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2008

Summary in English of

ABOLISHED COMPANY TAXATION - ANALYSIS AND CONSEQUENSES

(Swedish title Slopad Bolagsbeskattning - analys och konsekvenser) by Erik Norrman http://www.nek.lu.se/NEKeno/teaching.htm and Niclas Virin


In recent years, there has been an international trend to reduce corporate taxation. Within the course of ten years, the average tax rate in the 15 older member states of the EU has fallen from 39 to 29 percent. Looking at all member states, the average rate of corporate taxation in 2006 was 25 percent.

Even though the reduction in tax rates was accompanied by some broadening of the tax base, there has also been a general move towards tax relief and tax exemption for certain types of company establishments. An intensive international discussion is under way on what has come to be called harmful tax competition, i.e. methods of using tax relief by certain countries to attract foreign investment with conditions to employ only local staff, carry on operations only in certain free zones, not to carry on competitive operations within the country etc.

What has largely been overlooked in this discussion is whether taxation on business - or at least corporate income tax - can be dispensed with completely. This book examines the practical, legal, accounting and business economics problems generated by the taxation of business. It then analyses and describes the economic consequences of the taxation of business and the macroeconomic effects of the abolition or substantial reduction of the corporate income tax.

A starting point for the book is the role of taxation on business in a schematically-described economic cycle. In a simple model such as this, the subject of taxation of business, i.e. corporate profits, are studied as part of the flows between the household and the business sector in the form of payment for work and capital which runs parallel to payments for goods and services. Corporate profits can then be described as a temporary collection of the results of production. This connection between corporate profits, salaries and dividends means that the taxation of these different bases also is closely linked. The scope for salaries and dividends, for example, is reduced when corporate profits are taxed.

The historical background to business taxation is described in more detail in Chapter 3, which concludes that there is no evidence that any in-depth analysis was made on the introduction of taxation on corporate profits during the 19th century. With the appearance of companies with limited liability, it became practicable to raise capital from people not directly involved in the business. This form of taxation subsequently became internationally accepted and generally implemented. Today, the arguments for corporate taxation would probably be purely fiscal and political. The conception that this form of taxation is to be based on good reasons or is systematically essential has probably been sustained by the discussion being carried on in various international bodies with the aim of eliminating 'harmful' tax competition and tax evasion through tax havens etc.

The review in Chapter 4 of various problem areas caused by the taxation of business reveals both theoretical and practical difficulties. The relationship between the taxation of business and accounting law means that a high degree of complexity is unavoidable. The general tax law issues include problems in determining taxable and non-taxable income, deductible and non-deductible expense, profit transfers through transfer pricing, profit/loss equalisation over time and within groups etc. If an international perspective is introduced, the problems are exacerbated, and, for example, the principles for handling countries' overlapping tax claims (international double taxation) add further layers of complexity.

The extensive theoretical analyses required to establish the tax base can verge on the unreasonable, as can be seen, for example, in questions of how income and expenditure are to be allocated over time. If, in addition, cross-border business transactions and a number of national tax systems are involved, differing allocation rules may lead both to double taxation and to complete tax exemption, and may also complicate or render impossible the deduction of or credit for foreign taxes. Furthermore, fiscal requirements can often conflict with commercial interests, both national and international. This becomes particularly serious when states' interest in preserving their tax bases - i.e. what in reality is a dispute between nations - has a negative impact on companies through double tax demands, litigation costs, uncertainty and wasted time.

The costs of implementing corporate taxation are investigated in Chapter 5. The compliance costs to companies have been examined by NUTEK, among others, and are reported at SEK 2 billion per year. The EU Commission investigated the division of costs by size of company, and reported that the costs to small and medium-sized companies amount to over 30% of the tax paid. The tax authorities' costs in respect of notices, forms, audit procedures etc. have been estimated at SEK 1.9 billion. To this can be added what is probably an even larger sum for legislative work in committees, government departments and Parliament, as well as the court costs of hearing cases involving taxation of business. On top of this, corporate taxation may also be deemed to give rise to costs of several billion SEK through unprofitable investment and lost time in the national economy as well as legal uncertainty, creating a negative attitude towards tax and perhaps even inducing criminal behaviour.

The effect of corporate taxation on investors' yield requirements in making investment decisions on the basis of traditional theoretical structures is examined in Chapter 6. According to these theories, the effect of corporate taxation on yield requirements depends on whether equity is used to finance marginal investment. The assumption that marginal investments are wholly or partly financed through equity implies that a reduction - or the abolition - of corporate taxation would lead to a reduction in the gross yield requirements of foreign shareholders, with a consequent increase in investment in Sweden (provided that foreign parent companies' business in Sweden are not taxed, which neither is the case for most countries). In certain cases, however, the abolition of corporate taxation would lead to the tax base moving from Sweden abroad. The reactions of other countries to unilateral Swedish action are impossible to predict. Countermeasures could mean that the yield requirement would actually rise, despite the fact that corporate taxation had been abolished in Sweden and the tax base exported to other countries as a result.

In Chapter 7, the analysis is broadened to include the macroeconomic effects of corporate taxation. It is established that the underlying assumptions of the theoretical model for an open economy can be questioned on empirical grounds. In practice saving and investment are not mutually independent. This means that the taxation of Swedish shareholders may have greater significance for the size of the capital stock than the strict theoretical version of the open economy model would indicate. This is partly explained by "home bias", i.e. investors' preference to invest in their own country; a feature well supported by a number of empirical studies. Another contributory explanation is that, in practice, all investors - especially foreign investors - lack perfect and detailed information on available investment opportunities.

Accordingly, the analysis of the macroeconomic effects of the abolition of corporate taxation indicates that foreign investors would be very interested in investing in Sweden, whether or not a reform of this type is combined with other Swedish fiscal measures. In the short run, the existence of agglomeration, i.e. establishments within the same area (clusters), and the cost of establishing in other countries are responsible for a certain amount of inertia which means that adaptation takes time.

As far as Swedish investors are concerned, the effect of the abolition of corporate taxation would very much depend on what specific Swedish fiscal measures accompany the move. Swedes would also invest and increase their shareholdings in companies provided that the reform was financed other than through taxes on shareholders. Both Swedish and foreign investment leads to higher salaries. Obviously, the abolition of corporate taxation also involves a reduction in administration for companies, which generates efficiency gains and tends to make enterprise more attractive. If the reform were to be linked to increased taxes on Swedish shareholders, one of the main effects would be a rise in foreign ownership of existing major companies. This would also be accompanied by increased salaries.

An unambiguous conclusion is that the foreign investors are the winners from a reform in which corporate taxation is abolished through the removal of the "tax export" currently charged to them. Swedish wage earners would probably gain from the abolition of corporate taxation, at least if it took place in combination with other fiscal measures to increase the tax on shareholders. If, on the other hand, the accompanying fiscal measures took a different approach, there is some uncertainty as to whether increased gross salaries would outweigh the negative effects of, for example, tax rises and reductions in expenditure that may affect wage-earners. The theory also suggests that whether Swedish investors gain or lose from the reform is largely a matter of how the different generations are affected. An interesting question is the extent to which a reform involving the abolition of corporate taxation would need to be combined with other fiscal measures, and this would be determined in part by the expected effects from the abolition of corporate taxation.

The effects of the abolition of corporate taxation are analysed in detail in Chapter 8, starting from the available empirical studies of investor response among Swedish and foreign investors. From these, effects on shareholder structure and central government finances are estimated. Even if foreign investors are not more sensitive to changes in the corporate income tax than Swedish investors, their large volume still implies that the effects for Swedish economy will be powerful, when they become more interested in investing in Sweden. The response to lowered corporate income tax from foreign investors therefore result in significantly larger effects on the Swedish stock of capital, compared to domestic actors. This implies that total investment in small, open economies such as Sweden's is strongly affected by reductions in corporate taxation.

The analysis shows that the abolition of corporate taxation could be largely self-financing in the long term. It is not, therefore, definite that other fiscal measures would be required. The conditions for this appear to be particularly good when the analysis considers the situation for small and medium-sized companies and large companies respectively. The condition is that profits and salaries rise sufficiently so that taxes on shareholders and wage earners can compensate for the tax shortfall from corporate taxation.

In the short term, it is almost always the case that the public finances are negatively affected by tax reductions. In the longer term, however, new investment takes place, and this means that total salaries rise. Since the tax on earned income is relatively high, an increase in total salaries generates a strong contribution to the financing of a reform of this type. When both profits and salaries rise, not least through increased employment, it appears that a significantly lower elasticity on the part of foreign investors is sufficient for the reform to be self-financing than the available empirical studies suggest. When the analysis is carried out on the assumption that small and medium-sized companies are more salary-intensive than large companies, an even lower elasticity is enough to fulfil the condition that the central government budget balance must not change. This result must be considered in relation to the general insight that the elasticity normally is higher in the long term and not lower. If the elasticity is higher than the level sufficient to maintain the balance in central government finances - as the available studies indicate - then the abolition of corporate taxation would create scope for other taxes to be cut as well.

It is, however, a necessary condition for the analysis that it involves only an isolated reduction of corporate taxation in Sweden, and that other countries do not take any countermeasures when Sweden unilaterally abolishes corporate taxation. Should other countries reduce their corporate taxation rates before Sweden, it can be expected that the effects of a reduction in Swedish corporate taxation at a later date would be more modest.

In Chapter 9, possible problems with abolishing corporate taxation are examined. These include the ability to save through deferral offered by companies (the piggy-bank effect) and the question of the conversion from earned income to investment income. Existing tax laws already include methods of handling these questions. It should, therefore, be possible to deal with the problems, even though the tensions within the existing system may increase if corporate taxation is abolished. The reaction of other states to unilateral action by Sweden is less certain. With the rules currently applied in tax treaties between Sweden and its most important trading partners, the effects of an abolition of corporate taxation would not automatically be neutralised. Nor does it appear that the current CFC rules in other countries would be an immediate threat. However, an assessment of what changes in this respect may come in the future is difficult.

The conclusions from the analysis are given in Chapter 10. The traditional macroeconomic, legal and political arguments for corporate taxation are considered to rest on fragile grounds. The tax can be seen in a context where it affects and is affected by the taxation of salaries and dividends. How the tax burden will finally be allocated among these bases - the incidence - is difficult to assess. In the short term, there are clear indications that investors bear corporate taxation, while in the longer term there is no reason that corporate taxation on the whole should affect the allocation of the results of production between investors and wage earners. The analyses of the economic effects of the abolition of corporate taxation suggest considerable gains for investment, for government finances etc., as was shown in the preceding chapter.

To some extent the abolition would mean that Sweden would lose the corporate tax revenue presently collected from the profits accruing to foreigners. The untaxed profits would, therefore, be distributed tax-free (or at a low rate) to foreign shareholders who are then taxed in their own countries. Since Sweden would not deduct any tax, there would be no tax to set off against tax in the recipient counEnglish try. This loss of Swedish tax revenue to the benefit of the recipient country would, however, appear to be very limited. Among the countries of major economic significance to Sweden, it is only the USA that taxes dividends from Swedish companies. EU countries do not tax dividends from associated companies in other EU countries.

One effect of Sweden completely abolishing corporate taxation would be that Swedish companies would not be able to benefit from Sweden's tax treaties. This would be answered by Sweden introducing a very low rate of tax. The risk of other countries taking countermeasures is assessed to be low, partly because the climate in favour and the understanding of very low corporate taxes or the complete abolition of corporate taxation has increased in recent times.

The crucial question in connection with the abolition of corporate taxation in Sweden is how other countries would react. Historical experience shows that it is likely that a substantial reduction in corporate taxation in one country is seen as an aggressive act aimed at attracting capital from other countries. In the worst case, other countries could introduce special rules aimed at penalising companies investing in Sweden. If a number of countries abolish corporate taxation, however, the effects in terms of inflows of foreign capital would be significantly less for any individual country. The contribution of foreign investors to capital formation in Sweden, and so to the financing of such a reform though taxation of earned income would therefore, shrink. This in turn would place greater pressure on public finance measures such as reductions in expenditure or rises in other taxes. For a country that is left behind, i.e. is left isolated with high corporate taxation, there is a substantial risk of being left in a seriously worse situation. The investment stimulus from an inflow of foreign business capital would disappear.

Provided that the above-mentioned problems can be dealt with, the abolition of corporate taxation would in general hardly give rise to any negative effects that could not be overcome. The positive effects, on the other hand, would be many and almost overwhelming.


2003

The Swedish National report to the IFA Congress 2003 in Sydney

Trends in company/shareholder taxation: single or double taxation?

--------------------------------------------------------------------------------

Branch Reporter Niclas Virin*

1. Company tax rate and tax base

The present Swedish tax system was introduced in a major tax reform in 1990. As regards company/shareholder taxation the most important features of the reform were the broadening of the tax base for companies combined with a lowering of the tax rate and the introduction of a dual taxation system for individuals with a flat rate capital income and capital gains tax.

