1 Introduction
2 Background
2.1 Taxonomy of corporation tax regimes
Type of corporation tax regime | Principal features (CT \(=\) corporation tax; PT \(=\) personal income tax) | Some literature references |
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A. Equity income (profits)
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1. Classical system | Profits taxed in full after deduction of interest. Dividends net of CT taxed again at shareholder level under the PT. In practice, capital gains taxed on a realization basis at reduced PT rates | |
2. Dividend relief systems (partial integration) | Profits taxed in full after deduction of interest, but double tax on dividends mitigated through: (a) imputation system (credit for CT against PT on dividend income grossed up by CT); (b) dividend deduction system (deduction from profits of dividends paid out, and PT on full dividend net of CT); (c) split rate system (lower CT rate on distributed profits and PT on dividend income net of CT); (d) ad hoc approaches (lower PT or partial exemption of net dividend income). Capital gains taxed as under classical system | |
3. Full integration system | Profits allocated to shareholders in proportion to their shareholdings. If retained, CT serves as withholding tax for PT. Windfall capital gains taxed on an accrual basis | |
B. Capital income (profits, interest and royalties)
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1. Dual income tax (DIT) | All capital income, corporate and non-corporate, taxed separate from labor income at uniform CT rate. Profits taxed in full after deduction of interest which may be subject to withholding tax. Dividends exempt from PT or, equivalently, taxed at shareholder level at capital income tax rate (\(=\)CT) with credit for CT. Interest also taxed at personal level at CT rate with credit for withholding tax. Capital gains taxed at personal level on a realization basis | |
2. Comprehensive business income tax (CBIT) | Profits taxed in full without deduction of interest and royalties. Dividends, interest and royalties exempt at recipient level. Capital gains taxed on a realization basis |
US Department of the Treasury (1992) |
C. Economic rents (above-normal returns)
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1. Cash flow or flat tax | Profits taxed on a source basis, but immediate write-off of investment goods and claw back of interest and royalties. Dividends and realized capital gains taxed at (reduced) PT rate. Alternatively, above-normal return taxed on a destination basis in the country of the user or consumer of the corporation’s product (called destination-based cash flow tax, or DBCFT, for short), similar to the business cash flow component of VAT. Realized capital gains taxed at (reduced) PT rates | |
2. Allowance for corporate equity (ACE) | Deduction of normal rate of return from profits net of interest; dividends and realized capital gains taxed at reduced PT rate | |
3. Rate of return allowance (RRA) | Deduction of normal rate of return from returns on capital income at corporate and personal level. Dividends and capital gains taxed at personal level after RRA |
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Conventional CT regimes (classical systems) that take equity income or profits as their base and that permit a deduction for interest paid on debt. Double taxation of profit distributions can be mitigated through dividend relief systems and by applying reduced PT rates on capital gains. Double taxation would be fully avoided if corporate profits would be allocated to shareholders proportionate to their shareholdings under a full integration system, called piercing the corporate veil.6
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CT regimes that tax profits, interest and royalties (jointly called capital income) at the level of the corporation under a dual income tax (DIT) that purports to tax all capital income, corporate and personal, once at a uniform rate. Alternatively, interest and royalties, like dividends, are not allowed as a deduction from profits and are not taxed at recipient level under a comprehensive business income tax (CBIT). Disallowing interest and royalty deductibility under the CBIT is equivalent to imposing final withholding taxes on interest and royalties at the corporate level under the DIT at rates equal to the CT rate.
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CT regimes, called cash flow taxes, whose base is confined to above-normal returns by permitting the immediate expensing of business assets while clawing back interest and royalties, or by allowing a deduction from profits of the normal return on equity (as well as interest), referred to as allowance for corporate equity (ACE)—an allowance that can be extended to non-corporate capital income through a rate of return allowance (RRA).7 But for the extension, these forms of taxing economic rents are identical, if it is assumed that the value of corporate assets represents the discounted value of all their future earnings at the normal rate of return. Note that economic rents equal the business cash flow component of the value added tax (VAT), which can be derived by deducting wages from the difference between sales and purchases (including investment goods), which represents value added.
