An overview of the main issues that emerged at the fourth meeting of the subgroup on assets (SG1)

EUROPEAN COMMISSION DIRECTORATE-GENERAL TAXATION AND CUSTOMS UNION Analyses and tax policies Analysis and Coordination of tax policies Brussels, 19 May 2006 Taxud E1 MH/FF CCCTB\WP\032\doc\en Orig. EN COMMON CONSOLIDATED CORPORATE TAX BASE WORKING GROUP (CCCTB WG) An overview of the main issues that emerged at the fourth meeting of the subgroup on assets (SG1) Meeting to be held on Thursday 01 June 2006 Centre de Conférences Albert Borschette Rue Froissart 36-1040 Brussels WORKING DOCUMENT B-1049 Bruxelles / B-1049 Brussel - Belgium. Office: MO59 04/091. Telephone: (32-2) 299.11.11; direct line (32-2) 298.40.07. Fax: (32-2) 295.63.77. E-mail: taxud-e1@ec.europa.eu 1

I. Background information and purpose of the document 1. The purpose of this note is to give a brief overview of the main issues that emerged at the fourth meeting of the subgroup on tax depreciation of assets (hereafter SG1), and to steer the discussion on those on which the SG1 sought more guidance from the plenary. 2. The fourth meeting of the SG1 was organised on 3 and 4 April 2006 in Berlin by Germany. Austria, Cyprus, Czech Republic, Denmark, Finland, France, Germany, Italy, Luxembourg, The Netherlands, Poland, Romania (as an observer) Spain (only the first day), Sweden and Commission Services attended the meeting 1 and Germany chaired it. Four issues were discussed: financial assets; leases; intangible; and other issues. 3. Before the meeting, four room documents were circulated, one prepared by the chair on the tax treatment of leases and three prepared by the Commission Services (CCCTB\SG1\008 summary of responses on financial assets; CCCTB\SG1\009 points for discussion financial assets and CCCTB\SG1\010 points for discussion intangible assets). The discussions of SG1 followed the order of the room documents prepared and annotated by the Commission Services and of the power point presentations prepared by the chair. 4. As in the past, the Chair of the SG1 prepared the Report on the results of the fourth meeting, which gives an overview of the discussion and views expressed by the members of the subgroup. The SG1 being a technical group, the conclusions contained in the report represent a contribution by the sub-group to be discussed at the main working group and offered as assistance to the Commission in formulating any subsequent formal proposals. II. Key discussion points Financial assets 5. As regards realised financial capital gains/losses, it seemed to be agreeable that they should be in principle respectively - fully taxable/relievable following the same rules as 'non-financial' assets. Such gains/losses have the same nature as 'ordinary' income and the method for calculating gains/losses can also be the same (i.e. the difference between the consideration received for the asset and its tax value). Although it is not necessary to treat them as separate item of income (i.e. 'ring-fenced') some kind of anti-avoidance rules may be envisaged 2. 1 1 In common with all CCCTB Working Group documents references to 'Member States considered that ' etc refer to the comments by experts from the various Member States administrations and do not represent a formal position of a Member State. 2 For instance, it could be envisaged that losses can only be off-set by gains of the same nature. 2