The reform of company taxation consisted in a broadening of the tax base and a reduction of the tax rate. Earlier there were generous provisions for inventory devaluation and investment fund appropriations. After the tax reform the profit calculation for tax purposes has been based more strictly on the official accounts, i.e. on acquisition or market valuation of assets and liabilities. A new general reservation based on closing balance capital or salary cost (SURV) was introduced but later exchanged for a reservation based on profit or salaries called income allocation reserve (IAR) still in use. The tax rate was reduced from 52 per cent (57 per cent including the effect of a profit sharing tax abolished at the same time) to 30 and a couple of years later to 28 per cent. Estimates indicate that the average effective tax rate before the tax reform had been some 20 per cent but with a large spread over the years and between companies, whereas after the reform it is about 25 per cent. So in practice the tax reform has increased the tax burden on company income and the total revenue from company tax has risen from about 10 to 50 billion SEK. However, even after this rise in tax revenue company tax accounts for only some 5 per cent of total taxes.

Since modern company taxation was introduced in the beginning of the 20th century (except for the income year 1994) Sweden has applied the classical double taxation system, and this was not changed in the tax reform. However, the reduction of the company tax rate from 52/57 to 28 per cent and the introduction of the flat capital income tax rate of 30 per cent, which in many cases meant a reduction of 40-50 percentage points, alleviated the tax burden on distributed company income. Still, the combined effect of company tax and dividend income tax gives a tax burden of about 50 per cent.

Since the 1960s companies have been allowed to deduct about 5 per cent of new issued share capital for ten years after the issue provided a dividend of that size has been paid. Later the time limit was abolished and the right to deduct was enlarged to 10 per cent annually, and the accumulated maximum deduction amounted to the total of the share issue. This limited alleviation of the double taxation remained after the tax reform but was abolished in 1994 when dividend income was exempted from tax. The taxation of dividend income was reintroduced in 1995 but the limited deduction for dividends was not. During 1994 also the taxation of capital gains of shares was alleviated. Only half of the gain was taxed. In 1995 full taxation of capital gains was reinstalled.

The dual system for individuals implies a separation of the taxation of employment and business income from the taxation of capital income and capital gains.

Employment and business income and other income from professional productive activities are taxed at a local tax rate of about 30 per cent (depending on local and/or regional political decisions varying between 29 and 33 per cent). Above a certain limit annually adjusted in relation to inflation, presently around 300,000 SEK (30,000 euro), intended to include some 15-20 per cent of the top income earners, an extra national tax of 20 per cent is introduced. On income above around 450,000 SEK there is a surtax of 5 per cent. The maximum marginal tax rate is thus about 55 per cent. On business income a deductible fee of about 30 per cent is charged. To a certain extent that fee is to be regarded as a tax rather than a fee for pensions, social security, etc.

Capital income and capital gains are jointly assessed and taxed at a flat rate of 30 per cent. Negative capital income and capital gains may offset positive income and gain and a negative net total of capital income and gain may reduce the tax of employment and business income by 30 or, if certain restrictions are applicable, 21 per cent of the deficit. There are a number of restrictions and limitations to the possibilities of offsetting, the most important one being the reduction to 70 per cent of the part of the deficit above 100,000 SEK. So although the system is a dual one there is some interdependence between the two parts of it.

To summarise, the company tax rate was reduced following the international trend towards lower tax rates. Other reasons for the reduction were the distorting effects that a system with a high tax rate had on investment decisions and the locking in of capital in historically profitable companies. The reduction of the tax rate was combined with a broadening of the tax base, one reason for this being the intention to keep the tax burden on the company sector unaffected. The narrow tax base also offered ample tax planning opportunities. Capital taxation of individuals was separated from taxation of working income. The tax rate was decided with regard to expected inflation and equality in the tax burden on working income and capital income and was also in harmony with the tax rate for companies and other legal entities.

2. Nature of company/shareholder tax system

2.1. Dividends

Swedish companies are taxed on their worldwide income. Swedish legal entities are taxed in Sweden due to their registration in Sweden. Foreign legal entities are liable to tax in Sweden mainly for income from permanent establishments in Sweden. Virtually all kinds of income are taxable. Dividend income and capital gains from shares are taxable unless specifically exempted (see below). The tax rate is 28 per cent. Taxable income is calculated according to the official income statement of the annual accounts. The accounting legislation has thus a great impact on the calculation of taxable income and is in fact decisive as regards the distribution over time of accrued income and cost. Only where the tax law prescribes special treatment may the accounts be overruled. There are e.g. special tax rules regarding the reservation for the cost of pension and guarantee commitments. On the other hand, deductions of 30 per cent on balance value of machinery and equipment are allowed regardless of economic depreciation. As mentioned above, an allowance can also be made to the IAR. Every year an amount of 25 per cent of taxable income (before the allowance) can be allocated. The IAR reserve is recaptured on dissolution and must be dissolved after six years.

The fact that dividends and capital gains from shares are regarded as taxable income gives rise to triple or chain taxation of company income. To avoid this where it is regarded as inappropriate, there is a set of rules of exemption from tax for dividend income. Companies (but seemingly not Swedish branches of foreign companies) holding share capital with at least 25 per cent of the voting power of another company are tax exempt for dividends. Even a smaller holding may qualify for tax exemption if the company can prove the need of the holding for business reasons. However, there is no corresponding exemption from taxation of capital gains on qualified shares, so to avoid or reduce chain taxation a company should reduce the value of its shares by a huge dividend before the shares are sold. This may, of course, be difficult when there are several shareholders with diverging interests. Case law also indicates that a capital loss due to excessive dividends that are tax exempt for the shareholder is not deductible. This consequence may be dependent on the fact that the dividend is paid out of profits accumulated before or during the time of the recipient's holding. As mentioned below, capital gains on shares are expected to be abolished for companies by 1 July 2003. Capital losses on shares will then be non-deductible.

Also dividends from foreign companies are tax exempt if the holding meets the same requirements as shares in dividend-tax-exempt Swedish companies. The exemption is, however, also conditioned on the level of taxation of the profits from which the dividend is paid. This condition is normally met if the profits have been taxed by 15 per cent. Normally dividends from companies resident in treaty countries are deemed to be paid out of profits taxed at a level similar to the Swedish one and are thus tax exempt without test. If the fisc can show that there is a systematic attempt to circumvent Swedish taxation foreign dividends are always taxed. If the tax avoidance is regarded to be of limited scope dividends may still be tax exempt.

If the dividend income of shares in foreign companies does not qualify for tax exemption because it does not emanate from properly taxed income but other criteria for tax exemption are fulfilled, the company is entitled to a tax credit of 13 per cent of gross dividend income. This right does not interfere with the right to a credit for tax actually withheld.

If the foreign dividend is regarded as a taxable income then a tax withheld by the source state at payment is regarded as a deductible cost. The value of that right of deduction is, however, only 30 (28 for a company) per cent so there is also a domestic law tax credit system similar to that applied in the double taxation treaties. Foreign taxes may be credited from Swedish taxes on the same foreign income (before tax). As the credit must, however, not exceed the Swedish tax a credit limit must be estimated. However, Sweden applies an overall credit system where all foreign taxes are related to all foreign income (whether taxed in the foreign country or not). If the average foreign tax rate is lower than 30/28 per cent then even an individual tax rate of e.g. 40 per cent can be credited to the Swedish tax amount. If the foreign tax exceeds the estimated credit limit the exceeding tax may be carried forward for three years and then be added to the foreign tax amount. The same rules are applicable to companies and individuals. The domestic credit rules are supplemented by credit rules in about 75 double taxation treaties.

If the dividend income from foreign shares is tax exempt in Sweden but has been taxed in the source state, then the foreign tax will be neither deductible nor creditable. Neither will that income and that tax be a part of the overall estimation of foreign tax and income when calculating the limit for the tax credit.

There is no mechanism for the credit from Swedish taxes on a Swedish holder of foreign shares for taxes levied on the foreign company. However, if the foreign company does not qualify for the qualified legal concept of "foreign company" but only "foreign legal entity", then the income of that legal entity may under certain conditions be taxed directly with the Swedish holder. A "foreign company" is a legal entity that is liable to tax in its country of residence in a way and to an extent that is similar to that of Swedish companies. A "foreign legal unit" is qualified as a "foreign company" if it is resident and liable to tax in some 75 enumerated tax treaty countries unless the foreign legal entity is of a kind that is excluded from protection in a treaty. If the legal entity does not qualify as a "foreign company" then the income of that entity will be taxed with the Swedish owner either if partners of the legal unit are liable to tax in the country of the entity (partnership) or if at least 10 per cent of the share capital or voting power belongs to a Swedish resident (and his relatives and related companies) and at least 50 per cent of the shares or voting power belongs to or is controlled by Swedish residents. Still, according to a formal interpretation of the tax law made by the Supreme Administrative Court a tax credit may not be granted.1

A fundamental prerequisite for the company/shareholder double taxation principle is that dividend payments are not deductible whereas interest payments are. Hence it is important to identify the two items. There are, however, no thin capitalisation rules in the Swedish tax law and it has long since been accepted that family owned companies have reduced the result of the company by salary payments to the shareholders if they have actually been working for the company. In practice this had earlier no importance since capital income was added to and taxed together with working income. After the 1990 tax reform when the dual system was introduced it has become important that only what is in an economic sense interest is treated as interest. The value to the company of a deduction is the same in both cases but the interest income is taxed at a flat rate of 30 per cent and salary income at a progressive rate between about 30 and 55 per cent. However, there are no specific rules about deductibility for interest payments to shareholders but instead rules to tax shareholders for interest free loans from the company. It would be suspected that if the interest rate on a loan from a shareholder were too high that would be treated as a deductible salary cost for the company and taxable salary income for an employed shareholder but a non-deductible dividend had the recipient been an unemployed shareholder.

There is also a set of rules to secure that too large an amount is not treated as capital income (dividend) for shareholders of family owned companies. What is regarded as a surplus is treated as salary income for the shareholder. As the payments are not booked as cost there is no deduction for the company.

On the other hand, there are rules to alleviate the double taxation of dividends from unlisted companies. Only dividends above a certain level are regarded as taxable income for individuals. The basis for the calculation is the acquisition cost for the shares plus the salary sum above a certain minimum level (to exclude "normal" salary cost) multiplied by 70 per cent of the interest on government bonds.

In 1977, when profit sharing bonds were made legal, special tax legislation was necessary to prevent companies from labelling dividends as interest cost. In principle the variable (profit related) part of the interest is deductible if the loan has been publicly issued unless the company is family owned, in which case only interest paid to non-family members is deductible. If the issue was directed to specific buyers the variable interest cost is deductible to the extent that the issue was not directed to shareholders unless the shares were listed. In that case, however, the company must add an amount equal to the capitalised value of the right of preference to buy the loan to its taxable income at the year of issue of the loan.

Further, there is a complicated set of group contribution rules to enable group companies to offset profits and losses. There are also rules to enable group reconstructions without immediate tax consequences through the permission of transfer of assets at book value. The rules have been created in accordance with the rules for exemption of double and chain taxation of dividends so that the restrictions of dividend tax exemption are not circumvented by group contributions. There is also a set of rules to avoid taxation of profit from intra-group share transfers.

Finally, there are arm's length pricing provisions for international transactions. After the 1990 tax reform they include the transfer of shares.

Investment companies and equity funds are taxed for dividend income but are entitled to a deduction for dividends paid out. They are exempt from tax on capital gains. Instead they are taxed for a special standard income of 1.5 per cent of the market value of their share holdings at year-end. Institutions, qualified funds and trusts are exempt from tax on capital income and capital gains, in most cases if they use at least 75-80 per cent of their capital income (interest and dividends but not capital gains) for a qualifying purpose. Pension funds and pension and capital insurance companies are not taxed on their actual income. Instead they are taxed for an income estimated at the market value of their holdings at year-end times the average interest rate of the preceding year on government bonds. The tax rate is 15 or 27 per cent respectively.

Individuals resident in Sweden are liable to capital income and capital gains tax for inter alia dividend and interest income and capital gains on shares and other securities. There is no tax-free minimum amount but dividends and capital gains are taxed from the first SEK. Capital gains are also taxed regardless of the time length of the holding. The tax rate is 30 per cent. Non-residents (including Swedish nationals) are not liable to tax on capital income. Dividends from Swedish companies to non-residents, however, are taxed at 30 per cent according to a special withholding tax code. Also capital gains (except on Swedish real estate) are exempt from tax in Sweden for non-residents. Capital gains on shares and convertible bonds, etc., issued by Swedish legal entities realised within ten years after the individual's emigration are, however, taxable.

