TALES OF TAX AND TRICKERY (A)

If you believe the Europhiles, tax harmonisation is a tale...
"Told by an idiot, full of sound and fury,
Signifying nothing."

Listen to the Sceptics, though, and they will...
"... a tale unfold whose lightest word
Would harrow up thy soul, freeze thy young blood,
Make each particular hair to stand an end
Like quills upon the fretful porpentine".

And if only the debate were carried on in the language of Shakespeare, and not that of the "langue de bois" (or wooden euros, as the Russians call it) which passes for English amongst our present masters.

Whatever the words of its converse, the debate has been going on long enough now for one or two general characteristics to become plain.

The first, and most important, is that almost all the argument so far has been about direct corporate taxes. Apart from a little flurry of interest when the UK objected at the last minute to doubling VAT on art imports to 5%, indirect taxes have, rather like the English cricket team, not "troubled the scorers". This is a worrying omission.

Michel Aujean, Director of the European Commission's DGXXI and himself personally in charge of the detailed negotiations with the City over the proposed "Withholding Tax" Directive, is also overseeing plans to bring together the VAT operating systems of member states and to harmonise rules for deduction of VAT across the EU [speech to CFE Forum 1999; Brussels, 21 April 1999; reported Taxation Practitioner July 1999, p.37].

Court cases concerning the extension of VAT to financial services - and therefore, eventually, mortgages - continue to be remitted from the UK's courts to the ECJ for decision. Of the latest two, Continuum has already been sent and FDR is likely to go, via the Court of Appeal, later this year.

"These cases are testing the scope of the VAT exemption for financial services [in the UK] under European law", commented the news editor in Taxation[3 June 1999 p.240].

The outcome of them may have an impact on the 1999 Budget change in this area. That is to say: the ECJ has replaced Gordon Brown as the chooser of the annual goodies in New Labour's even newer Red Box, down to the last dot and comma of VAT law. So the debate on tax harmonisation is narrower than the scope of the actual harmonisation either currently being carried out, or envisaged, by the European Commission. It is also limited to fears that tax rates will rise.

The Sun's attack in November 1998 on Oskar Lafontaine as the most dangerous man in Europe was based on the supposition that he wanted EU tax harmonisation in order to increase our taxes. This was thoroughly altruistic of the Sun, given that only one of its readers - its proprietor - is likely to suffer much from the effects of the two subjects under discussion at the time; the proposed "Withholding Tax" Directive which will concern non-UK tax residents, and the Code of Conduct which applies only to business taxes.

The "Withholding Tax" Directive will certainly cause a great deal of damage to the UK's financial services business, and therefore has quite properly been opposed by all those who have the interests of an independent and prosperous Britain at heart. But the constitutional means by which it will be foisted on us is no different from that to be used for its companion, the Interest and Royalties Directive [98/C 123/07]. This Directive eliminates tax on all intra-group interest and royalty payments across the borders of the Member States. There have been no voices raised against this proposal, even though it dismisses with breath-taking condescension the tax sovereignty of individual countries.

Even on the EU-sceptics' side, it seems that an EU Directive which raises business taxes is to be deplored, whilst one which eliminates them, albeit for multi-nationals, is quietly ignored. As the Mother Superior of a convent once said to Casanova, "It is the pregnancy we detest, Sir, not the loss of virginity."

Tax harmonisation is not to be opposed just because it will raise taxes in the UK - though it will; nor because it will damage the City and cause unemployment - as it certainly will. The chief objection to it is constitutional. In ceding control over its right to tax interest or any other kind of income, the people of the UK lose one of the badges of self-governance - and we lose it irrevocably. The language of the Interest and Royalties Directive is quite clear on this head.

It is as if Westminster were wagging its finger at a couple of English local authorities which had decided to increase corporation tax for businesses within their boundaries. The European Commission may be prolix in its Directives, but it is never obscure when it comes to telling the Member States how inferior they are to it in its overall scheme of things.

The constitutional damage takes two forms. The battles over the Withholding Tax Directive show how little influence the UK has "at the heart of Europe" The row over the meaning and scope of the Code of Conduct demonstrates that this complete lack of influence has thoroughly corrupted our government. Ministers mislead Parliament and the country at large because they dare not show how impotent that are in the face of the Commission's demands.

First the Withholding Tax Directive. The text at present under consideration, COM(1998)295 Final, did not spring fully armed from Mario Monti's brow. It is based on an earlier attempt in 1989. This foundered on Margaret Thatcher's opposition. But the Commission has a cat's patience, and merely waited until it saw that conditions were favourable. This occurred in 1996. With the UK in the toils of the BSE scare and Kenneth Clarke at the Treasury, the Commission had the perfect opportunity to launch its new drive for tax harmonisation at the informal ECOFIN held in Verona that year. The Withholding Tax Directive was a central part of these plans.

