself and 
across the EU. Clearly, action at EU level will guarantee that Member States are bound by the 
exemption of withholding taxes to the same extent.  

Objectives 

The objective of this initiative is to reduce the above-described cross-border obstacles to the 
internal  market  by  extending  the  scope  of  the  withholding  tax  exemption  provided  by  the 
Directive at the least possible cost. In particular, it is essential to eliminate the distortions due 
to  the  different  regimes  applicable  to  the  capital  flows  of  dividends,  interest  and  royalties. 
Alignment of the Directive’s scope with that of the Parent-Subsidiary Directive is thus one of 

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the main goals. This should promote financing and technological activities and reinforce the 
EU’s specific policies in these areas. 

Policy options 

There is a range of policy options to be considered:  

- Option 1: not taking any particular action. 

-  Option  2:  the  benefits  of  the  Directive  could  be  extended  to  payments  between  non-
associated  undertakings;  in  addition,  the  list  of  types  of  company  to  which  the  Directive 
applies could be broadened.  

- Option 3: another solution would be to align the conditions of the Directive’s benefits with 
those of the Parent-Subsidiary Directive, by considering that companies are associated when 
there is a direct or an indirect holding of 10 % and by extending the list of types of company 
to which the Directive applies. 

-  Option  4:  the  legal  text  of  the  Directive  could  be  amended  to  clarify  that  payments  by  a 
permanent establishment related to its activities do enjoy the tax exemption. 

-  Option  5:  a  subject  to  tax  requirement  could  be  introduced  that  would  rule  out  the 
withholding exemption when the recipient of the payment is not effectively subject to tax on 
the income derived from it. 

Impacts of policy options 

Option  1  would  not  address  the  economic  costs  and  distortions  resulting  from  withholding 
taxes and would not solve the problems described above. 

Option 2 would affect Member States’ tax revenues. Concerning interest payments, the 13 EU 
Member  States  that  still  apply  withholding  taxes  to  outgoing  interest  payments  –  Belgium, 
Bulgaria,  the  Czech  Republic,  Greece,  Hungary,  Ireland,  Italy,  Latvia,  Poland,  Portugal, 
Romania,  Slovenia  and  United  Kingdom  -  account  for  intra-EU  interest  payments  that 
 112 billion in 2008. Considering that only 10 % of the gross debt position in 
equalled almost €
EU countries is between companies and that the average withholding rate in the countries that 
apply  withholding  tax  to  cross-border  interest  payments  is  7.1 %,  the  gross  revenue  from 
 0.8 billion. These lost revenues on 
withholding tax on inter-company payments works out at €
outgoing  interest  would  tend  to  be  offset  by  gains  from  lower  credits  for  withholding  taxes 
paid  in  host  countries.  Hence  netting  for  this  effect  would  likely  leave  very  limited  net 
 200 to €
revenue effects: the loss should not exceed €

 300 million3. 

Concerning  royalty  payments,  the  total  intra-EU  outflow  of  royalties  and  licence  fees  was 
 31 billion in 2008. The 22 EU countries that apply withholding taxes to outgoing 
more than €

3 

Source:  Copenhagen  Economics,  Taxation  of  interest  and  royalties  —  impact  assessment  of 
amendments to the present Directive, October 2010. 

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royalty  payments  account  for  intra-EU  royalty  payments  equal  to  €
 23.3  billion.  The  gross 
revenue from outgoing royalty payments considering an average withholding tax rate of 5.5 % 
is  potentially  around  €
 1.3  billion  for  the  EU  as  a  whole.  These  lost  revenues  on  outgoing 
royalties  would  tend  to  be  offset  by  gains  from  lower  credits  for  withholding  taxes  paid  in 
host  countries.  Hence  netting  for  this  effect  would  likely  leave  very  limited  net  revenue 
effects: for the seven countries with the largest negative royalty balances as a share of GDP - 
Bulgaria,  the  Czech  Republic,  Greece,  Poland,  Portugal,  Romania  and  Slovakia  -  the  loss 
should not exceed €

 200 million4. 

 100 to €

Currently,  the  scope  of  the  Directive  and  the  Parent-Subsidiary  Directive  is  limited  to 
associated companies. Extending the Directive’s benefits to unrelated undertakings would be 
a new feature affecting the EU tax relations of all Member States. 