A capital income deficit, i.e. higher interest cost than interest and dividend income, cannot be used to offset labour or business income. Instead 30 per cent of the loss may reduce the tax amount on such income. If the deficit is larger than 100,000 SEK only 70 per cent of the tax on the excess amount can be deducted. A capital income deficit of any amount can, however, be deducted from capital gains.

As just mentioned, dividends paid to foreigners are liable to a withholding tax of 30 per cent. The tax rate is reduced to - in most cases - 15 per cent according to double taxation treaties. Dividends paid to companies in EU countries holding at least 25 per cent of the shares and fulfilling the conditions of article 2 of the EU Parent-Subsidiary Directive are tax exempt. The same goes for dividends to holding companies in non-EU treaty countries and countries where the taxation is similar to the Swedish one. Although dividend income may be tax exempt for qualified Swedish institutions (cf. above) there is a withholding tax on dividends paid to similar foreign institutions unless there is a specific agreement between the Swedish and the foreign government. There is no withholding tax on interest paid to foreigners. On dividend and interest payments to Swedish residents there is a preliminary tax of 30 per cent. Normally the institutions making the payments withhold the taxes.

As said in section 1 above, Sweden applies the classical double taxation company/shareholder tax principle. There are no exceptions from the tax liability of resident individuals for dividends from listed companies and there is no right to deduction for companies for the dividends they pay. So the classical double taxation system is totally comprehensive. Sweden has never introduced an imputation system.

The tax system could be described by the numeric example in Table 1.

Table 1

Individual holder Legal entity holder Qualified companya holder Company Company income 100 100 100 Company tax 28 28 28 After-tax company income 72 72 72 Shareholder Dividend 72 72 72 Holder's tax (30/28/0%) 22 20 0 Result Total tax 50 48 28 Shareholder income after tax 50 52 72 a A company qualified for participation exemption, i.e. a more than 25 per cent or a business related holding.

There is no regard to the fact that the distributed income emanates from tax-exempt income except for the case where a company receives such dividend from a foreign company where it has a holding of 25 per cent or more. As indicated above, the company is then taxed for the dividend as ordinary income but is granted a credit for an imaginary tax of 13 per cent.

If the shareholder is a Swedish legal entity the company is not obliged to withhold dividend tax. So the fact that the shareholder is tax exempt does not create any internal problems. If it is a foreign tax-exempt entity full tax (or tax according to double tax treaties or EU directive) is withheld regardless of the recipient being a qualified holder or not.

2.2. Retained earnings and capital gains tax

Companies and other legal entities are taxed at 28 per cent of their worldwide income regardless of whether it is retained or distributed. Individuals are taxed at 30 per cent for capital gains. Taxable income for both legal entities and individuals includes capital gains from shares and any other asset. The tax liability for capital gains is absolute and totally independent of factors such as size or length of time of the holding. There is, however, a set of rules to avoid taxation of profit from intra-group transfers of qualified (more than 25 per cent ownership, etc.) shares. Taxation is triggered only when the shares are sold outside the group - or the shares of the buying company or its parent, etc., are sold. In the meantime the original seller is entitled to a postponement of payment of tax. The rules are applicable on transfers of shares in Swedish and foreign companies but the buyer must always be a Swedish company.

Only qualified legal entities and trusts may be tax exempt - in most cases subject to their distribution of 75-80 per cent of their capital income (interest and dividends) for qualified purposes. Also investment companies and equity funds are tax exempt for their capital gains. Pension funds and pension insurance companies are not taxed for their factual income but are taxed for an estimated standard income. The taxation of a company is not dependent on the status of its shareholders. Companies and other legal entities may deduct capital losses - but only from capital gains. Before 7 December 2001 a capital loss on qualified holdings in shares (more than 25 per cent of business conditioned holdings) was deductible from ordinary income. After that date a net loss on shares is never deductible against ordinary income but can be carried forward. Individuals may deduct a capital loss on shares from capitals gains on shares, and get a tax reduction from salary and business income by 30 per cent of 70 per cent of a net capital loss on shares.

There is also a set of rules for capital gains taxation that corresponds to and supplements those regarding the taxation of dividends/salaries in family companies and partial tax exemption for dividends in unlisted companies mentioned in the previous section.

The following example shows how the tax systems regarding company income, retained earnings, and shareholder capital gains work. The total tax will partly depend on the possibility for a shareholder to offset capital losses. In the example situations are shown where the shareholder cannot (i) and where he can (ii) offset a loss.

Table 2

Company Company income 100 Company tax 28 After-tax company income 72 First shareholder Cost of shares 10 Sale price of shares 82 Individual's income (capital gain) 72 Individual's tax (30%) 22 Second shareholder Cost of shares 82 Dividend 72 Sale price of shares 10 Loss on sale of shares (72) Net position (i) 72 - 70%*72 21 Net position (ii) (capital gains available) 0 Net shareholder tax (i) 21*30% 6 Net shareholder tax (ii) 0 Result for first shareholder Total tax 28 + 22 50 Shareholder income after tax 72 - 22 50 Result for second shareholder Total tax (i) 6 Total tax (ii) 0

There are no special rules to deal with retained company income. The lawmaker has tried to establish a system with as few tensions as possible. The tax rate for companies and the tax rate for capital income and capital gains were initially 30 per cent. Today the company tax rate is slightly lower (28 per cent) but after the system was implemented there have been different taxable income deferral systems (SURV and IAR) creating an effective tax rate of about 25 per cent. The combined company/shareholder tax is around 50 per cent, i.e. about the same as in the second income bracket (30 + 20 per cent). If the "tax" part of the social security fee of about 30 per cent is included the factual tax on income in that bracket is higher. So there is a certain tension in the system in favour of retained income. This situation has been resolved by rules, commonly referred to at the 3:12-rules, that prevent shareholders of family owned companies from taking too large a part of their income from the company in the form of dividends and/or capital gains rather than salary.

Individuals and legal entities liable to income tax are taxed for capital gains on shares and other assets regardless of time or size of their holdings. A governmental committee has suggested that capital gains tax on shares (and deductibility of losses) be abolished for companies.2 A bill is expected to be presented to the Parliament late in 2002 and the new law to be in effect by 1 July 2003. The price for that amelioration for the companies is expected to be a more effective CFC legislation. As mentioned above, the right to deduct capital losses on shares has already been restricted, the reason for that being expected and already observed activities amongst companies to deduct pending losses or even to construct losses on shares before the enactment of the new law.

3. International taxation and company/shareholder taxation

An individual (resident in country A) may face the following possibilities for a portfolio investment abroad. He may (a) invest in a domestic company A which invests in a foreign business (permanent establishment) in country B, or (b) invest in a foreign company in country B which invests in a business in its own country (B), or (c) he may invest in a domestic company with a direct investment (more than 25 per cent) in a foreign company/subsidiary in country B which invests in a business (permanent establishment) in its own country. This section will deal with the tax consequences of these different investment opportunities both from the source-country perspective and the residence-country perspective. A three-country situation where an individual resident in country A invests in a company in country B with a permanent establishment in country C (a conduit situation) is only briefly discussed in section 3.3.

3.1. Dividends

3.1.1. Source-country perspective

A company resident in state A which (a) derives profits from country B (source state Sweden) pays a dividend to a shareholder in country A, or (b and c) a company resident in state B (source state Sweden) pays a dividend to a shareholder resident in state A.

In the first case (a) there is only ordinary taxation in country B (Sweden) of the profit from the business activities of the branch. There is no withholding tax in Sweden for dividends on the ground that it is paid out of profits arisen in Sweden. In the second case (b), i.e. where a company resident in Sweden pays a dividend derived from profits arisen in Sweden (or elsewhere), a tax of 30 per cent will be withheld (portfolio and direct investment) unless there is a double taxation agreement between the country of residence of the company (Sweden) and that of the shareholder. In most cases the tax will then be reduced to 15 or in a few cases 20 or 10 per cent. In only a few cases will the reduction be achieved by a restitution procedure. Normally, however, the reduced tax rate will be applied directly. If the foreign shareholder is a company (c) the tax rate will be reduced on direct investments to 0 per cent if the owner holds more than 25 per cent of the stock and is a resident of most treaty countries or is regarded as a "foreign company" (see section 2.1 above), otherwise to 10 or 5 per cent according to double taxation treaties. Sweden has implemented the EU Parent-Subsidiary Directive, so if the owner is an EU resident company holding more than 25 per cent of the stock also for that reason no withholding tax will be levied.

As indicated above, there are no special rules for dividends paid to foreign tax-exempt shareholders. The withholding tax rate is 30 per cent unless there is a double taxation treaty prescribing a lower rate (15 per cent).

3.1.2. Residence-country perspective

A shareholder in country A (Sweden) receives (a) a dividend from a domestic company which derives profits from a branch in country B (source state), or (b and c) a shareholder resident in state A (Sweden) receives a dividend from a company resident in state B (source state).

3.1.2.1. Portfolio investment

A Swedish resident individual or company or a Swedish branch of a foreign resident or company is liable to tax for all dividend income (and all capital gains) from portfolio investment in shares in domestic and foreign companies. Under domestic law the Swedish tax on foreign income (or gain) (before foreign tax) can be reduced by the foreign tax on that same income (or gain) through a credit mechanism. There is, however, a limitation of the credit amount so that it cannot exceed the estimated Swedish tax. On the other hand, Sweden applies an overall method including all foreign tax and all foreign income (whether taxed in the source state or not), which enables a Swedish taxpayer to absorb all foreign taxes as long as the average of foreign taxes do not exceed 28 per cent (individuals 30 per cent) of total foreign income. If the Swedish tax is too low to absorb the foreign tax the exceeding amount can be carried forward. Alternatively the foreign tax is regarded as a deductible cost.

As mentioned above, there is no regard to taxes levied on the foreign company (underlying tax) when taxing the Swedish holder.

The domestic international Swedish tax law is inspired by the OECD model tax treaty but is, due to the application of the overall credit principle, more generous. Although each treaty considers only income and taxes occurring in the two treaty countries and prescribes limitation of tax credit to the relationship between the countries, domestic law makes overall credit possible. Hence tax treaties do not affect the treatment under domestic law negatively.

There are no special rules for the taxation of dividend income from foreign companies for tax-exempt or potentially tax-exempt resident shareholders. A tax-exempt institution does consequently suffer an extra taxation on foreign portfolio investment compared to a domestic investment if there is a withholding or other tax in the source state. There will be no payback from the domestic tax authorities to the institution of the tax levied in the source state. In rare cases the competent authorities have agreed that the source state abstains from the withholding of taxes from domestic companies on dividends to qualified recipients in the other state.

3.1.2.2. Direct investment

An individual resident in Sweden (a) is subject to worldwide tax liability on dividends from foreign companies regardless of the holding being of a portfolio or a direct investment nature. He will be granted a tax credit for foreign withholding taxes. The same principles and techniques as are applicable to companies will be applicable to an individual. A tax treaty will not affect the treatment negatively. If he (b) has a holding in a domestic company which in turn has received dividends from a direct investment in a foreign company the dividend from the domestic company will be fully taxable and there is no relief from double taxation. This is also in line with the principle of double taxation.

A Swedish resident company (b) is exempt from tax on dividend income from direct investment in shares in domestic and foreign companies. Direct investment implies a holding of at least 25 per cent of the share capital or voting power of another company. Even a smaller holding may according to Swedish tax law qualify for tax exemption if the company can prove the need of the holding for business purposes. As the dividend income is tax exempt there is neither a tax credit for withholding taxes (if any) nor deductibility for the withholding taxes as a business cost.

A Swedish branch of a foreign company (c) is not exempt from tax on direct investment in foreign shares. According to domestic law the branch is entitled to a credit for foreign withholding tax. However, this right to a credit is restricted to cases where there is no double taxation treaty. In a double taxation treaty situation, therefore, dividend income from foreign shares will be regarded as taxable income also when the investment is of a direct nature. As tax treaties normally protect only resident taxpayers from double taxation there is no possibility of relief of double taxation in these cases. The only relief is the general right to deduction of foreign tax as an ordinary business cost.

As is the case for portfolio investments there are no special rules for tax-exempt or potentially tax-exempt resident shareholders receiving dividends from direct investment.

3.2. Retained earnings and capital gains

3.2.1. Source-country perspective

An individual or a company resident in country A (a) sells shares in a company resident in country B (Sweden) or (b) an individual or a company resident in country A sells shares in a company resident in country A which derives profit from country B (Sweden).

Capital gains from the disposal of shares will be taxed in Sweden only if the seller is a Swedish resident individual (unless recently expatriated, cf. above) or legal entity. Business activities, including capital income and capital gains, performed by foreign companies will be taxed in Sweden only if the activities are performed through a permanent establishment in Sweden and the shares have been attributable to the permanent establishment.

