Before starting a discussion on the taxation system of any EU accession country and on the comparability of such a system with that in any other accession country or in any EU Member State it is necessary to draw a line of demarcation between indirect taxes (i.e. excise tax, VAT) and direct taxes, as the potential EU membership has an essentially different impact upon the two groups or ‘blocks’ of taxes.
A very important role in the formation of the common market was played by maximum harmonisation of indirect taxes, therefore, in order to provide to as high as possible degree equal conditions for competition, the regulation of these taxes laid down in the EU regulations and directives was made fairly stringent. Accession countries had to adapt to such harmonisation processes. True, there is an essential difference in the conditions under which accession countries today transpose acquis communautaire into their legislation and the conditions under which its was implemented in the current Member States: taxation systems in accession countries are “overgrown” with a multitude of various “interim” stipulations and exemptions from the main rules clearly laid down in the directives and regulations, while the fact that such exemptions will continue in effect “until the close of the transition period and the European Union rules are finally set” often mean an unlimited possibility to refrain from de facto implementation of stringent standards and objectives laid down in the EU directives and regulations.
Differently, accession countries were encouraged to implement the “pure” (“puritan”) model of the EU acquis, namely, “what is written on paper”, and not what is in many cases actually practiced by the member States. Possibilities of accession countries for any exceptions or reservations have been rather limited and the results of the Taxation Negotiations chapters were a vivid illustration of that, as the number and scope of the reservations granted is indeed insignificant and relates to application of exemptions that are of a local character (for instance, preferential VAT rate applied on restaurant food, etc.).
Taking into account such a rigorous position of the negotiations partner, i.e. the actual requirement to almost unconditionally implement the EU acquis in the sphere of indirect taxes, the future EU membership will have practically an identical impact the taxation systems of all the three Baltic countries. The three Baltic countries will have (in fact, they already have) very similar VAT systems as well as the excise tax administration systems, therefore, any further changes will not have any significant impact either upon the three countries’ attractiveness for investors, or their conditions for competition. Certainly, the procedures of practical implementation of one or another provision may vary in each country, each of them may have different administrative barriers or different additional requirements differently attributing to the general climate, creating either advantages or disadvantages, which, however, cannot be that significant so as to be bale to “vote” for or against any of the countries. Usually all administrative requirements and barriers (including those in the sphere of taxes) are integrated into a single picture of a wide range of barriers, and their impact is merged with the that of other barriers, they do operate alone.
As regards the level of indirect taxes – tariffs – it should be noted that in this respect there is also little difference between the Baltic countries, and the future EU membership does not seem to promise any major differences. There are no essential differences in either the VAT or excise taxes, exemptions for some groups of goods are of a local character and should also have no major impact upon competitiveness. The requirement to harmonise the excise tariff applied to diesel fuel with the minimum level set in the acquis will actually have the same impact upon economy of all the three countries and their general economic competitiveness, in each case bringing about a significant increase in the nominal rate at the same time echoing in other sectors of economy and the cost-price of other goods and services.
Therefore, the procedures of harmonisation with the EU law in the sphere of VAT and excise taxes will not allow any of the three Baltic countries to get ahead one over another, thus winning additional “points” in competition.
The number directly relevant EU regulations or legislation in the area of direct taxes is minimal – only two directives can be mentioned here pertaining to reorganisation of companies established in different EU countries as well as to profit distribution to parent companies, and Convention on Double Taxation Avoidance in adjusting profits of related companies, i.e. in applying methodologies for contract adjustments. Said legal acts regulate definite matters that are, among other things, related to the provisions of free movement of capital, however, there is no such act of law that would at least contribute towards equalisation of the direct taxation systems in general terms, i.e. taxation subjects, rate of taxes, calculation procedure and other aspects that finally determine the amount of tax contributions.
This situation is a good illustration that Member States have not been prepared and, perhaps, are still unprepared to make decisions on the unification of profit and income at the EU level, though relevant discussions have been going on for quite a time, and of late they are acquiring a certain more definite shape in terms of some potential decisions.
The only more stringent guideline in this area is the Resolution on the Code of Conduct, adopted by the Council and Finance Ministers of Member States in 1997, which condemns destructive competition by means of taxation. The Resolution allows to conclude that competition as such among countries in terms of taxation systems is not denounced by the European Union, though judging from the EU perspective, where each state is making attempts to maximise its competitive edge instead of making efforts to maximise the competitive edge of the EU as a whole, the borderline between “destructive” and “useful” competition becomes vaguely identifiable, and it gets difficult to visualise the implementation of the EU common goals laid down in various documents.
