An interpretation of tax discrimination in the European Union informed by competitiveness
Mason and Knoll
The ECJ is charged with deciding whether the laws of EU member states violate the fundamental freedoms guaranteed by the TFEU. The ECJ frequently has held that tax discrimination violates those freedoms. Although the ECJ has been aggressive in finding violations, its failure to clearly articulate a guiding principle in tax cases has attracted extensive critical commentary.
We believe the the prohibition of tax discrimination. is informed by the prevention of protectionism (expressed negatively) or the promotion of competition (expressed affirmatively). In other words, the tax-nondiscrimination principle promotes a level playing field between similarly situated economic actors from different member states. Thus, the nondiscrimination principle requires member states to refrain from using taxes to make it more difficult for cross-border actors than for domestic actors to compete for jobs or investments. Thus, we conclude that the ECJ’s interpretation of the fundamental freedoms amounts to requiring what public finance economists call “capital ownership neutrality” (CON).
After arguing that the best interpretation of the tax nondiscrimination principle is that it promotes competitiveness, we then turn our attention to how courts could consistently apply that interpretation. The principle of competitive neutrality involves two major requirements: (1) uniform source and uniform residence taxation (a source tax is uniform if it applies the same way to taxpayers earning income in the jurisdiction without regard to their state of residence; a residence tax is uniform if it applies the same way to all residents of the jurisdiction, no matter where they earn their income) and (2) universal adoption of one of two possible methods of double tax relief (either worldwide taxation with unlimited foreign tax credits or what we label “ideal deduction,” one instantiation of which is exemption of foreign-source income).
Finally, we note that because the ECJ views itself as lacking authority to force all member states to move towards either system of double tax relief, there is no way to achieve competitive neutrality without harmonization as long as some states credit foreign income taxes whereas other states exempt foreign income. Accordingly, as long as the member states employ different methods of double tax relief, we believe the ECJ should interpret the principle of tax nondiscrimination to prevent member states from enacting non-uniform taxes. Such an approach would balance the goal of preventing protectionism, which underlies the fundamental freedoms, with the flexibility states have in designing their own tax systems.