3.2.2. Residence-country perspective

An individual or a company resident in country A (Sweden) (a) receives a capital gain from selling shares in a non-resident company or (b) from selling shares in a domestic company deriving profits from country B.

A Swedish resident individual or company will be taxed on his/its worldwide income. That income includes capital gains.

Capital gains on shares in foreign companies and legal entities are - like gains on shares in Swedish companies - taxed as ordinary income for companies (28 per cent) and as capital gains for individuals (30 per cent). According to domestic law provisions a tax credit will be granted if the seller has been taxed for the same gains also in another country if the gains according to the law of that country are regarded as attributable to that country. Normally that would be the country of residence of the company or the country where the company has a permanent establishment to which the gains are attributable.

Normally Swedish residents will not be taxed on retained income of foreign companies or other legal entities. However, if the foreign legal entity does not qualify for the concept of "foreign company" but is regarded only as a "foreign legal entity", then - as mentioned above, section 2.1 - the income of that legal entity may under certain conditions be attributed to the Swedish holder. Capital gains from the disposal of shares in such legal entities are taxable in the same way as are gains from the disposal of shares in Swedish and foreign companies. On the calculation of profit from the disposal no account seems to be given to the (non-deductible Swedish) tax on the current income of the foreign entity.

If tax-exempt shareholders receive capital gains on which tax is levied in the source country no tax relief is possible. Also pension insurance companies and pension funds, which are taxed according to special rules (see above), can get no relief for foreign taxes.

As indicated above, a governmental committee has suggested that capital gains tax on non-portfolio shares (and deductibility of losses) be abolished for companies. A Bill is expected to be passed in Parliament late 2002 and the new law to be in effect by 1 July 2003. When that law is in force no tax relief for foreign capital gains tax will be possible.

3.3. Circular and conduit international situations

A circular investment situation prevails where the income is sourced in the same country (A) as that in which the shareholder is resident but the income passes through a company resident in another country (B). The income of the non-resident company could be derived (a) through a branch of the company situated in the country of the shareholder (A) or (b) through a subsidiary resident in the same country. What consequences will that give? Will such cases be treated in the same way as where the income is derived directly through a company resident in the country of the shareholder?

If the branch is situated in Sweden (a) it will be taxed in the same way as if the branch had been a company. It would, however, not be entitled to rely on Swedish double taxation agreements (the branch is not a Swedish resident unit) but according to domestic credit provisions it would be possible for the branch to get a credit for foreign taxes. Should the country of residence of the company apply Swedish rules, the company would be taxed there also for its foreign branch (Sweden) income. In that case the company would be entitled to credit foreign (branch) tax from the domestic tax on that same income. In that case it may, however, be more favourable that the branch does not ask for a foreign tax credit, because the only effect of that would be that the company in its home country will lose its base for credit for branch taxes because the foreign branch tax is reduced by the credit asked for by the branch. Anyway, the company may have two ways of calculating the space for a credit and can choose the most favourable one. Suppose that the company has an overall loss and hence no tax is levied by the tax authorities in its home country. In that case the branch should ask for a credit for foreign taxes.

A dividend paid by the company in country B would trigger a withholding tax had the company been a resident of Sweden. The tax rate would be 30 per cent unless a reduced tax rate is prescribed in a double taxation treaty. The tax is calculated on a gross basis. If the investor has financed the share holding with a loan and has an interest cost, the basis for the foreign tax credit would (had the investor been a Swedish resident) be limited to 30 per cent times the net capital income. If the net income is zero (after interest cost) there will be no credit at all. In that case the investor would be taxed for an income of zero minus foreign tax. The loss would be deductible from other capital incomes and gains and the final effect would be an extra tax burden of 70 per cent of the foreign tax.

To sum up, under most favourable conditions this form of a circular investment would not trigger tax costs higher than when the investment is made through a domestic company. In practice there would, however, most likely arise extra tax costs due to insufficient absorption of foreign tax.

If the circular structure consists (b) of a foreign company resident in country B with a subsidiary in country A, i.e. the same country as that of which the individual shareholder is a resident, the profit of the activities in country A (Sweden) would be taxed in the subsidiary. A withholding tax of 30 per cent would be levied on the dividend payment to the parent company unless there is a double taxation treaty. In that case the tax rate would normally be 15 per cent unless (which seems to be the case here) the holding is a direct investment (more than 25 per cent of share capital). The tax would then - according to domestic law - be 0 per cent for recipients in EU and most other treaty countries and even other countries if the recipients qualify as "foreign companies". The percentages, 10 or 5 per cent, normally agreed in double taxation treaties have effect only in a few unqualified treaty cases. The dividend income in the parent company, had it been a Swedish company, would be tax exempt unless the income of the subsidiary has been subject to an "unreasonably" low taxation. The dividend paid by the parent company would (if Swedish) be subject to a withholding tax of 30/15 per cent. Finally, the shareholder (if Swedish) would be subject to capital income tax of 30 per cent with the right to a credit for foreign taxes limited to 30 per cent of net income (dividend minus financing cost).

Also in this case under the most favourable circumstances no extra tax would occur compared to the case where the shareholder invests in a domestic company. Otherwise extra costs in the form of withholding taxes will occur on the subsidiary's payment of dividend to the parent company. Still more costs may occur if the individual shareholder cannot fully absorb the withholding tax on the dividend payment to him.

Viewed from the perspective of the country of residence of the company rather than the shareholder, the circular case is an example of a more general conduit situation, i.e. one where the income of the company is foreign source (whether from a foreign branch or subsidiary) and the shareholder is resident in a third country. A conduit investment situation prevails where an investor in country A owns shares in a company resident in country B receiving income from a branch or subsidiary in country C.

According to Swedish tax legislation exactly the same consequences as in the case of circular investment would occur. The fact that the business activities of the branch/subsidiary are performed in another country than that of the individual shareholder is irrelevant.

3.4. Non-discrimination

No situation of discrimination seems to have been observed in the Swedish tax law regarding international taxation arrangements for company/shareholder taxation described in previous sections.

4. International tax planning to relieve company/ shareholder double taxation

International (juridical) double taxation must be distinguished from company/ shareholder (economic) double taxation. The Swedish rules for avoiding international double taxation are very effective. The foreign tax can be credited by means of provisions in the domestic tax law. There is thus no absolute need of a double taxation treaty to avoid or reduce international double taxation. The domestic law applies the same technique to restrict the amount of credit to the actual amount of double taxation as do the double taxation treaties. By implementing an overall method, foreign tax levied at a higher rate than in Sweden can be absorbed if other foreign taxes are levied at lower rates. In fact also tax-exempt foreign incomes are included in the denominator when calculating the average foreign tax rate. The overall method is permissible also when double taxation treaties are applicable.

So in most cases international double taxation can be avoided or at least substantially reduced for Swedish residents.

The Swedish company/shareholder double taxation system seems to be quite comprehensive. There seem to be very few loopholes. The company income is calculated according to approved accounting standards and there are very few exceptions from tax liability. Although dividend income from direct investment in most cases is tax exempt, capital gains from the disposal of shares in related companies are not. Even share buybacks by subsidiaries and liquidation of companies are taxed as ordinary income according to capital gains rules.

Sweden has no thin capitalisation rules. It is possible to inject a high share capital in a foreign subsidiary resident in a low-tax country and finance it by an interest bearing loan. If the interest offsets the tax-free dividend income from the subsidiary tax-exempt income is created in the Swedish parent. Only under certain circumstances could this arrangement be attacked with CFC rules. By this method the first stage of the double taxation system could be avoided. Of course the method can also be effectively applied by a Swedish parent company to absorb deficits in foreign companies.

As capital gains from the disposal of shares are taxable also for companies there is an element of triple taxation in the Swedish tax system. This effect is frequently circumvented by the transfer of shares in subsidiaries to a subsidiary in a foreign country where capital gains are not taxed and then letting the foreign subsidiary sell the shares. It is well known that such transactions have been performed by large Swedish companies, inter alia the state-owned Mail Company and the listed partly state-owned Telecom Company. However, such transactions do not eliminate the double taxation. The company the shares of which have been sold has been or will be taxed in Sweden for the profits that underlie the capital gains from the disposal of its shares, and the shareholders of the former group parent company will in due time be taxed for the dividends made out of the capital gains.

As mentioned before, a governmental committee has recently suggested that the taxation of capital gains from the disposal of shares be abolished for companies. However, such a law is expected to create ample opportunities for tax planning and therefore a reinforcement of the CFC rules has been proposed.

Another governmental committee has in May 2002 proposed alleviations of the double taxation element for family companies.3 It is too soon to have an opinion as to what extent that report will result in substantial changes. There is, however, no intention to abolish the double company/shareholder taxation principle.

5. Discussion and suggestions

As just mentioned, there is presently no political ambition to abolish the double company/shareholder taxation principle in Sweden. The right wing government in the beginning of the 1990s passed a law exempting dividend income from taxation in 1994 but the reform was reversed the following year when the social democrat regime, still in office, returned to power. It must be admitted that the abolition of dividend tax created serious technical problems and a very complicated legislation was needed to block possibilities for misuse and unacceptable tax planning. In part this was caused by the well-founded suspicion that the company/shareholder double taxation principle should be reinstalled after a shift of governments. Because the taxation of capital gains (although halved) was retained it was feared that the new rules would lead to provocatively high dividends. The exemption from tax was therefore restricted in an amendment to 120 per cent of the highest dividend during the company's preceding five years. A complicated law for the taxation of dividends paid out of tax-free foreign income was also needed.

Although there is a general consensus that the conditions for companies and businesses (especially small and medium size businesses) should be ameliorated, very little has happened in this regard during the last decade. It is often said - both by the government and the business community - that the Swedish company and business tax system is "competitive", a strange word to use when characterising a tax. It seems to imply that the tax is an economic resource. Or that according to a law of nature or even a commandment of a superior force there must be a company tax and that Sweden - better than other countries - in some cunning way has succeeded in escaping its grip. In fact a suggestion by the government in 1999 to reduce the company tax rate by 3 percentage points to 25 per cent was rejected by prominent spokesmen for the business society and was never followed up with legislation.

The critique is rather directed against the taxation of dividend income and the complexity of the tax system and other regulations. Also the present system for reservations based on profit is regarded to be complicated and of uncertain economic effect although it can be used as a loss carry-back mechanism. It is expected that it will be abandoned if the tax rate due to international pressure would be further reduced. A general reduction of company taxation or a reduction of the tax rate does, however, not seem probable unless Sweden is forced by international competition.

Lately, Göran Grosskopf, professor of tax law and chairman of Tetra Pak Group, has4 suggested that company taxation be replaced by a system where the companies are taxed only for paid out dividends. In order not to provoke public opinion also dividend income should, according to Grosskopf, be taxed with the shareholders with a right for them to a credit for the underlying tax. A similar idea has recently been adopted by Estonia. Estonia does, however, not tax dividend income so the need for a complicated credit system to conceal the fact that the shareholders do not in reality pay tax on their dividends seems to be overestimated.

For my own part I have during the last decade been arguing in newspaper articles and public discussions for the solution of the problems emanating from the double company/shareholder taxation principle by abolishing company taxation altogether but retaining the taxation of shareholders. I was greatly inspired by Señora Milka Casanegra de Jantscher from Chile at the 1996 IFA Congress in Geneva, where she in her speech at the seminar on the taxation system of the coming century put forward this idea. In fact not only company taxation should, in my opinion, be abolished but also the taxation of individuals' businesses. Only what is extracted from the company/business and available for private consumption or investment should be subject to tax. Although the problems concerning individuals' business taxation are not as great and severe as those concerning company taxation and not involved in the double company/shareholder taxation problem issue, there is in principle as little reason to tax individuals' businesses as there is to tax companies. When I hereafter use the wording company tax I include also individuals' business tax.

It must be made absolutely clear that the abolition of company tax must not be combined with restrictions regarding disclosure of information. There is no intention to create possibilities for tax evasion. Sweden has a long tradition of exchange of information through e.g. double taxation treaties and there is no reason to change that policy if company tax were abolished.

My arguments are founded on three pillars: legality, economy and ignorance of changes in the structure of the modern society.

5.1. Legality

The company tax system is extremely complicated and has to be so because of the complexity of business life. That makes tax a risk of the rule of law. Many tax law concepts lack precision and cannot be identified in practical life. One striking example is the never-ending problem story of transfer pricing. Court decisions are unpredictable. In practice the difference between legal tax planning and criminal tax evasion is sometimes subtle or, as expressed by a leading Swedish newspaper columnist,5 often a matter of "conventional respectability". By abolishing company tax an area of potential (artificially created) criminality would disappear. That would ease the burden on the police and the prosecution of white-collar criminality.

