Metodología

changed in order to abolish withholding tax on EU dividends and exempt inbound EU divi- dends. The tax treaties of the Member States need not be changed because tax treaties solely provide authority to mitigate taxation, not to impose taxation. Option 7 would remove both juridical and economic double taxation of cross-border dividends. From an EU law perspec- tive, discrimination of cross-border dividends would be removed. Option 7 would be con- sistent with the approach of the Parent-Subsidiary Directive to eliminate juridical double taxation by abolishing source country taxation and to abolish economic double taxation by way of exemption. Option 7 could potentially cause distortions vis-á-vis the Directive, e.g. that companies might aim at shareholdings lower than 10 per cent if the new rules do not set additional requirements similar those in the Directive. The legal impacts of Option 7 are summarised in Table 4.12.

Table 4.12 Legal impacts of Option 7

Problem France Germa- ny

Ireland Italy Luxem- bourg Nether- lands Spain Sweden UK Simplification of MS’s tax systems

Yes Yes Yes Yes Yes Yes Yes Yes Yes

Practical diffi- culties and new admin- istration No No No No No No No No No Conflict with principle of source- country enti- tlement to tax

Yes Yes Yes Yes Yes Yes Yes Yes Yes

Costs related to the intro- duction of au- tomatic ex- change of in- formation No No No No No No No No No Need to amend do- mestic legis- lation]

Yes Yes Yes Yes Yes Yes Yes Yes Yes

Need to amend Double Tax Conven- tions

No No No No No No No No No

Source: Deloitte survey of withholding tax rates in selected EU countries.

4.8.

S

UMMING UP THE LEGAL IMPACTS OF THE PROPOSED OPTIONS

The legal impacts of Options 2-7 are summarised in Table 4.13. While the UK and Ireland sometimes stands out from the other countries, all other countries (including UK and Ire- land in most cases) are affected similarly by the options. While Option 2 and 7 implies a simplification of Member States’ tax systems, Option 4, 5 and 6 adds practical difficulties and new administration. Option 3 seems to imply neither a simpler or more complicated system. Option 2, 4 and 7 conflicts with the principle of source-country entitlement to tax. Option 5 implies costs related to the introduction of automatic exchange of information. Table 4.13 Legal impacts of Options 2-7

Problem Option 2 Option 3 Option 4 Option 5 Option 6 Option 7

Simplification of MS’s tax systems Yes No No No No Yes Practical difficulties and new administra-

tion

No No Yes Yes Yes No

Conflict with principle of source-country entitlement to tax

Yes No Yes No No Yes

Costs related to the introduction of auto- matic exchange of information

No No No Yes No No

Need to amend domestic legislation] Yes Yes Yes Yes Yes Yes Need to amend Double Tax Conventions No No No No No No

In this chapter we touch upon some of the cross-cutting issues that are relevant for assessing the overall impacts of the proposed options. First, we discuss how impacts on tax burdens differ across investor types. Second, we quantify the impact of reduced compliance costs on the capital stock and on GDP, and we discuss qualitatively how EU investors may respond to the reduced or eliminated withholding taxes. Third, we make a short note on the impacts on third countries. Fourth, we evaluate the internal market impacts of the proposed options and discuss how a reduction of withholding taxes may impact on incentives. Fifth, we carry out a sensitivity analysis of the main assumptions in our model. And, finally, we make an overall evaluation that brings together the main aspects of the proposed options.

5.1.

I

MPACTS OF THE PROPOSED OPTIONS ON DIFFERENT INVESTORS

Current tax liabilities on cross border dividend flows are not evenly distributed across differ- ent types of investors, cf. Figure 5.1. It is CIVs that carry the main burden since such in- vestment vehicles very often face double taxation due to the fact that withholding tax levied abroad cannot always be credited in the tax to be paid in the residence country. The income tax paid by individuals (who are the ultimate owners of the portfolio equity investment) is also taken into account.

Figure 5.1 Distribution of current tax liabilities from cross border dividend flows on in- vestor type

Note: Data is from 2009. Source: Copenhagen Economics.

We find that all the options reduce the tax burden of investors but that the impact differs across investor types, cf. Table 5.1. Since the different options aim to remove or reduce withholding taxes, the investor groups that will gain the most in per centage of their total tax payments from such options are the investors paying the most in withholding tax relative to

Individuals 19% Non-financial companies 3% Insurance companies and pension funds 21% CIVs 40% Bank and other financial institution

their income dividend taxes. Since households in general are charged a relatively high divi- dend income tax, they do not gain as much in per centage from reducing withholding taxes. On the other hand CIV’s, which pay (almost) all their dividend taxes through withholding taxes (income dividend taxation is zero for CIV’s in almost all countries) get a comparatively higher reduction in their total tax burden. We note that a reduced tax burden of CIVs, bene- fit the ultimate owner such as regular stock holders.

Table 5.1 Change in tax burden of investors (compared to the current situation)

Investor type Option 2 Option 3 Option 5 Option 6 Option 7

Individuals -10% -9% -5% -10% -100%

Non-financial companies -16% -14% -8% -53% -100%

Insurance companies and pension funds -50% -47% -23% -83% -100%

CIVs -100% -99% -47% -100% -100%

Bank and other financial institution -28% -27% -13% -69% -100%

Total change in tax burden -46% -45% -22% -65% -100% Source: Copenhagen Economics.

5.2.