Resolution on the terms and conditions for business taxation defines certain principles, or assessment criteria, based on which taxation law provisions that may create destructive competition stipulated are identified. The main criteria of “destructiveness” are as follows:
· application of provisions in a way beneficial to non-residents only or disposition thereof in such a way (which even includes cases when only non-residents take advantage of preferential provisions – this alone is deemed a sign of “destructiveness”);
· profit tax calculation rules failing to comply with the general taxation principles (primarily, the OECD rules);
· not transparent and inarticulate rules on exclusive taxation terms which are not subject to uniform regulation.
It is also interesting to note that even following the adoption of the above Resolution things have not become any clearer, since the drawing up of methodology for the interpretation of the destructiveness criteria required considerable time, as each of them (with an exception of the formal ones) could be subject to ambiguous treatment unless supplied with additional explanation. It should be noted that under the business taxation rules it is practically impossible to “condemn” the entire profit taxation system effective in one state or another, - assessment is possible only in respect of its individual aspects.
According to the provisions of the said Resolution the European Commission conducts the systemic assessment of the profit taxation system of all candidate states, including the Baltic states, and the resulting decision is submitted to the Council. As to date the assessment of provisions effective in the Baltic states has not yet been approved. Beyond any doubt, all post-communist countries may potentially face problems related to measures implemented seeking to attract foreign investment into the countries, since such investment “hunting” as some kind of panacea was characteristic of any such country (by, for instance, fixing exclusive terms for investment into certain specific zones or simply providing for reliefs to foreign capital). Even in cases when provisions governing profit taxation do not designate all kind of preferences as designed for non-residents, i.e. they are universal, de facto it is non-residents that largely take advantage of such provisions. Such provisions may also be treated as potentially destructive, no matter how weird it may look. Even more strange seems the fact that in this particular case the category of non-residents include not only companies and natural persons established abroad, but also companies incorporated under national legislation in which more than 50 percent of interest is owned by non-residents.
It is understandable that the Resolution on business taxation terms came into existence as some kind of response to processes taking place in Europe aiming to develop a most attractive investment image. A political undertaking to refrain from the use of such measures, i.e. not to develop any new measures, and limit the validity of those currently in effect, radically modified the strategy of Member States in the filed of taxation. Decisions or intentions of Member States to reduce the general rate of profit tax have become increasingly frequent, although the measures often look like token measures, since in practice the tax is reduced only by 1-2 percentage points. Thus the process of competition by means of taxation rules continues, and many an expert have already named it as “race to the bottom” process.
What do the taxation systems of the three Baltic States look like in the light of this process?
Having essentially altered the profit tax application principles and the taxation procedure in effect from 2000, Estonia claims to have developed a taxation procedure especially conducive to investment. Compared to the practice of any Member State or a candidate state the Estonian taxation procedure seems rather unusual,– subject to taxation is only the distributed profit, as well as costs not related to business operations. Dividends paid to non-residents are subject to an additional taxation “at source”, with an exception of cases when the share of interest held by a non-resident is below 25 percent. It is notable that under the new taxation procedure the generated profit does not need to be invested into the enterprise in order not to pay the profit tax, - for that purpose the profit may be retained, i.e. not brought to distribution.
Having modified the taxation procedure Estonia spared no efforts for promotion and popularisation of the new provisions among investors. The system was declared to be particularly attractive to investors, special schemes were designed for those seeking to take advantage of the agreements on double taxation avoidance between Lithuania and Estonia, as well as Latvia and Estonia, stipulating the exemption from “at source” taxation of dividends paid from one state to another.
This certainly produced an impact on further decisions passed in neighbouring Baltic states, – measures were taken in the area of agreements governing the avoidance of double taxation (especially worth of notice at this point is the decision of Latvia to exempt from the provisions of the agreement the new Estonian taxation system, as well as the fact that a new agreements has already been concluded), as well as in own “backyard”, although a statement that changes in the profit taxation system were caused by decisions taken in Estonia would not be entirely true. Nevertheless, the new taxation procedure developed in Estonia did produce some influence upon the process development of proposals concerning taxation procedure, since time permitted a thorough assessment of all advantages and shortcomings of the Estonian system.
Having replaced the previous Law on Taxes on Profits of Legal Persons by the new Law on Profit Tax Lithuania took route entirely different from that of Estonia. The selected model stipulated a very low general rate and favourable taxation terms with respect to distributed profits, which in our opinion is much a more effective tool in competition for investment attractiveness. The general tax rate of 15 percent levied on profits is virtually the lowest among the European states. The profit tax imposed upon distributed profit as of 2003 is also rather low, which complemented by the “participation exemption” rule (exemption of dividends received by companies holding a 10 percent interest) contributes to the development of a sufficiently competitive profit taxation system. Of course, important are not only nominal tax rates, but also the tax base from which these are calculated. Here, apart from the general principles of establishment of taxable profit, comparable to those practiced in states employing the OECD provisions, complementary measures were developed, such as favourable terms for calculation of depreciation, especially in respect intangible assets, recognition of research and development costs as eligible deductions and others.