The basis of company tax is the accounts and they are based on and motivated by other principles and interests than taxation. To a large extent the result of a business year consists of estimations of present values of future receipts and payments, i.e. predictions about a future of which we know nothing. A loss during one year may in fact be the consequence of an overestimation of the position for a previous profit year. The heavy losses in the telecom and information industries are striking examples. In the beginning of the 1990s there was also a real estate and bank crash. In all these cases the loss years have been preceded by years with astonishingly high profits. Taxes were paid on these profits. Had the accountants been able to look into the future they should of course have made reservations for expected losses.

Every accountant knows that a correct result may vary substantially; it depends on a lot of more or less subsumed prerequisites and conditions. In a modern economy more and more values consist of intangibles. That makes taxation of company profits still more uncertain and inaccurate. Depending on the valuation of these assets, i.e. an estimation of the future receipts from them - a perfect task for a sibyl - a profit can be shown - and taxed - although at the end of the day the asset proved to be of no value. Recently a number of accounting scandals have been revealed where billions of US dollars have been accounted for as investments, but mistakes need not be criminal to be very large. Still what the future reveals as mistakes have been taxed in the past. At least in countries that, like Sweden, lack loss carry-back provisions this results in heavy overtaxation.

The complexity makes the company tax expensive. The revenue from company tax in Sweden represents only some 5 per cent of total tax revenue but demands highly skilled personnel to manage for the lawmaker, tax authorities, courts and the companies. The taxation is paid in arrears and often demands audits or other forms of in-depth investigation. Some 60 or 70 per cent of the income tax rules concerns business and company tax and the same proportion of the resources can be expected to be spent on its administration. Salary income and payroll taxes, on the other hand, account for 50 or 60 per cent of total revenue and are collected automatically and at the same time as the salaries are paid out. There are large sums to be saved or even gained on clever company tax planning. It is amazing - or to some people's horror and others' admiration - to see the ongoing struggle over the company tax base. In what other area of legal practice is the artful and deliberate circumvention of the law so respectably established?

5.2. Economy

Business and company taxation is not necessary to prevent any part of the economic flow escaping taxation. I believe most people regard company income as comparable to household income. It is not! Company income is an indicator of the value of created capital whereas household income is a factor remuneration. Probably many people also imagine that if company income were not taxed then money would disappear in a black hole in the economy. That also is a misconception. The base for company tax is new capital created for the single purpose to broaden and strengthen the base for future economic wealth and progress. Nobody can consume company income. In fact, I would prefer not to use the word company "income" but rather "profit" or "capital creation" to distinguish the concept from household income. Household income, on the other hand, is the remuneration for labour and capital efforts, i.e. is an inescapable condition for life. Taxing means that we as individuals are prevented by the state from consuming part of the result of our efforts and forgo it to people who for different reasons have not been in a position to take part in the production process, such as children, students, sick, and elderly persons. The principle of ability to pay tax cannot be applied to a company. A company does not consume for its own sake, and there is no such thing as a "wealthy" company. Paradoxically, from a "humane" and ability-to-pay-tax viewpoint a company can be said to own too much capital (be rich) only if it cannot give its capital a higher yield than the market interest rate. A "poor" company, i.e. a company in need of more capital, is a company with unusually high yield. The company "income" is created only to build up a capital to improve its capacity to earn still more money and to pay still more wages and dividends. Thus the analogy between household income and company profit is false.

Tax amounts not paid by companies will generate more future profits in the company sector that will ultimately be paid out to employees and shareholders and will then (when it can be privately consumed or invested) be taxed as household income. So the initial loss of revenue from company tax will be only temporary and will be compensated by future taxes on salaries and dividends. The taxation of companies means only a prepayment of taxes that will be paid anyway. There will probably be a sudden rise in profits in the company sector immediately after the abolition of company tax but soon the employees and the labour market will be adapted to the new situation and restore the "normal" proportion of remuneration to employees and shareholders. There is no reason to believe that this socially and culturally well-established relation will be permanently changed only because companies cease paying taxes on their profits.

Tax amounts paid by companies and hence not generating more future profits in the company sector will be distributed according to political decisions. Although the need for public expenditure may be urgent you could ask yourself if the withdrawal of real economic resources is the best way of pursuing political goals. When Volvo sold its car division to Ford there was a discussion whether there was a taxable profit rendering a tax bill of 10 billion SEK or not. The Supreme Court decided eventually that there was no taxable profit at all. Apart from the legalistic aspect illustrated by the enormous unpredictability as regards the tax amount - it would have accounted for a quarter or one-fifth of the total company tax revenue for that year -suddenly productive economic resources of that size would have been withdrawn from the business sector.

Company taxation also makes the tax system less transparent. As a customer you do not know if part of your payment is necessary for the company's tax payments. That depends on the profit/loss situation of the company. If the idea of company tax is to hide from citizens what is actually paid in tax I would call it an immorality.

Taxing companies is to tax capital accumulation. Taxing capital accumulation means punishment of effective use of factors of production and - astonishingly - remuneration of economic parasites. Loss-making companies that have spoiled existing (once created by the sweat of people's brows) economic resources do not pay for it. Company tax is counterproductive. It shortens the length of the pole of the pole-vaulter.

Another economic consequence of company taxation is the impact that the taxes have on investment and other forms of important business decisions, e.g. choice of place of business. Not only will the decisions be delayed because aftertax calculations and other tax considerations have to be made but the fact that tax considerations affect the content and quality of the decisions also tends to make them irrational and implies an economic loss of efficiency. So considering this and the high cost of administering company tax and the damage it inflicts on legal security, the abolition of company tax would mean a social and economic advantage. Maybe company tax does not even produce net revenue for the state. The tax actually charged on the companies will ultimately be paid by the individuals. To the extent that a country has an export surplus the country tries to tax the surrounding world. In other words, the abolition of company tax would ameliorate the terms of trade of the country.

5.3. Changed social and economic structure

Now if there are such harmful consequences attached to company and business taxation and if it is in fact unnecessary, why do we still have it in practically every country?

Firstly it is because we have always been used to taxing business. In primitive economies rulers governed their realms by travelling around. They demanded free board and lodging. The rulers also demanded food and other supplies for their castles, for fortresses, transportation, etc. It was big business of that time, i.e. the subordinate rulers, which had to furnish that need, i.e. to pay tax. Political and economic power was united. Private wealth did not exist. Ordinary people lacked knowledge and freedom of most rights. They were salaried only to sustain and normally paid in kind. It was easier to tax the large estates, farms and other businesses than ordinary people.

Secondly I think it is for political reasons. Companies are not allowed to vote. And it would probably be politically difficult to explain why - during a transition period - taxes on salaries must be raised to finance the disappearance of company tax.

But anyway, conditions in a modern economic society are totally different from those where business taxation was the only alternative. Today political power is split from economic power. Capital ownership is split from capital management. Private wealth is obtainable for anybody. Employees are well educated and there is a labour market where they can freely choose their employment and they are paid in cash. Efficient public administration, bank and credit markets and monetary systems make it possible and natural to tax individuals, i.e. those who supply the factors of production and get remunerated for it. The taxes can also be adjusted according to political aims in respect of where to place the tax burden. What was earlier impossible is today possible. What was earlier the only solution is no longer necessary but only harmful. What was earlier a necessary evil is today an unnecessary evil.

6. Conclusion and suggestions

My conclusion is that company and business taxation is harmful, unnecessary and out of date. The best way to solve the problems connected with double company/shareholder taxation is to abolish the first stage of it, i.e. the company tax. If double taxation is to be abolished it must be politically more practicable to create more sound businesses and stable employers and to tax work free income than the contrary. The country that takes the lead in reduction of company tax rates will probably not only reduce its legal and technical problems connected with company/shareholder double taxation but also benefit from international companies' channelling of income through the country. A very low tax may create a very large revenue if many companies are optimising their tax structures. But other countries will follow suit and there will be a race to the bottom. That will bring the Glasperlenspiel6 of company taxation to an end.

For a more comprehensive presentation in English of my thoughts on the merits of the abolition of company tax than is possible within the framework of this report I refer to my article in Tax Planning International Review7 and my comment in the appendix to the CEPS Task Force report on an EU corporate tax reform.8

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* Former Bank Director and Tax Expert, Svenska Handelsbanken; Former Member, Tax Panel of Swedish Industry; Member, The National Tax Law Council of Sweden

1 Supreme Court decision RÅ 2002 ref. 46.

2 "Dividends and capital gains from company owned shares", SOU 2001:11.

3 "Taxation of small enterprises", SOU 2002:52.

4 Corporation Taxation: Some Reflections From a Swedish Perspective, Liber Amicorum Sven-Olof Lodin, Kluwer Law/Norstedts Juridik, 2001.

5 Anders Isaksson, Dagens Industri, 16 November 2001.

6 Hermann Hesse, Das Glasperlenspiel, 1943.

7 Tax Planning International Review, vol. 26 no. 6, BNA International Inc., June 1999.

8 Centre for European Policy Studies, EU Corporate Tax Reform, report of a CEPS Task Force, Brussels, November 2001.


Address to the IFA Congress 2003 (not published)

The Taxation of Enterprises - an Unnecessary Evil

Niclas Virin 2003-08-07

Introduction

The double shareholder/company taxation principle seems always to have raised problems and questions of numerous kinds. Different aspects have been highlighted in a number of IFA congresses - and this year its time again. The double taxation principle creates problems of legal, practical, and economic nature. It affects international division of labour, production, and trade in that the companies have to establish themselves and structure their groups according to tax consequences. That means economic efficiency losses. It creates unintended obstacles but also opportunities for circumvention of the law; there are even possibilities for making financial profit by combining different countries' differing tax systems. International tax planning devices (which often are also applied domestically and in combination) have been developed and have been identified in the national reports to this year's congress. The following - almost frightening list of examples of perverted intellectual inventiveness - is presented in the general report:

a) streaming or trading in imputation credits or other company shareholder tax attributes using classes of shares, stapled shares, debt/equity swaps, synthetic equity, derivatives and other structures that particularly focus on the different tax treatment of resident and non-resident shareholders;

b) double-headed companies which are linked together by an equalisation agreement and give shareholders a choice in which company to invest to suffer the least tax or to gain access to tax benefits that depend on the residence of shareholders;

c) transparent or hybrid entities which are increasingly used instead of the normal company vehicle for investment, especially since the advent of the check-the-box regulations in the US, to avoid double taxation issues, to obtain treaty benefits and generally to reduce tax on international investments by companies;

d) treaty shopping which has long been used to obtain favourable dividend withholding tax, capital gains tax and other tax positions;

e) techniques that play on the borderline between dividends and capital gains such as share buybacks, capital distributions and company liquidation and allow substitution of low or zero taxed capital gains for high taxed dividends;

f) exploiting the different treatment of dividends and capital gains, particularly dividend and capital gains stripping;

g) thin capitalisation which substitutes deductible low taxed interest in a source country for high taxed equity.

Not surprisingly, the general reporter writes, countries have reacted to these devices with a plethora of anti-avoidance rules which often greatly complicate the tax system without solving the underlying problem. In a general sense the problem may be identified as distinctions in tax treatment of similar or swappable situations.

You could question whether the double taxation principle is worth all the problems it creates. Why do we apply a system that the states try to reduce the effects of, and that renders the companies such ample opportunities of circumvention and also need of careful tax planning in order not to be overtaxed? Does it follow from a physical law like the Law of Gravitation?; Or from The Law of Nature in a Lockean sense?; Is it necessary for human existence?; for economic life?; for business reasons? Is it a necessary prerequisite for or unavoidable consequence of the capitalistic or any other social system?

No, as I see it, it is a consequence of inveterate experience, economic ignorance and intellectual (and possibly political) inability to adapt to changed conditions and circumstances. The first element of the double taxation, the taxation of company profit, is superfluous if not harmful. If it were abolished the double taxation would disappear and with it also a number of unnecessary problems and harmful consequences.

Why do we tax business income?

From a national and international perspective company income taxation is becoming more and more complicated and resource consuming. In Sweden 70 - 75 per cent of the tax administration is occupied with business tax matters. About the same percentage, 70 - 75 per cent, of the total wording of the tax law and of the case law accounts for company and business income taxation. Despite this, business income tax accounts for a very tiny proportion of total tax revenue, 5-6 per cent, about 2-3 per cent of national GNP.

One reason behind this development seems to be the continuing growth in complexity of economic life. The aspirations of politicians to monitor and direct business activities seem also to have accounted for much of the complexity. In international taxation the protection of national tax bases has forced countries to introduce transfer pricing and thin capitalisation rules and procedures and CFC-legislation.