2.2 Trends in corporation tax rates and revenues
3 Current tax treatment of corporate source income
3.1 Overview of corporation tax systems
Member State | Equity income (profits, dividends, capital gains) | Debt income (interest) | ||||||
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CT rate\(^{\mathrm{a}}\)
| PT on dividends | CT \(+\) PT\(^{\mathrm{c}}\)
| (Top) PT on capital gains\(^{\mathrm{d}}\)
| PT on interest | Debt/equity ratio | |||
Included in global income [(top) PT rates] | (Top) PT rate or WHT\(^{\mathrm{b}}\)
| Included in global income | (Top) PT rate or \(\hbox {WHT}^{\mathrm{b}}\)
| |||||
Taxing profits
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(1) Classical system | ||||||||
Denmark | 22 | Yes (27/42) | 27 | 43.1/44.8 | 27/42 | Yes | 22 | 4:1 |
\(\hbox {France}^{\mathrm{e}}\)
| 34.4 | Yes (50.23; ex 40) | 21 | 54.2 | 16 | Yes | 24 | – |
Ireland | 12.5 | Yes (51) | 20 | 57.1 | 33 | Yes | 20 | – |
UK | 20 | Yes (7.5,32.5,38.1; ex £5000) | – | 26–50.5 | 20 | Yes | – | World cap |
(2) Imputation system | ||||||||
Malta | 35 | Yes but full tc | 35 | 35 | – | No | 15* | – |
Taxing capital income
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(1) Dual income tax (DIT) | ||||||||
Finland | 20 | No (30/34; ex 15) | 25.5 | 44/47.2 | 30/34 | No | 30* | 25% EBITDA |
Spain | 25 | No (19–23) | 19–23 | 39.2–42.2 | 19–23 | No | 19–23 | 30% EBITDA |
Sweden | 22 | No (30) | – | 45.4 | 30 | No | – | — |
(2) Comprehensive business income tax (CBIT) | ||||||||
Austria | 25 | No | 27.5* | 45.6 | 27.5* | No | 27.5* | – |
Bulgaria | 10 | No | 5* | 14.5 | – | No | – | 3:1 |
Croatia | 20 | No | 14.2 | 31.4 | 14.2 | No | – | 4:1 |
Czech Republic | 19 | No | 15* | 31.1 | – | No | 15* | 4:1 |
Germany | 30.18 | No | 26.4* | 48.6 | 47.5 | No | 26.4* | 30% EBITDA |
Greece | 29 | No | 10* | 36.1 | 15 | No | 15* | 30% EBITDA |
Hungary | 20.6 | No | 15* | 31.5 | 15 | No | 15* | 3:1 |
Latvia | 15 | No | 10* | 23.5 | 15 | No | 10* | 4:1 |
Lithuania | 15 | No | 15* | 27.7 | 15 | No | 15* | 4:1 |
Luxembourg | 29.22 | No (ex 50) | 15* | 36.7 | – | No | 10* | 85:15 |
Poland | 19 | No | 19* | 34.4 | 19 | No | 19* | 1:1 |
Portugal | 29.5 | No | 28* | 49.2 | 28 | No | 28* | 40% EBIT |
Romania | 16 | No | 5* | 20.2 | 16* | No | 16* | 3:1 |
Slovakia | 22 | No | – | 22 | 19/25 | No | 19* | 25% EBITDA |
Slovenia | 17 | No | 25* | 37.7 | 25 | No | 25* | 4:1 |
Taxing economic rents
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Allowance for corporate equity (ACE)\(^{\mathrm{f}}\)
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Belgium | 33.99 | No | 27 | 51.8 | 0.4 | No | 27 | 5:1 |
\(\hbox {Cyprus}^{\mathrm{g}}\)
| 12.5 | No | 17* | 27.4 | – | No | 30* | – |
Italy | 31.4 | No | 26* | 49.2 | 26* | No | 26* | 30% EBITDA |
No CT or PT
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Estonia | – | Yes (20) | 20 | 20 | 20 | No | 20* | – |
Netherlands | 25 | No | 15 | 25 | – | No | – | – |
3.2 Taxing profits (equity income)
3.3 Taxing profits and interest (capital income)
3.4 Taxing economic rents
3.5 Taxing capital gains and closely held corporations
Country | Type of income | Criterion | Tax treatment |
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Austria | Capital gains | 1% ownership | Taxed at 25% |
Bulgaria | Capital gains | Unquoted shares | Taxed at 10% |
Czech Republic | Capital gains | 5% ownership or votes | Taxed at 15%, but exempt after 5 years |
France | Capital gains | Active shareholders | Taxed as business income |
Germany | Interest | 10% ownership | Taxed at progressive rates |
Capital gains | 1% ownership | Taxed at 60% taxed as business income | |