6. As regards unrealised financial capital gains/losses, it seemed to be agreeable that they should be in principle not relevant for tax purposes, except for certain items (referred to as liquid asset, or current assets, or held for trading assets). However, a definition of such assets should be drawn (some MS suggested making use of the IAS definition) 3. Another possibility would be to draw a list of such assets. Some MS raised again their concerns about the potential distribution of untaxed profit to shareholders in cases where unrealised gains were recognised for accounting purposes and distributed to shareholders without having been taken into account for tax purposes ie untaxed profits being distributed. The Commission Services suggested that in accounting such profits would presumably be reduced by the recognition of a deferred tax charge thereby reducing if not removing the problem. However, a few MS remain concerned as such a deferred tax charge would not alter the fact that a company might, in the their jurisdiction, distribute profits on which no tax had been paid to the administration. The Commission Services remains convinced that the issue of which profits may be distributed is a matter for Member States and as practices differ across the EU it does not seem possible, or desirable to include such rules within the CCCTB rules. 7. As regards a possible, asymmetric treatment of unrealised gains and losses, the same positions that emerged during the discussions on 'ordinary' assets were presented. In this respect, financial assets were not considered to deserve a special treatment compared to other assets. Therefore, once the decision is taken whether taking a symmetric or an asymmetric approach towards unrealised gains and losses, this approach should apply to all assets. 8. As regards participation exemption (exemption from taxation of capital gains on 'qualified' participations), it seemed to be agreeable that it should be granted to avoid economic double taxation 4 and to improve the attractiveness of the tax environment. It was agreed that certain requirements should be fulfilled, possibly along the lines of the Parent/Subsidiary Directive (minimum threshold ownership, minimum possession duration, etc.); however no decision was taken on such requirements. 9. Given the similarities between participation exemption and dividend exemption, the two issues were dealt with together. The following four situations were discussed: (i) intra CCCTB group; (ii) between two CCCTB groups; (iii) inbound (from non CCCTB to CCCTB) and (iv) outbound (from CCCTB to non CCCTB). It was generally agreed that intra-group situations were a non-issue, as they would disappear with the consolidation. It was also noted that providing a different treatment for dividends and capital gains depending on whether the underlying company applies CCCTB rules or not could raise non-discrimination issues. As 3 IAS 39, paragraph 9 classifies as held for trading assets which are (i) acquired principally for the purpose of selling them in the near term; (ii) part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent or actual pattern of short-term profit taking; (iii) a derivative (except hedging instruments) 4 The participation exemption avoid double taxation because the increase in value of shares is linked to undistributed profit already taxed or to the expectation of future profit, which will be taxed in the future. 3

regards outbound situation, it was mentioned that the discussions (some of which would also be discussed by SG4) could go much beyond the scope of the CCCTB as they could include withholding taxes and taxation of shareholders. However, some form of common approach would be necessary; otherwise MS would start tax competition (for example if one or few MS had no withholding taxes on outbound dividends, tax planners would arrange their business structures accordingly (forum shopping). 10. The following issues - which were mentioned in connection with participation exemption require further analysis from the Group: (i) the treatment of expenses correlated to the exempt income (such as interest paid to borrow money used to purchase shares that benefit from the taxation exemption regime); and (ii) possible anti-avoidance measures to contrast tax planning (such as assets sold in the form of shares to benefit from the exemption). Nb this issue was also touched upon during the recent Sub-group 3 meeting and the papers relating to that meeting also contain some information relevant to the wider discussion in this Group. Leases 11. It was chosen to discuss leases to show how a general definition of economic ownership such as the one previously discussed by the group would need to be accompanied by more detailed clarifications for specific cases. Some MS mentioned the risk that the 'economic owner' approach could attribute an asset to two different entities due to different qualifications, thus having two tax deductions (double-dip situations). However this could be avoided by introducing anti-avoidance rules, such as that an asset should be depreciated by only one entity (this is without prejudging final position of the group on the more general issue of economic ownership). 12. IAS 17, paragraph 10 contains factual situation which qualify the lease as a financial lease, meaning that the leased asset should be attributed to the lessee as the economic owner although the legal property still belonged to the lessor. In addition, IAS 17 paragraph 11 lists further situations that could guide the prepares of the accounts in deciding whether the assets should be attributed to the lessor or to the lessee. However, the main criterion for distinguishing between financial and operating lease (thus for the asset to be recognised by the lessor or by the lessee) is the substantial transfer of all the risks and rewards incidental to ownership of an asset (IAS 17.4) and the situations in IAS 17.10 and 17.11 are only indicators. 13. The various criteria were discussed in depth and found to be useful although not decisive, in particular those descriptive criteria such as 'the major part of the economic life' and the specificity of the asset. The criteria should be kept as simple and flexible as possible, also bearing in mind that there would be litigations with tax authorities anyway. 14. Once decided who is entitled to recognise the asset and depreciate it, IAS 17 provide guidance on measurement of depreciation allowances and on financial costs linked to the lease. If the lessor recognises the asset (this would be the case of an 4