The Stockholm Group, composed of distinguished members of the European and North American tax law science, in a paper 18 June 1999, examined the problem with fifteen different European corporate tax regimes as a source of competition between EU Member States for corporate investment, distorting the operation of the single market. Divergent rules offer companies scope for tax planning, further undermining the corporate tax base within Europe. The group proposed the introduction of Home State Taxation to combat this development. The present system is widely expected to create unbearable consequences and obstacles to economic growth. In my opinion it is evident that business taxation - especially in an international environment - will become a dinosaur. Business taxation will simply not keep pace with the changes in business and transaction structures or -worse still - may be an obstacle to necessary restructuring and modernising of businesses and industries.

Something must evidently be done. But nobody attacks the root of the evil. And HST will not be the solution.

I think there is widespread opinion that the existence of business taxation is necessary to prevent a leakage in the macro economic system. The Stockholm Group paper evidently presupposes that business taxation itself is an indispensable part of a comprehensive taxation system. There has always seemed to be a general understanding that business income is to be treated in the same way as household income as regards taxation. I think that this is a misunderstanding based on an ignorance of the economic difference between business and household income.

Secondly it is my belief that the reason why business taxation is unquestioned is the fact that it has been part of the natural order for so long that people don't realise that business taxation is or has developed into an economic anomaly. The social and economic structures of a modern industrialised country are such that what was previously the only rational technique for collecting taxes has now become unnecessary and even economically harmful.

The question can be addressed from at least three different angles. With a judicial, an economic and a social approach.

The judicial approach

In this section I would like to draw attention to some legal and technical problems emanating from the fact that business income is used as a tax basis. I take Sweden as an example. Other countries have their peculiarities, depending, for example, on politicians' endeavours to influence economic life, and to balance the tax burden between the household sector and the business sector or between different groups within these sectors, etc.

To start with: What is company income? As shown below it is to a great extent a matter of forecasting future flows of payments, something we no nothing of. What income is taxable - what income is tax-free? What costs are deductible - and what costs are not? Should taxable income diverge from the official p/l-statement of the company? What provisions for future risks and future cost such as guarantees, pensions etc. are acceptable? Can transactions be performed at non-market prices between close companies? What about taxation periods and loss carry back/carry forward provisions?

There is the question of double taxation of company income. What about taxation of dividends? To what extent should capital gains be taxable? What about group contributions or other group taxation issues, mergers, demergers etc. How and to what extent should double taxation of company income be alleviated? Should it be on the shareholder level (tax exemption, tax credit) or company level (deduction for dividend)?

Different tax systems create problems and opportunities for companies operating in several countries. Because the companies have the advantage of initiative, new patterns of organisation and transactions aimed at tax saving tend to emerge all the time. The lead-time for fiscal counteraction is typically very long.

Transfer pricing rules and Advance Pricing Agreements constitute obstacles and possibilities. The idea of an artificially decided price level can always be questioned. Not only can the company present reliable arguments for most prices within a reasonable range but also some transactions that are performed between close companies will never take place at arm's length distance. A rising part of the value of new products consists of know-how and other intangible assets, which are almost impossible to price.

Other methods to shift tax bases from one country to another are over- or under capitalisation. As there will never be a scientifically correct debt/equity ratio depending on the unique - and continuously shifting - conditions in every company and group of companies, any standard relation will be misleading.

The growing ambitions of the states to protect their tax bases and their endeavours to broaden them and to counteract other countries' efforts create a situation where the companies are temporarily overtaxed until the countries have solved their colliding tax claims. In many cases an over-taxation will never be totally eliminated.

The rule of law may be in danger where we establish concepts and definitions of phenomena that are difficult, and in many instances impossible, to observe in real life. One good example, in depth discussed at the IFA congress in Geneva in 1996, is the concept of permanent establishment. Although it is of paramount importance for a correct taxation it is in practice impossible to draw the perfect border line. Many fanciful examples were discussed in Geneva showing different tax authorities' and companies' differing views of what was and what was not a permanent establishment.

Another example would be the concept "branch of activity" (EG merger directive 90/434/EEC Art 2 (c) and (i)): All assets and liabilities of a division of a company which from an organizational point of view constitute an independent business, that is to say an entity capable of functioning by its own means. In a recent case (C-43/00) the ECJ found that the criteria were not met. Its Swedish equivalent of the rule has been tried in numerous advance rulings by the National Tax Law Board, which has found it applicable in virtually all cases. To my opinion the rule is impossible to apply unless very clear facts prevail or formal criteria are not met. Who would tell that Sony-Ericsson will survive? Depending only on the skill of argumentation something could be classified as inside or outside the border and the performed act classified as legal or illegal or as a case of ignorance or malicious intent.

The legal framework tends to be very complex and the different components of the legislation so incompatible that nobody really can have a grasp of the entire system. This makes the tax system a social and political risk, because neither the tax authorities nor the courts can be consistent. Some taxpayers achieve economic advantages by using tax planning measures that others find illegal or immoral, which distorts competition conditions.

In Sweden the effort to combine current business income with dividend income and capital gains has time and again turned out to be unsuccessful. And how could it be otherwise? It is obvious that the three income items can not be added. They are not part of the same totality. Sweden has at last decided to abolish the taxation of companies' capital gains from substantial holdings of shares. One price for that reform will, however, be an extended and immensely complicated CFC-legislation.

The economic approach

Even the negative consequences described in the passage above must be tolerated if business taxation were necessary in a sense that it follows from a Law of Nature. As mentioned above it does not. And it doesn't follow from any economic law either.

The role of taxes in the economic circuit can be described with the Economic Cirquit (see Home).

H = Household sector, B = Business sector, S = State, L + C = Labour and Capital, W + D = Wages and Dividends, G + S = Goods and Services, P =Prices, I + G = Inheritance and Gifts, W + RE = Wealth and Real Estate, CG = Capital Gains

There is a flow of labour and capital from the household sector to the business sector. In the opposite direction there is a flow of payments for labour (wages) and capital (dividends). The result of the production flows from the business sector to the household sector in the form of goods and services and the payment for it flows in the opposite direction. The purchasing power emanates from the wage and dividend income. The flows of payments and the flows of capital and labour and goods and services are all interdependent.

There is a flow of semi-manufactures round and round in the business sector and a flow of payments in the opposite direction. Successively in this circulation and definitely when the products leave the business sector, profit is created. This profit is used as a tax base in the business income tax system. Part of the profit is distributed as dividends to the shareholders and taxed again. The profits not distributed to the shareholders accumulate to the real values in the business sector. This increase in real values is mirrored in the household sector by a rise in financial wealth, i.e. a rise in value of shares.

A flow of about the same size as salaries and dividends is also used as a tax base if there is a general consumption tax (VAT). The consumption (or a part of it) can also be taxed by way of special goods taxes and excise duties paid by the household sector or the business sector depending on the technique of collection, i.e. tobacco, alcohol, petrol, energy, environment pollution, etc.

Finally taxes are collected in the household sector as a consequence of actions or events there, such as inheritance and gift, possession of wealth and real estate, etc. The bases for these taxes are - unlike all other mentioned tax bases - not inexhaustible. Households are also frequently taxed for the realisation of capital gains, i.e. the accumulation of values created - and taxed - in the business sector.

In this diagram it is easy to see that business income tax is only a surtax on household income tax or rather a prepayment of household income tax. The tax reduces what would otherwise have been paid to the employees or shareholders and reduces thereby the tax bases for salary and/or payroll taxes, and dividend tax. It can also be seen that the abolition of business profit tax would not create a leakage of tax bases. Adding business profits to household factor income gives a sum exceeding the net national product (NNP).

If the business tax were removed, profits would, in the short run, rise and, hence, dividend income for capitalists, but in the longer run the employees would recover what they lost and the long-term ratio between labour and capital income would be restored. There is no reason to believe that this ratio would be dependent on the business tax level. In the short run total tax would probably be reduced but in the longer run the state would recover what it lost by a rise in wage and dividend tax amounts. What the companies paid in taxes was financed by sacrifices made by individuals. After the abolition of company tax the individuals make the sacrifices in the form of tax payments instead of goods prices and reduced salaries.

So nothing would really happen. Except that taxes would disappear as a cost item in the profit/loss-statement of companies and because of that there would be no company tax to administer and no company tax consequences to take into consideration.

Suppose history started with a system without business tax and business taxation were introduced. What would happen? There would be a decline in return on existing capital. Would the shareholders accept that? Of course not! The value of existing shares would decline and restore the long-term expectations and demands of yield. Prices would rise to compensate for the new cost and salaries would fall. In the long run we would be back where we started but there is a new cost item - company tax - in the profit/loss-statement.

However, we would also have been obliged to introduce a special tax code, people would be engaged in interpreting the tax code and trying to avoid its consequences, or trying to enforce it; the police and the courts would be occupied. Businesses must make before and after tax calculations; investment and establishment decisions would be dependent on tax consequences. These consequences would be difficult to preview because it concerns the future and in the future everything may be changed. Even the tax code itself may be changed. The business risk will therefore increase. Risk implies cost and a loss of economic efficiency.

We would encounter the double taxation problem. Different ways to solve the problem create new problems and the need of a complicated regulation.

Why do we tax business profit at all? I think most people believe that it is an indispensable part of a comprehensive economic system. We tax the employee so we must also tax the self-employed person. If we tax the self-employed person we must also tax the company. This is wrong! As long as the assets of a company or a sole trader are not used by the shareholder or the business person for his or her personal consumption, there is no need to tax.

The profit of a business is simply not comparable to the income of an individual. The income of an individual is the counter-value of his or her participation in the production process. The income that the individual receives is the prerequisite for his living. The individual works to be able to live. Part of the remuneration must be left to his or her fellow citizens because they have not been able to take part in the production process: children, students, pensioners, sick and disabled people, etc. That is taxation. And in the long run there is nothing except the production to share.

Corporate income on the other hand is something completely different.

Corporate income is the difference between two estimates of present values of future payments. Each estimate consists in turn of two estimates: inflow of income payments and outflow of cost payments. If there is a positive difference, i.e. the present net value at the second time of measuring is larger than the first one, then there is a profit or, in other words, capital wealth has been created and accumulated. The capital base for future activities has been strengthened. But there is no such thing as a "wealthy company". Only if the company cannot give its capital a higher yield than the market interest rate can it be said to own too much capital, i.e. be rich. So, the principle of ability to pay tax is irrelevant to companies. The company income is created only to build up a capital to improve its capacity to earn still more money and to pay still more wages and dividends. Nobody can eat that capital. A company does not consume for its own sake.

Business valuation today is becoming more difficult as the asset values to a growing extent consist of intangible assets and the intellectual skills of the employees. The asset side of the balance sheet walks out of the enterprise every day. Will it return tomorrow? So, the base for taxing the company is much more uncertain and instable today than it used to be.

As a consequence of good behaviour - the creation and accumulation of new capital - companies are punished by taxation. Loss making companies that destroy existing capital, i.e. economic parasites, don't pay for their protection, access to governmental service or infrastructure at all. The propelling force of economic progress - the specialisation and division of labour - stimulates the birth of new enterprises. As some of them are bound to fail and go bankrupt, the average level of tax on the net profit in the business sector will rise because of this specialisation and division of labour. So, the company tax runs counter to the fundamental process for creation of prosperity!

The false parallel between company income and household income creates a completely absurd consequence in the obligation to pay tax on the formation of new capital. If we started to use the expression "business capital creation tax" instead of "business income tax" we would perhaps realise this absurdity and break the spell of the word "income". The mere idea of taxing businesses for their profits is absurd. It's like shooting yourself in the foot. It's like shortening the pole for the pole-vaulter.

The social approach

If business income taxation is so harmful, why do we have it at all? Why did we ever start taxing business profits? And couldn't any tax system be accused of being harmful? Taxing salaries can be said to reduce peoples' willingness to work, so by reducing wage taxes we would stimulate the supply of labour. It's probably true that all taxes have harmful and distorting effects and that is because they are compulsorily levied on the taxpayer. Even if people realise that there is a need for public consumption and accept being taxed for the financing of it, they are forced to pay for something they wouldn't have bought voluntarily. But to be taxed is to accept the sharing, with somebody else, the value of one's contribution to the total production. And nothing can be produced without the input of labour and capital. To live we need produced goods and services. We are simply forced to work "by the sweat of our brows" to survive. So we have to accept that household incomes such as wages, interest and dividends constitute bases for tax despite possible harmful consequences.

But why tax companies? In some way or other even taxes on companies are carried by individuals. If the companies pay them according to profit, labour cost, turnover or any other factor they pass the tax burden on to the individuals. Companies can - and inevitably do - avoid the burden of the tax, individuals cannot.

This ability to pass on the tax burden to individuals seems to have completely different consequences today than in earlier days when taxing companies was the only possible way to collect taxes.