Clarke's replacement by Gordon Brown merely speeded up matters so that at the December 1997 ECOFIN the New Labour government "was keen to show its European credentials" as Anthony Fisher observed [Taxation Practitioner, Off-shore Supplement, March 1998, p.5]. The Withholding Tax Directive flourished, along with the Code of Conduct on business taxation, the Interest and Royalties Directive and plans for the Commission to bring in consultants to assess the administrative practices of the Member States' tax authorities, for possible further co-ordination. By June 1998, the final text of the Directive was ready for the public to gaze upon in wonder or in horror, according to taste. The City reacted in horror.

As Kit Farrow, Director General of the London Investment Banking Association (LIBA) warned Jacques Santer in a letter of 21 September 1998,
"... the Directive will be ineffective in securing [effective international action to counter tax evasion] given the freedom of capital movements whilst, at the same time, it will discourage cross border investment within the Community and will damage the EU's financial services industry and the competitiveness of EU issuers."

The extent of the damage is spelt out for even a Santer to comprehend. "..... a triggering of gross up and early redemption provisions ........ accounting for up to $115bn of borrowing which would result in potentially serious losses for investors (and a consequent decrease in tax revenues).........[an] increase [in] the finance costs of EU borrowers ........ paying agent and custody business is likely to be lost to financial centres competing with the EU ....... currently we estimate that the gross UK revenues of the largest custodians amount to $1bn or so a year, and that they employ over 5,000 people ............ there will be a similar damaging impact on investment and private banking within the EU ..... currently we estimate the value of the assets of high net worth individuals in the UK is $0.6 trillion ...."

Anyone who follows the argument back and forth between the City's champions and the Commission will see at once how false it is to claim that the UK has any influence whatsoever at the heart of the EU. The City asked for the exemption of the wholesale "Eurobond" market from the Directive, a concession which the Commission had been willing to offer in 1989. Santer's answer of 12 November 1998 to the City's plea is Bourbonic in its boneheadedness. "The Commission considers that a blanket exclusion of Eurobonds or any other specific debt instrument would lead to future distortions in the allocation of savings capital and would not be compatible with the aim of ensuring the effective taxation of savings income."

To be fair to Santer, or rather Monti who most likely drafted it on his behalf, the reply does engage more intelligently with other points of detail made by Farrow, which space here does not permit me to discuss. Yet the overall impression is simply that the Commission has made up its mind on the principles underlying the Directive itself, and will only discuss the technicalities of implementation.

After Santer's rebuff, the City turned to its supposed new friends in New Labour. Would they stick up for the UK's interests in Brussels? LIBA's taxation committee discussed this point at its meeting on 17 November 1998. It was minuted, however, that the position of the UK Government on how hard they would oppose the application of the Directive to Eurobonds was still somewhat unclear.

By 2 December 1998, the taxation committee was faced with re-considering how a Eurobond exemption should be drafted, since there seemed to be "quite a lot of political pressure" in Brussels at that time to ensure that some sort of measure was passed during the German Presidency of the EU Council of Ministers (January to June 1999). This "political pressure" could only have been coming from the Commission, that is - Santer, with Monti behind him.

On 16 December 1998 Derek Tyler of the LIBA wrote to Fernando Perez Royo at the Commission, following Royo's meeting with the main UK banking associations on 25 November where he heard the City's concerns about the Directive. Amongst Tylers worries was a paragraph in the Commission's report to the European Parliament (EP) preparatory to the EP's vote on the Directive and amendments to it supported by the City. Tyler identified the political impetus behind the Directive implicit in the Commission's words. He quoted them:

Tyler pointed out, as gently as possible, how misleading this statement was. Only a very small proportion of the total Eurobonds outstanding will be held by UK resident individuals, which it is the purpose of the Directive to tax. Most of these holdings are likely to be of issues by UK companies in any case, and thus outside the scope of the Directive. On the same day, Dawn Primarolo, at that time Financial Secretary to the Treasury, wrote to Farrow at the LIBA stating that: "We are in favour of international action to tackle evasion of tax on cross-border savings, but ... we believe that action based on exchange of information would be preferable to the withholding tax. ...... We certainly have no intention of agreeing to a course of action which would seriously damage the UK and other European financial markets, and our view is that Eurobonds must be excluded from the scope of the Directive if it is to be acceptable to us."

So is the UK about to witness a grand demonstration of the influence it can now wield at the "heart of Europe"? Will Monti's heart be softened by Dawn's dulcet appeals? Will Santer's paws be "moistened"? When Santer/Monti replied on 7 January 1999 to Farrow's follow-up letter in which the need to have third countries introducing withholding tax regimes on savings if the EU Directive were to be workable and less damaging, no sign of New Labour's New Dawning could be detected in the frosty rebuke. "The Community simply cannot allow itself to become paralysed as far as concerns progress in areas essential for the proper functioning of the Single Market, because of a fear that third countries will not follow its initiative."

And by mid-May 1999, St. George, far from slaying the Eurodragon, was discussing with it how to carve out its preferred cuts of the Cityâs juiciest business, the Eurobond market.

As Clifford Dammers, Secretary General of the trade group the International Primary Markets Association said: "[We] reluctantly accept the exclusion of all bonds held in national or international clearing systems as the least bad of all the alternatives ....... If the Chancellor decides to put forward this definition, Britain will still be objecting to the plans in general. But it has to show good faith" [reported in Evening Standard].

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