operative lease) and depreciates it, s/he also accounts for the lease payments as income, while the lessee can deduct the lease payments as expense. On the other hand, if the lessee recognises the asset (this would be the case of a financial lease) s/he would also recognise a liability for the payments to be done to the lessor. S/he depreciates it, but accounts for the lease payments as partly to decrease the payable and partly as interest expense (as if s/he had borrowed money to purchase the asset). On the other hand, the lessor should recognise a receivable and the lease payments should be partly used to decrease the receivable and partly as income. This approach is agreeable but raises some concerns as regards how to apportion the payment among interest and repayment. Intangibles 15. Since this topic had been already dealt with in the past, the discussions focussed on the following points: 16. Definition. The definition of asset already elaborated by SG1 could apply to intangible, too, but should be accompanied by a non-exhaustive list of intangibles and possibly some guidance (as it happens in MS with administrative circulars and the like). 17. Internally generated intangible assets. It was generally agreed that neither internally generated goodwill nor other internally generated intangible assets should be recognised, as it would be difficult to itemise the expenses linked to the research and development 5 of such intangibles and to distinguish them from the overhead costs for the running of the business as a whole. Those MS which would favour an option for capitalising internally generated intangible assets and start-up costs admitted that a system of unlimited carry-forward of losses would eliminate the risk that some costs would be de facto non deductible due to the absence of income in the first years of research and development. 5 Although as regards development costs this would be a deviation from IAS 38 (which allows capitalising development costs under certain conditions), this would represent a major simplification for taxpayers and tax authorities. 5

18. Acquired intangibles. As regards acquired goodwill, it seemed to be agreeable that its recognition and its amortisation during a period of time in the range of 5 to 20 years could be allowed. For other acquired intangibles the example prepared by the Commission Services 6 provoked some discussion. The prevailing view seemed to be that there were very few circumstances were an acquired intangible would be treated as an asset which should be depreciated. If the acquisition resulted in rights which were limited in life (as in the example with a five year patent licence) then no asset as such had been purchased and it was simply a question of how to spread the initial payment over the life of the patent. Similarly, when there is a separation between the right of property and the right to use an intangible (such as a software licence) the right to use an intangible should not be capitalised but the related expenses should be spread over a number of tax years. The Commission Services would like to confirm within the wider Working Group that this approach is generally accepted particularly for example, with the example of major software purchases where the life of the licence is infinite and depreciation over the useful life would seem more appropriate than a spreading of costs or royalties over an arbitrary period of years. 19. Finally, the possibility to depreciate intangible assets in pool was mentioned, although some of the MS who favour the pooling method of depreciation for tangible assets would prefer an individual method for intangible assets Other issues 20. The following issues were covered (very briefly though): assets used partly for business, partly for non business purposes; subsequent expenditure on assets; special rules for depreciation in certain activities (such depletion in case of mines) and capital gains on current assets. Some of the issues are related to the work carried out or to be carried out by SG3 (business purpose test current assets) and 6 SG1/010 Points for Discussion Intangible Assets, para 12 Example: A) A company purchases a patent for 5 years. According to the contract a company is obliged to pay a royalty of EUR 2000 a year plus 0.05% of their turnover. A company is only allowed to manufacture a product based on the patent, it cannot be sub-licensed. B) A company purchases a patent for 5 years. According to the contract a company is obliged to pay a premium of EUR 5000 and royalty of EUR 1000 a year plus 0.05% of their turnover. A company is only allowed to manufacture a product based on the patent, it cannot be sub-licensed. In which situation would a company recognise an intangible asset for tax purposes? The difference between the two situations is in payment arrangements, A) has an annual payment whereas B) has an initial payment, followed by lower annual payment, an overall costs are the same in A) and B). What other information / characteristics of the situation is material from a corporate income tax point of view to decide whether an asset should be recognised and depreciated. Would it be different if a company was allowed to sub-license the patent to other companies? 6

should be further developed there. The most favourable option would be a test which allow companies to deduct expenses linked to assets only insofar as they are related to the business, and in case of partial use the deductibility would be partial as well (for example an asset that serves the company for at least 50% of its value say 60% - would be deductible for the 60% of its cost); although some MS consider that there was a kind of 'presumption of business purpose' for assets purchased by a company. 21. As for subsequent expenditure, the general criteria that they should represent an extension and enlargement of the original asset in order to be depreciated and not a simple maintenance, repair was agreed. Some MS mentioned that there should not be a minimum threshold as a decisive criterion. 7

SUMMARY AND PRELIMINARY CONCLUSIONS As regards financial assets, discussions on financial capital gains and losses have been fruitful and the subgroup has identified common approaches in several areas. However further work has to be carried out for specific aspects, such as anti-avoidance rules, unrealised capital gains and participation exemption. The discussion and analysis done by the subgroup will represent a valuable input and starting point for further work done by Commission Services. As regards the other issues discussed by the subgroup (leases, intangibles, other remaining issues) here again the Commission Services have gathered very fruitful information, although additional work and discussion remains necessary as outlined above. An updated summary table of progress to date is annexed for discussion. 8