In those days the power to rule was exercised by an emperor, king, count, governor, etc., by travelling around in his realm enforcing the law, judging, settling disputes, etc. He and his court and his counsellors had their temporary regional and local headquarters in the different palaces, castles and estates of local princes, counts and landowners, etc. They had to feed their master and his suite and escort and give them housing. They had probably also to deliver goods and services to their master's own residence and furnish him with troops, armament etc in times of war and build roads and bridges, etc. and they were responsible for "postal service", transport and security in their domains. That was the taxation technique of that time although they did not use that expression for it.

In those days economy was primitive and consisted mainly of agriculture, forestry and mining and other forms of extraction of natural resources, shipping and trade. To a very large extent trade was performed through barter. Very little capital was accumulated: the harvest was used for consumption and sewing new crops. Serfdom was in practice, if not formally a reality. The workers received (hardly) enough to survive and they received it in kind rather than in cash. If capital was accumulated it was made in the hands of the rulers and their subordinates (and the Church), i.e., in the hands of the entrepreneurs and large enterprises of those days. It would have been foolish to try to tax the workers and ordinary people. There was nothing to collect from them. So there was no alternative to taxing the entrepreneurs.

Today everything is totally different, at least in the developed countries. Money economy prevails; industrialisation has made possible permanent and constant economic growth and thus an unprecedented general accumulation of capital. Anyone can set up a business enterprise. Legal forms for capital investment in joint-stock companies with limited liability exist. You don't need to work for the company you own shares in. Top management doesn't necessarily own shares in the company they work for. Employees are free to change their employment. There is a generally accepted legal framework, efficient administration of national and local authorities, high standard of education, etc. Creation of private wealth is possible and widespread.

Enterprises are no longer symbols and economic strongholds for political power but tools for individuals to create goods and services and to accumulate real capital. It is individuals who decide in what enterprises to invest their capital. The real wealth consists today - as always - of business and private assets, but it is the general public that formally own it and decide what income to take out of it as salaries and dividends.

In a modern economy it is also possible to charge the individuals with tax. What was earlier impossible is today not only possible but also an efficient means of fair individual taxation. The taxation of companies and entrepreneurs not only fails to burden the formal taxpayer but hits the ultimate payer in an unpredictable way. And it is detrimental to the productive capital.

Conclusion

Undoubtedly the abolition of company (and business) taxation would - at least in the short term - reduce revenue. But, as shown in the diagram above, part of the amounts otherwise paid to the treasury as taxes would be paid as wages and dividends and taxed as such. Depending on personal tax rates the net loss of revenue would be much less than the loss of revenue from company taxes. Maybe only half of that loss!

Part of the loss would be compensated by the increase in profitability. The risk would decrease and it would become possible to make investment and establishment decisions without any tax effect considerations. That would give business activities a fantastic stimulus and the companies possibilities to raise wages and dividends.

The need for expensive tax planning, tax administration and control would be dramatically reduced. A number of international tax issues (transfer pricing, permanent establishment, international double taxation) would disappear.

Last but not least: The company/shareholder double taxation problem would disappear.

Ceterum censeo tributum commercii esse delendum

Intervention at plenary session at the IFA Congress 2003

The Taxation of Enterprises - an Unnecessary Evil

Mr Chairman,

Ladies and Gentlemen

My name is Niclas Virin and I am the author of the Swedish national report.

I am afraid that my intervention does not address the questions of this session in quite the same manner that they have been discussed here by the panel, but I was delighted to hear Krister Andersson say that he expects continued reduction of company tax rates.

I have worked with double taxation matters in all my professional life - in the tax administration, as counsellor to one of the leading Swedish banks, and as a member of the National Swedish Tax Law Council giving companies advanced rulings - but the more I have learned the less I understand. And as the time span of my career is almost 40 years by now, my understanding of double taxation is close to zero. My concerns regard rather the fist level of the double taxation - company taxation - than the second - dividend taxation.

It seems to me - and that impression has been confirmed by to-day's discussion - that the only way tried to solve the problems caused by the double taxation has always been by eliminating or reducing the second level of it, i.e. the taxation of dividends. To me that is completely perverted: That means punishing capital creation in the companies by a tax and favouring labour free income by tax exemption. Quite contrary - we should not tax business income, but (possibly) tax dividend income. Thereby we would stimulate capital formation and get rid of a real scourge. Business taxation is - and probably must be - extremely complicated; it gives very little revenue for the states; it is expensive in that it demands high skilled personal efforts for the tax authorities, the companies and the tax courts; it lends itself to very profitable tax planning; and possible over-taxation for companies lacking good advisors. Because of its complexity it also lends itself to unserious activities or even crime.

Company tax also distorts investment decisions and thus causes losses of economic efficiency. It raises the level of risk. Company tax also makes states involuntary co-financiers of companies' investments through complicated tax-driven investments schemes.

And remember! There is no need for business taxation in the sense that otherwise part of the GNP would escape taxation or disappear in a black hole. Because what is not taxed at company level will anyway eventually be taxed as salary or dividend income.

So, why at all do we tax business income?

I think most people, including members of parliaments and law makers, in fact believe that company taxation is necessary for some reason they think is there but they don't really understand. I think they believe that potential taxable bases would disappear if the state did not tax the companies. The mere fact that we call the tax base business income may reveal this misconception: We tax salary and personal capital income so why shouldn't we tax business income? However, business income - or preferably business profit - is not comparable to household income - it is rather the opposite. Business income implies capital formation and accumulation whereas household income is remuneration for factor input and the base for consumption.

We - as individuals - have to work to be able to consume. The part of the production that we don't consume will be saved i.e. invested. Invested in the companies it will be used to enable greater future production and higher salaries and dividends. Something we all strive for. To tax profits will only reduce the companies' possibilities to achieve these goals. Why should we cut off the pole for the pole-vaulter? Why shoot ourselves in the foot?

Taxing companies' profits is to tax capital accumulation. Taxing capital accumulation means punishment of efficient use of factors of production and - astonishingly - remuneration of economic parasites. Loss companies that have spoiled existing economic resources don't pay for it. The company profit tax is counterproductive.

You may object and say: if a country doesn't tax its companies other countries will do. Wrong. In fact, what they do is through CFC-legislation to tax their companies for profits earned by their companies' subsidiaries in a non-tax country. That reduces the profitability of their companies to invest in the non-tax country. But it doesn't reduce the profitability for companies acting in the non-tax country. And if there is no CFC-legislation in the country of the parent company, its companies would be stimulated to invest in the non-tax country, that is create assets in that country and give its citizens occupation and income. Who is against? Taxing profit only raises the minimum level of profitability and discourages investment. Sweden reduced its company tax rate from about 60 % to 28 % between 1990 and 1994.

Today, nobody misses the tax rates between 28 and 60. So, who will miss the tax rates between the present 28 % and zero? Nobody.

But the country will relieve itself from lots of problems: the tax code will collapse into a third or a quarter of its present size; a lot of unnecessary work will not have to be done; the rule of law will be safer because a lot of uncertainties have disappeared. I have a striking example of this. When Volvo sold its car division to Ford there was a discussion in Sweden regarding the tax consequences: Some analysts argued that there was a profit of about 40 BSEK (4 BEUR/USD) causing a tax of about 10 BSEK. That amounts to a quarter or a fifth of total annual company tax revenue. However, in a ruling by the National Tax Law Council we found that taxable profit of the transaction should be zero. The public was confused and I don't blame them. The tax law is complicated and even unpredictable. The ruling was later confirmed by the Supreme Court.

There would be other positive effects of the abolition of company taxation: Investment and company decisions would be based on business circumstances only. (Just think of the tax planning devices to be discussed in this afternoon's break-out session A.) The companies will keep their resources intact. An area of white-collar criminality will disappear.

Now, if company tax puts the rule of law at risk, is very expensive, and for economic reasons is unnecessary and even harmful and probably founded on a misunderstanding of the meaning of the concepts of income and profit, why on earth do we tax business profit?

We do so because we have always done so. In underdeveloped societies the taxation of companies was the only possibility to finance public expenditure. And its disadvantages were not so visible. But changed social, technical and economic structures have made the taxation of individuals possible. In Sweden taxes on salaries, individuals' interests and dividends are collected automatically at the source and at a very low cost.

I think it is time to wake up and realise that business taxation to-day is unnecessary, complicated and harmful but - I must admit - that it is also gives ample opportunities for interesting and sophisticated discussion and analysis. In fact it is an activity very similar to what the great Swiss/German author and Nobel Prize winner Hermann Hesse in his famous novel called Ein Glasperlenspiel. In contrast to his Glasperlenspiel, that had positive elements in developing human thinking, company taxation carries negative elements such as threats to the rule of law, economic destructivity and even criminality. Das Glasperlenspiel takes place around year 2200. I hope that the present game of glass pearls is gone by then. Until then, company taxation is an unnecessary evil.

Thank you Mr Chairman.


1999

The Taxation of Enterprises - an unnecessary evil

Published in TAX PLANNING, International Review, Volume 26, Number 6, June 1999http://www.bna.com/products/tax/tpon.htm

This paper is intended to start a discussion about the raison d'être of business income taxation. For the sake of brevity, I will concentrate on three issues: the complexity and cost of the system, the macro economic reason for business taxation and the change of the social and economic environment that has resulted in business income taxation being out of date.

From a national and international perspective business income taxation is becoming more complicated and resource consuming. In Sweden 70 - 75 per cent of the tax administration is occupied with business tax matters. About the same percentage, 70 - 75 per cent, of the total wording of the tax law and of the case law accounts for business income taxation. Despite this, business income tax accounts for a very tiny proportion of total tax revenue, 5-6 per cent, i.e. about 2-3 per cent of national GNP.

One reason behind this development seems to be the continuing growth in complexity of economic life. The aspirations of politicians to monitor and direct business activities seem also to have accounted for much of the complexity. In international taxation the protection of national tax bases has forced countries to introduce transfer pricing and thin capitalisation rules and procedures and CFC-legislation. Also the concept of permanent establishment has become more and more important. The economic double taxation principle has been widely questioned and most developed countries have abolished it or alleviated its consequences by way of different imputation systems, which has added to the complexity of the company tax systems.

The Stockholm Group, composed of distinguished members of the European and North American tax law science, in a paper 18 June 1999, examined the problem with fifteen different European corporate tax regimes as a source of competition between EU Member States for corporate investment, distorting the operation of the single market. Divergent rules offer companies scope for tax planning, further undermining the corporate tax base within Europe. The group proposes the introduction of Home State Taxation http://ec.europa.eu/taxation_customs/taxation/company_tax/home_state_taxation/index_en.htm to combat this development. This is not the place to question or discuss this very interesting attempt to alleviate some of the inherent problems of business taxation. I mention it here only to note that the present system is widely expected to create unbearable consequences and obstacles to economic growth. In my opinion it is evident that business taxation - especially in an international environment - will become a dinosaur. Business taxation will simply not keep pace with the changes in business and transaction structures or - still worse - may be an obstacle to necessary restructuring and modernising of businesses and industries.

Secondly there is a widespread opinion that the existence of business taxation is necessary to prevent a leakage in the macro economic system. The Stockholm Group paper evidently presupposes that business taxation itself is an indispensable part of a comprehensive taxation system. And there has always seemed to be a general understanding that business income is to be treated in the same way as household income as regards taxation. I think that this is a misunderstanding based on ignorance of the economic difference between business and household income.

Thirdly it is my belief that the reason why business taxation is unquestioned is the fact that it has been part of the natural order for so long that we don't realise that business taxation is or has developed into an economic anomaly. The social and economic structures of a modern industrialised country are such that what previously was the only rational technique for collecting taxes has now become unnecessary and even economically harmful.

The legal framework

Under this heading I would like to draw attention to some legal and technical problems emanating from the fact that business income is used as a tax basis. I take Sweden as an example. Other countries have their peculiarities, depending inter alia on the politicians' endeavours to influence economic life, and to balance the tax burden between the household sector and the business sector or between different groups within these sectors etc.

The taxpayer has to be identified. What income is taxable - what income is tax-free? What costs are deductible - and what costs are not? Should taxable income diverge from the official p/l-statement of the company? What provisions for future risks and future cost such as guarantees, pensions etc. are acceptable? Can transactions be performed at non-market prices between close companies? What about taxation periods and loss carry back/carry forward provisions?

The question of double taxation of company income. What about taxation of dividends? To what extent should capital gains be taxable? What about group contributions or other group taxation issues, mergers, demergers etc. How and to what extent should double taxation of company income be alleviated? Should it be on the shareholder level (tax exemption, tax credit) or company level (deduction for dividend)?

Different tax systems create problems and opportunities for companies operation in several countries. Because the companies have the advantage of initiative, new patterns of organisation and transactions aimed at tax saving tend to emerge all the time. The lead-time for fiscal counteraction is typically very long.

Transfer pricing rules and Advance Pricing Agreements constitute obstacles and possibilities. The idea of an artificially decided price level can always be questioned. Not only can the company present reliable arguments for most prices within a reasonable range but also some transactions that are performed between close companies will never take place at arm's length distance. A rising part of the value of new products consists of know-how and other intangible assets, which are almost impossible to price.