In our opinion the model selected by Lithuania shows the following basic advantages:
· even taxation system, leaving no room for decisions distorting motivation;
· low tax rate and common procedure for calculation of taxable profit;
· favourable procedure for taxation of distributed profits.
Due to the low profit tax rate the model has not designed to encourage artificial reduction of taxable profit, or distribution of profit concealing dividends by all kinds of costs (interest, payments for all kinds of rights, know-how, etc.). In order to prevent this kind of tax evasion models, it is necessary to make appropriate administration systems operational which involves increased administration costs.
We are also aware of plans in Latvia to reduce the basic profit tax rate, which in the year 2004 is estimated to reach the 15 percent threshold, although to all our knowledge this Baltic state does not anticipate any essential modifications in the taxation procedures and principles.
Hence, all the three Baltic states passed some sweeping decisions in the area of profit taxation, which reflected the desire of the states through the selected method of favourable taxation procedure (in the understanding of the states) to contribute to the general economic growth and investment processes, and to create conditions conducive to investment.
The further steps in this area will be largely shaped by decisions passed in the European Union, and the processes that are taking place are already observable. The research conducted by the European Commission and the conclusion that in view of differences in profit taxation systems in Member states the idea of Societas Europea may be difficult to implement, as well as reaching the goal of developing the EU as the most competitive economy in the world in the course of the next 10 years as stipulated in the Lisbon declaration may be impeded, cause concern and drive to the search for models to deal with the problem. There have been more than one model proposed ranging from a uniform profit tax payable to the EU budget to an ultimate approximation of taxation systems in all Member states. The latter proposal would imply that profit tax regulation throughout the EU would become comparable to that of the VAT, i.e. uniform profit tax computing principles are put in place, while leaving the fixing of specific amounts of the tax to the discretion of Member states. Although at this point it is unlikely that under the current procedure for passing decisions in taxation area any such EU legislation on universal harmonization of profit tax could come into effect in a foreseeable future, all candidate states, including the Baltic states are under obligation to observe the process closely, and become an active participant therein upon accession to the EU.
The Lisbon declaration highlighted another important item directly related to the competitiveness of national economies and investment attractiveness, – taxation of labour force. The issue was approached from a slightly different angle – an undertaking to alleviate the income tax burden, primarily in respect of recipients of low income. The income tax reform launched in Lithuania in essence reflects the provisions of the above declaration, although the latter was passed way later than the decision was taken concerning the model of the forthcoming Law on Residents’ Income Tax.
Labour force costs have a direct impact upon the competitiveness of the national economy, and in this respect the situation in Estonia or Latvia may seem more attractive due to lower rates of income tax. However, it should be borne in mind that currently the income tax integrates to kinds of payments (income tax and health insurance contributions). Currently, proposals are being tabled to reduce the income tax (by currently reducing the general rate, which beyond doubt would open some space for manoeuvre to reduce labour force costs at the expense of reduction of the tax), however, such proposals must be assessed by taking due account of the state’s financial capabilities to approve such decisions. The outcome in Lithuania (or Estonia or Latvia) that the reduction of income tax would cause a radical increase of revenues from the said tax is hardly conceivable, besides, consumption is not unlimited either.
Differences in income tax rates (and especially, income tax in combination with social insurance contributions) may play a role in comparison of the three Baltic states in terms of attractiveness, but it is not only the nominal tax rate that determines the scope of tax burden , – account must be also taken of the tax base. Thus changes in the calculation of taxable base in effect reducing the tax burden upon residents in Lithuania is also expected to produce an additional impetus to the national economy before long.
Making a recourse to the subject of the presentation and the similarities and differences between taxation systems in the Baltic states, a conclusion may be drawn that there are no especially marked differences between the taxation systems (with an exception of the Estonian profit taxation procedure), neither may they be anticipated in the future. Differences in certain aspects, unless these are special tax preferences, the possibilities of establishing and application of which will in all three states be defined by the Resolution on the terms and conditions of business taxation, does not have any decisive impact upon the competitiveness of the state, since the taxation system in general is not the most important issue for the competitive advantage or investment solutions. In the face of comparable taxation systems the business decisions to invest in one Baltic state or another, as well the growth of economy of these states will be determined by other factors, than provisions of tax laws.