For companies, the main effect of this second option would be to reduce compliance costs: up 
to  approximately  €
 126  million  could  be  saved  each  year.  The  positive  effect  would  be 
important  for  SMEs,  for  which  these  costs  are proportionally  higher.  This  type  of  company 
would also benefit from the elimination of withholding taxes on royalties: they tend to licence 
out  their  industrial  property  since  they  are  not  in  a  position  to  exploit  their  inventions 
themselves.  On  the  other  hand,  disparities  in  taxation  of  dividends,  interest  and  royalties 
would  remain,  with  the  corresponding  distortions  affecting  intra-firm  capital  structure,  the 
allocation of intellectual property of EU firms and the organisational form. 

Option  3  would  equalise  the  conditions  provided  for  in  the  Directives  on  taxation  of 
dividends, interest and royalties. It would contribute to the reduction of the above-mentioned 
tax  distortions.  In  addition,  it  could  produce  benefits  in  terms  of  increased  flexibility  and 
lower  restructuring  costs  in  firms’  choice  of  organisational  form,  capital  structure,  holding 
structures and allocation of intangibles. The savings in compliance costs for business could be 
estimated at between €
 58.8 million. The net revenue effects for the Member States 
would  be  even  less  than  in  the  previous  policy  option;  they  could  be  roughly  estimated  at 
 310 million. Transposing these changes into domestic law should not be particularly 
 160-€
burdensome,  since  experience  was  gained  with  the  implementation  of  the  Parent-Subsidiary 
Directive. 

 38.4 and €

In addition, there are two other initiatives that can be combined with options 2 or 3 in order to 
tackle two of the specific problems already described. Options 4 and 5 would surely help to 
make  the  Directive  work  better  and  should  for  this  reason  be  included  in  any  amending 
proposal.  

The above estimates should, however, be taken with caution as they are based on a number of 
assumptions and statistical data, where legal considerations could not be made. 

Comparing the policy options 

As options 4 and 5 can be combined with options 2 and 3 we will refer in the following to two 
alternatives: alternative I would combine options 2, 4 and 5 and alternative II would combine 
options 3, 4 and 5. 

4 

Source: see footnote 3. 

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€
                                                 
While  alternative  I  would  be  more  effective  in  reducing  compliance  costs,  it  would  also  be 
less efficient and inconsistent with other aims to improve the functioning of the Directive. In a 
context of unstable public finances, this solution would involve steeper reductions of Member 
States’  tax  revenues;  implementation  would  be  more  difficult;  and  it  would  be  inconsistent 
with the aim of eliminating the distortions deriving from the difference in scope between the 
Directive and the Parent-Subsidiary Directive. 

Thus, alternative II is the preferred option since it offers a more balanced solution. It would 
not be as effective as alternative I in reducing compliance costs but it would still achieve all 
the  objectives  set  by  this  initiative,  with  smaller  tax  revenue  reductions.  The  public 
consultation  launched  by  the  Commission  also  shows  that  most  of  the  stakeholders  who 
responded  preferred  this  alternative.  On  the  other  hand,  the  main  option  of  alternative  I, 
extending  the  Directive  to  payments  between  unrelated  undertakings,  received  very  little 
support, 29 % of the responses received. 

The  Member  States  also  had  an  opportunity  to  express  their  views  on  these  options  at  a 
meeting to discuss the Commission’s report on the Directive held on 23 November 2009. In 
general,  they  were  more  inclined  to  accept  initiatives  on  option  3;  some  of  them  rejected 
clearly  any  amendment  on  the  basis  of  option  2.  Concerning  the  technical  modifications 
proposed in option 4, most of the Member States’ delegates agreed on the need for a solution. 
Concerning option 5, the subject was brought up at the Ecofin Council meeting agreeing on 
the  Directive,  when  there  was  a  broad  majority  of  Member  States  supporting  Commission 
initiatives in this area. However, it should be stressed that the meeting of 23 November 2009 
was  of  a  technical  nature  and  delegations  were not  asked  to  take  a  political  position  on  the 
initiatives. In fact, a number of delegates remained silent during the debate. 

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