Other methods to shift tax bases from one country to another are over- or under capitalisation. As there will never be a scientifically correct debt/equity ratio depending on the unique - and continuously shifting - conditions in every company and group of companies any standard relation will be misleading.

The growing ambitions of the states to protect their tax bases and their endeavours to broaden them and to counteract other countries' efforts, create a situation where the companies will be at risk to be temporarily overtaxed until the countries solve their colliding tax claims. In many cases a complete over-taxation will not be totally eliminated.

The rule of law may be in danger where we establish concepts and definitions of phenomena that are in many instances impossible or difficult to observe or describe. Depending only on the skill of argumentation something could be classified as legal or illegal or as ignorance or intent.

In Sweden the effort to combine current business income with dividend income and capital gains has time and again turned out to be unsuccessful. And how could it be otherwise? It is obvious that the three income items can not be added. They are not part of the same totality.

The legal framework tends to be very complex and the different components of the legislation are so incompatible that nobody really can have a grasp of the entire system. This makes the tax system a social and political risk, because the tax authorities and courts fail to be consistent, some taxpayers achieve economic advantages by using tax planning measures that others find illegal or immoral which distorts competition conditions.

Business taxation in the macro economic system

Even the negative consequences described in the previous passage must be tolerated if business taxation were necessary in a sense that it follows from a law of nature. It does not. And it doesn't even follow from any economic law either.

The role of taxes in the economic circuit can be described in the following diagram. H = Household sector, B = Business sector, S = State, L + C = Labour and Capital, W + D = Wages and Dividends, G + S = Goods and Services, P =Prices, I + G = Inheritance and Gifts, W + RE = Wealth and Real Estate, CG = Capital Gains

There is a flow of labour and capital from the household sector to the business sector. In the opposite direction there is a flow of payments for labour (wages) and capital (dividends). The result of the production flows from the business sector to the household sector in the form of goods and services and the payment for it flows in the opposite direction. The purchasing power emanates from the wage and dividend income. The flows of payments and the flows of capital and labour and goods and services are all interdependent.

There is a flow of semi-manufactures round and round in the business sector and a flow of payments in the opposite direction. Successively in this circulation and definitely when the products leave the business sector, profit is created. This profit is used as a tax base. Part of the profit is distributed as dividends to the shareholders and taxed again. The part of the value added consisting of labour remuneration is also used as a tax base. Frequently it is used twice: as income tax for the employee as well as wage cost (pay roll) tax and social security contributions from the employer.

A flow of about the same size is also used as a tax base if there is a general consumption tax (VAT). The consumption can also be taxed by way of special goods taxes and excise duties paid by the household sector or the business sector depending on the technique of collection. Tobacco, alcohol, petrol, energy, environment pollution etc.

Finally taxes are collected in the household sector as a consequence of actions or events there such as inheritance and gift, possession of wealth and real estate, and realisation of capital gains etc. The bases for these taxes are - unlike all other mentioned tax bases - not inexhaustible. Some goods tax bases may be exhaustible - namely if the tax rates are so high that the consumption totally ceases. But that is an extreme example.

In this diagram it is easy to see that business profit taxes is only a surtax on household income tax or rather a prepayment of household income tax. The tax reduces what would otherwise have been paid to the employees or shareholders and reduces thereby the tax bases for salary, and/or payroll taxes and dividend tax. It can also be seen that the abolition of business profit tax would not create a leakage of tax bases. Adding business profits to household factor income gives a sum exceeding the net national product (NNP).

If the business tax were removed, nothing would happen but that taxes would disappear as a cost item in the profit/loss-statement of the companies. In the short run profits would rise and hence dividend income for capitalists, but in the longer run the employees would recover what they lost and the long run ratio between labour and capital income would be restored. There is no reason to believe that this ratio would be dependent on the business tax level.

So nothing would really happen.

Suppose history started with a system without business tax and business taxation were introduced. What would happen? There would be a decline in return on existing capital. Would the shareholders accept that? Of course not. The value of existing shares would decline and restore the long run expectations and demands of yield. Prices would rise to compensate for the new cost and salaries would fall. In the long run we would be back where we started but there is a new cost item in the profit/loss-statement.

But we have also been obliged to introduce a legal framework, people would be engaged in interpreting the tax law and trying to avoid its consequences, or trying to enforce it, the police and the courts would be occupied. Businesses must make before and after tax calculations, investment and establishment decisions would be dependent on tax consequences. These consequences would be difficult to preview because it concerns the future. Even the tax law may be changed. The business risk is increased.

We would encounter the double taxation problem. Different ways to solve the problem create new problems and the need of a complicated regulation, tax credit, ACT etc.

Why do we tax business profit at all? I think most people think it is an indispensable part of a comprehensive economic system. We tax the employee so we must also tax the self-employed person. If we tax the self-employed person we must also tax the company. This is wrong. As long as the assets of a company or a sole trader are not used by the shareholder or the business man for his personal consumption there is no need to tax him. As regards the company there are legal restrictions as to how the owner can use company assets for his personal needs. That may not be the case as regards the self-employed, but as long as the assets are kept in his enterprise and balanced as assets in the accounts there is no need to tax the owner. This is purely a technical issue.

The profit of a business is simply not comparable to the income of an individual. The income of an individual is the counter-value of his participation in the production process. The income he receives is the prerequisite for his living. He works to be able to live. C.f. tobacco tax where the consumer can avoid paying the tax by giving up smoking.

Part of the remuneration for his participation in the production process must be left to his fellow citizens because they have not been able to take part: children, students, pensioners sick and disabled people etc. That is taxation. And in the long run there is nothing except the production to share.

Corporate income on the other hand is something completely different.

It is the difference between two estimates of present values of future payments. Each estimate consists in turn of two estimates: inflow of income payments and outflow of cost payments. If there is a positive difference, i.e. the present net value at the second time of measuring is larger than the first one then there is a profit (I disregard capital injections and withdrawals) or in other words: capital wealth has been accumulated. The capital base for future activities has been strengthened. That is - including the capacity to pay wages and dividends - the only purpose of a business. There is no such thing as a "wealthy company". Only if the company cannot give its capital a higher yield than the market interest rate can it be said to own too much capital. The principle of ability to pay tax cannot be properly applied to companies, although some countries in fact have a progressive tax rate also for companies. The company income is created to build up a capital to improve its capacity to earn still more money and to pay still more wages and dividends. Nobody can eat that capital. A company does not consume for its own sake.

Business valuation today is becoming more difficult as the asset values to a growing extent consist of intangible assets and the intellectual skills of the employees. The asset side of the balance sheet walks out of the enterprise every day. Will it return tomorrow?

As a consequence of good behaviour - creating and accumulating new capital - companies are punished by taxation. Loss making companies that destroy existing capital, i.e. economic parasites, don't pay for their protection, access to governmental service or infrastructure at all.

The false parallel between company income and household income creates a completely absurd consequence in the obligation to pay tax for company profit. If we consistently use the expression "business profit" instead of "business income" we may be able to break that spell. The mere idea of taxing businesses for their profits is absurd. It's like shooting yourself in the foot. It's like shortening the pole for the pole-vaulter. The asymmetry created by the introduction of profit taxes increases the business risk.

The social and economic environment

If business income taxation is so harmful, why do we have it at all? Why did we ever start taxing business profits? And couldn't any tax system be accused of being harmful? Taxing salaries can be said to reduce peoples' willingness to work, so by reducing wage taxes we would stimulate the supply of labour. It's probably true that all taxes have harmful and distorting effects and that is because they are compulsorily levied on the tax-payer. Even if people realise that there is a need for public consumption and accept being taxed for the financing of it, they are forced to pay for something they wouldn't have bought voluntarily. But to be taxed is to accept the sharing with somebody else the value of one's contribution to the total production. And nothing can be produced without the input of labour and capital. To live we need produced goods and services. We are simply forced to work "by the sweat of our brows" to survive. So we have to accept that household incomes such as wages, interest and dividends constitute bases for tax despite harmful consequences.

To accept a large public sector is the same as accepting that the government may decide to a larger extent how and by whom the individual's contribution to the production shall be consumed. In some way or other every tax is paid by individuals. If the companies pay them according to profit, labour cost, turnover they pass the tax burden on to the individuals. Companies can avoid the burden of the tax - individuals cannot.

The ability to pass on the tax burden to individuals seems to have completely different consequences today than in earlier days when taxing companies was the only possible way to collect taxes.

In those days the power to rule was exercised by an emperor, king, count, governor etc. by travelling around in his realm enforcing the law, judging, settling disputes etc. He and his court and his counsellors had their temporary regional and local headquarters in the different palaces, castles and estates of local princes, counts and landowners etc. They had to feed their master and his suite and escort and give them housing. They had probably also to deliver goods and services to their master's residence and furnish him with troops, armament etc in times of war and build roads and bridges etc. and they were responsible for "postal service", transport and security in their domains. That was the taxation technique of that time although they did not use that expression for it.

In those days economy was primitive and consisted mainly of agriculture, forestry and mining and other forms of extraction of natural resources, shipping and trade. To a very large extent trade was performed through barter. Very little capital was accumulated: the harvest was used for consumption and sewing new crops. Serfdom was in practice if not formally a reality. The workers received (hardly) enough to survive. If capital was accumulated it was made in the hands of the rulers and their subordinates (and the Church), i.e. in the hands of the entrepreneurs and large enterprises of the time. It would have been foolish to try to tax the workers. There was nothing to collect. So there was no alternative to taxing the entrepreneurs.

Today everything is totally different, at least in the developed countries. Money economy prevails, industrialisation has made possible permanent and constant economic growth and thus an unprecedented general capital accumulation. Anyone can set up a business enterprise. Legal forms for capital investment in joint-stock companies with limited liability exist. You don't need to work for the company you own shares in. The top management doesn't necessarily own shares in the company they work for. Employees are free to change their employment. There is a generally accepted legal framework, efficient administration of national and local authorities, high standard of education etc. Creation of private wealth is possible and widespread.

Enterprises are no longer symbols and economic strongholds for the political power but tools for the individuals to create goods and services and to accumulate real capital. It is the individuals who decide in what enterprises to invest their capital. The real wealth consists today - as always - of business and private assets, but it is the general public that formally own it and decide what income to take out of it as salaries and dividends.

In a modern economy it is also possible to charge the individuals with tax. What was earlier impossible is today not only possible but also an efficient way to fair individual taxation. The taxation of companies and entrepreneurs not only fails to hit the formal taxpayer but hits the ultimate payer in an unpredictable way. And it is detrimental to the productive capital.

How to finance the loss of revenue

Undoubtedly the abolition of company (and business) taxation would reduce revenue. But as shown in the diagram part of the amounts otherwise paid to the treasury as taxes would be paid as wages and dividends and taxed as such. Depending on personal tax rates the net loss of revenue would be much less than the loss of revenue from company taxes. Maybe only half of that loss.

But the need for expensive tax planning, tax administration and control would be reduced. Economic double taxation would disappear, not to talk about triple taxation, i.e. company tax for dividends and capital gains from shares.

A number of international tax issues (transfer pricing, permanent establishment, double taxation) would disappear. Last but not least, it would become possible to make investment and establishment decisions without any tax effect considerations.

Perhaps the best way to finance the company tax abolition would be not to abolish it totally but to lower the tax considerably. Since Sweden reduced the company tax rate from about 60 percent before 1991 to 28 percent in 1994, total company tax revenue has tripled. One explanation for this is assumed to be that Swedish international corporate groups pay their taxes at home and charge their foreign subsidiaries as much as they can without infringing the transfer pricing rules of other countries. Foreign corporate groups are supposed use Swedish subsidiaries as intermediaries in intra-group transactions and leave some of the group profit to be cheaply taxed in Sweden.

Another conspicuous example would be Ireland where inward foreign investment has been favoured with low taxes or tax exemptions, which has taken the country from the bottom to an advanced position in the world wealth league. From 2003 the general company tax level will be 12.5 percent for trading profits.

The Estonian government has recently submitted a bill to the parliament for the total abolishment of company tax on undistributed dividends. The government has an absolute majority in the parliament so the law will enter into force in the year 2000. Poland is successively reducing its company income tax and will reach 22 per cent in 2003. UK has already introduced a tax rate of only 10 percent for small companies.

To derive any international advantage from the lower tax rate you have to be in the vanguard. So as soon as the advantages of a low or 0 rate company tax and the detriments of a company tax system are realized there may be cut-throat competition between the countries and a race to the bottom.

Niclas Virin

• Former Head of Department,
   National Tax Board

• Former Senior Vice President,
   Svenska Handelsbanken

• Former Member of Tax Law Committee
   for Advance Rulings

Niclas Virin

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