Greece | Capital gains | 0.5% ownership | Taxed at 15% |
Ireland | Dividends | Less than 5 owners | Taxed as labor income |
Interest | Shareholders/directors | Treated as dividends | |
Italy | Dividends, capital gains | Listed companies: 2% voting rights or 5% ownership; otherwise: 20% voting rights or 25% ownership | 49.72% taxed at progressive rates |
Luxembourg | Dividends | 10% ownership | Taxed at half the average rate |
Capital gains | 10% ownership | Taxed | |
Netherlands | Dividends, capital gains | 5% ownership | Taxed at 25% |
Portugal | Capital gains | Unquoted shares | Taxed at progressive rates |
Sweden | Dividends, capital gains | Active shareholders | Prescribed amount taxed at 2/3 of flat capital income tax rate; excess taxed as labor income |
United Kingdom | Capital gains | 5% ownership and voting plus employment in the company | Taxed at 10% up to £10 million on a lifetime basis |
3.6 Intra-EU capital income flows
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3.7 Some important findings
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Basically, the taxable return on corporate investments is defined in terms of equity income (profits), but increasingly Member States levy final withholding taxes on interest (and dividends) paid to domestic share and debt holders—income items that are subsequently exempted.
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In the domestic context, therefore, 15 Member States are moving toward some form of CBIT. Within this context, however, various forms of capital income are taxed at different effective rates, which may distort savings and investment decisions. Capital income is taxed more uniformly in three Member States with a DIT. Another three Member States do not tax the normal return to capital under their ACE, which, they believe, should promote investment.
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Generally, dividends are taxed at a higher rate than interest if the earlier CT is taken into account, as it should be. This favors debt over equity.39 The higher tax on dividends can be defended if they reflect above-normal profits. The tax on dividends, which stimulates profit retention, reduces the amount of capital becoming available on European capital markets and thus hampers the development of EU share markets.40
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Capital gains are widely taxed at schedular PT rates and only upon realization, implying lower effective rates. Higher rates would be appropriate if the gains reflect economic rents or windfalls. No state takes account of the earlier CT by correcting the basis of share purchases for retained corporate profits net of CT.
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Withholding taxes are imposed on dividends paid to non-related parties abroad, but to a lesser extent on interest and royalties. Payments to related foreign corporate entities tend to be exempted from tax. Withholding tax exemptions or lower rates are granted only if the beneficial recipient is effectively taxed. Prescribed debt/equity ratios effectively limit interest payments to foreign as well as domestic debt holders.
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In all Member States, pension and investment funds are not taxed and can hence be used as conduits for not paying tax on interest or dividends if tax is not withheld at corporate level or the withholding taxes on these payments are refundable.41 In addition, the tax exempt status of institutional investors affects their portfolio choice and thereby the ownership structure of firms.