M

ACROECONOMIC IMPACTS OF THE REDUCED COST OF CAPITAL

The reduction or elimination of withholding taxes has an effect on capital flows within the EU from at least two different channels. The first channel is through a reduction in the cost of capital within the EU due mainly to the reduced tax burden facing EU investors, but also due to a reduction in compliance costs. The reduced cost of capital will stimulate capital in- vestments, and the larger capital stock will have a positive impact on GDP through a higher investment level. The second channel is related to how the lower WHT rates make portfolio investments within the EU more attractive, which may give investors an incentive to down- scale their other investments (substitution effect). Capital may therefore be drawn from oth- er investment location or other investment products. The two impacts are described in more details in the following section.

Impacts of reduced costs of capital on GDP

Compliance costs and the tax burden related to withholding taxes are reduced or eliminated under the different options. The tax burden, and to a lesser extent, compliance cost consti- tute a real burden and expense on investors, and their reduction or elimination is therefore likely to lower the cost of capital. When the cost of capital is reduced, the amount of capital available for investments is likely to increase, which will stimulate GDP. In this section we make an attempt to quantify the extent to which each of the options reduce the cost of capi- tal and the macroeconomic effects that can be expected to follow.

We base our calculations on the European Commission FISCO study from 2009. The methodology can be described in four steps:

1. By how much will the cost of cross-border investments be reduced when withhold- ing taxes are reduced or eliminated?

2. By how much will capital costs be reduced when the cost of cross-border invest- ments are reduced?

3. By how much will the capital stock increase when capital costs are reduced? 4. By how much will GDP increase when the capital stock increases?

The FISCO study finds that simplifying the withholding tax relief procedure implies a re- duction in the cross-border cost of capital by 0.35 per cent. Under the assumption that 80 per cent of new real investments are financed by retained earnings of companies, the FISCO study finds that the cost of capital will be reduced by 0.07 per cent, when the cross-border cost of capital is reduced by 0.35 per cent. Based on the empirical finding that when the cost of capital is reduced by 1 per cent, the capital stock also increases by 1 per cent, the study finds that the capital stock increases by 0.07 per cent. And, finally, since 40 per cent of GDP is created by the capital stock, the ultimate change in GDP will be equal to 0.028 per cent (equal to €3.4 billion per year). Details of the calculations can be found in Box 5.1. Box 5.1 Detailed description of the FISCO method to calculate macro impacts

We use the example from the FISCO report to illustrate the methodology.

The study identifies three sources of costs related to withholding taxes on dividend and interest payments between EU Member States (including also payments to non-EU countries):

i. Liquidity costs due to delayed claims and payments of tax refunds amount to €1.84 billion per year. ii. Foregone tax relief due to investors who do not claim their tax refunds amounts to €5.47 billion per

year

iii. Administrative costs related to the reclaim procedure amount to €1.09 billion per year

The total value of the three components is given by €8.40 billion. The study then assumes that 90 per cent of all cross-border investments are affected (cases where withholding taxes are not already eliminated due to a bilateral DTT between the source and the residence country), the value is reduced to €7 billion per year. Furthermore, only 25 per cent of the holdings are related to portfolio investments in which case the cost re- duction potential is reduced to €1.89 billion.

The total amount of dividend and interest payments is €547 billion per year. A full elimination of the three cost components implies a reduction in the cross-border cost of financing of 0.35 per cent (€1.89 billion as a share of €547 billion).

According to the empirical cross-country study of Corbett and Jenkinson (1997) based on data from 1970- 1994, around 80 per cent of new real investments are financed by retained earnings of companies.58 _{For this}

reason the estimated impact on the cost of capital would amount only to 0.07 per cent (20 per cent of the 0.35 per cent).

Using their macroeconomic model they find that when the cost of capital is reduced by 1 per cent, the capi- tal stock increases by 1 per cent (elasticity equal to -1). This suggests that the 0.07 per cent reduction in the cost of capital increases the capital stock by 0.07 per cent.

Furthermore, estimates from Ratto et al. (2004) show that 60 per cent of GDP is due to labour input and 40 per cent is due to capital input. This means that the 0.07 per cent increase in the capital stock will ulti- mately raise GDP by 0.028 per cent (40 per cent of the 0.07 per cent). With GDP in the current year reaching €12 trillion, this value leads to an estimated increase of €3.4 billion per year.

Source: Copenhagen Economics, the European Commission (2009) FISCO study and Corbett and Jenkings (1998) and Ratto et al. (2004).

58 _{For similar conclusions, see Mayer (1988), Rajan and Zingales (1995), Corbett et al.( 2004) and van Treck}

We have used this methodology to quantify the macroeconomic impacts of the proposed op- tions. Let us use Option 2 as an illustrative example of how the effect on GDP is calculated. In Option 2, we find that the total reduced cost of cross-border portfolio equity investments is €3.7 billion (including reduced tax burden, quantifiable compliance costs and liquidity costs). Taking this as a share of total capital costs (dividends on all equity investments and interest payments, which amounted to €547 billion according to FISCO) it results in 0.7 per cent.59

The reduced cost of cross-border portfolio equity investments translates into a 0.14 per cent reduction in the cost of capital and hence an increase in the capital stock of 0.14 per cent (with an elasticity of 1). Consequently, we find that EU GDP increases by 0.05 per cent due to the reduced cost of capital. The results for the other options can be seen from Table 5.2. We note that our quantification of Option 6 excludes the reduced tax burden from crediting corporate taxes in the source country, since we do not find the FISCO methodology suitable to quantifying impacts of such changes. Moreover, in Option 7 we only consider the tax burden reduction from reduced WHT rates. We do not consider the reduced tax burden that comes from eliminating residence taxation. Option 7 therefore resembles Option 2, where withholding taxes are fully eliminated.

Table 5.2 Impact on GDP from a reduction in cost of capital

Impacts _{Option 2 Option 3 Option 5 Option 6 Option 7}

1. 1. 1.

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