In this article we will discuss about the treaty of European union.

Introduction to Treaty of European Union:

Several European countries established a common market under the Treaty of Rome (effective from 1958). This European Economic Community was eventually superseded by the Treaty of European Union (also called the Treaty of Maastricht or EC Treaty), which entered into force in November 1993 to create a single European Community (EC).

One of the main objectives of the Rome treaty was to eliminate internal trade and tariff barriers and create a Single Market. The EC Treaty established a single economic and monetary union based on the four fundamental freedoms that guarantee free movement of goods, persons, services and capital under the Single European Act of 1987. As from May 1, 2004, the European Union comprises of twenty-five Member States.

The EC Treaty contains several provisions that affect domestic taxation of Member States. They include:


a. Establishment of a common market (Article 2);

b. Development of an internal market without barriers on free movement of goods, persons, services and capital (Article 14);

c. Co-ordination of national tax laws to develop a Single Market (Article 3(h)); and

d. Prohibition of discrimination on grounds of nationality (Article 12).


In the area of taxation, the European Union has been successful in the harmonisation of value added taxes. It has been achieved through nearly 30 Directives of the EC Commission and over 300 rulings given by the European Court of Justice (ECJ). The Sixth Directive issued in 1977 (effective 1978) established a common VAT system with a uniform basis for assessment.

Under a 1993 Directive, the Commission implemented a system based on a mixture of origin and destination principles. Although Member States decide their own VAT rates, a 2001 Directive has set the minimum standard rate at 15%. The 2002 Directive on electronic commerce transactions was enforced from July 2003.

The early progress on direct taxes was slow since changes require a unanimous agreement of all Member States. In 1990, the Commission adopted the Parent-Subsidiary Directive, the Merger Directive and the Arbitration Convention (see below). The European Union also set up a Committee to assess the need for greater tax harmonisation.

The Ruding Committee Report, released in 1992, contained a number of recommendations on company taxation within the European Union. They included the elimination of withholding tax on cross- border inter-corporate dividends, interest and royalties, the broadening of the scope of the Parent-Subsidiary Directive, the harmonisation of the corporate taxable base, and levels of minimum and maximum corporate tax rates. The Report also recommended an expansion of the tax treaty network within the European Union and suggested guidelines for negotiation of treaties with non-EU countries.


Recent progress has been more rapid. The Commission has now taken steps to eliminate measures that distort competition either under its Code of Business Conduct (see below) or as illegal State Aid. The Competition Directorate of the European Commission published its guidelines concerning State Aid (referred to in Articles 87-89 of the EC Treaty) in November 1998.

They are designed to curb and remove State Aid that distorts or threatens to distort competition, otherwise called illegal State Aid, by favouring certain undertakings or production of certain goods. Unlike the Code of Conduct, State Aid provisions apply only to the Member States and not to their dependent territories. Moreover, they apply to companies, certain products and regional areas and include several exceptions.

Most Member States and their dependent and associated territories have now introduced revised or replacement measures for illegal State Aid, subject to certain transitional provisions.

For beneficiaries of those regimes on or before December 2000, a “grand­fathering” clause has been provided under which benefits have to lapse no later than end of 2005, independently of whether or not they were granted for a fixed period. Some extensions of benefits for defined periods beyond 2005 are also permitted for the old tax regimes in Member States and their dependent and associated territories.


The European Court of Justice (ECJ) has also over recent years given several decisions to safeguard the four fundamental freedoms and to prevent tax discrimination against nationals of Member States.

Under these decisions, they must be treated equally with own nationals for tax purposes. The ECJ has taken a purposive interpretation based on the European legislative history as well as the legislative intent of the EU Directives.

The Court has made exceptions only in special cases where they appropriately serve a legitimate public interest. The ECJ decisions are binding on the Member States and have forced several changes in their domestic tax laws.

The Commission has also adopted regulations for a European Company (Societas Europaea) in October 2001 that became operational for use on October 8, 2004. Under the European Company statute, a European Company can be set up by the creation of a holding company or a joint subsidiary or by the merger of companies located in at least two Member States or by conversion of an existing company set up under national law.


As of October 2004, only Austria, Belgium, Denmark, Finland and Sweden had taken steps to allow European companies. There is no special tax regime for them yet. Discussions are also in progress on home state taxation. Under this proposal, EU multinationals will file a tax return of the parent company consolidated with all its EU subsidiaries and branches under the tax law of its home state.

Business Code of Conduct:

In the ECOFIN meeting of 1997, a Code of Conduct was approved by the EC Council of Ministers. Unlike EC legislation or a Convention, the Code is not legally binding. The Code covers tax measures (legislative, regulatory and administrative) that have, or may have, a significant impact on the location of business in the European Union and unfairly reduce the tax revenue of Member States.

It requires Member States to voluntarily refrain from introducing any new harmful tax measures (“standstill”) and amend any laws or practices that are deemed harmful in respect of the principles of the Code (“rollback”).


The criteria for identifying potentially harmful measures include:

a. An effective level of taxation which is significantly lower than the general level of taxation in the country concerned;

b. Tax benefits reserved for non-residents;


c. Tax incentives for activities which are isolated from the domestic economy and therefore have no impact on the national tax base;

d. Granting of tax advantages even in the absence of any real economic activity;

e. The basis of profit determination for companies in a multinational group that depart from internationally accepted rules, in particular those approved by the OECD; and

f. Lack of transparency.

The Code of Conduct Group (Business Taxation) was established on March 9,1998 (chaired by Ms. Dawn Primarolo, UK Paymaster General) to assess the tax measures that may fall within the scope of the Code of Conduct for business taxation.

In 1999, the Group identified 66 tax measures with harmful features (40 in EU Member States, 3 in Gibraltar and 23 in dependent or associated territories). While the Code attempted to harmonise the tax base of Member States it did not regard competition on tax rates as harmful.


In June 2003, the EU finance ministers (ECOFIN) included the Code of Conduct as part of a tax package comprising:

i. The Code of Conduct for business taxation to amend, phase out or remove certain tax incentives given by EU Member States and their dependent and associated territories that were identified as harmful tax competition;

ii. A Directive to abolish withholding taxes on interest and royalties between EU group companies, as from January 2004 (“Interest and Royalties Directive”); and

iii. A Directive to ensure taxation of interest income of individuals either through exchange of information or interest withholding tax, as from January 2005 (“Savings Directive”).

European Union Tax Directives:

Some of the major Directives issued by the European Union so far on direct taxation include:

(i) Parent-Subsidiary Directive (1990):

The European Union adopted the Parent-Subsidiary (Dividends) Directive (90/435/EEC) in 1990. This Directive avoids the double tax on dividends and other distributions paid by subsidiaries to parent companies (not individuals) that are located in two different Member States.

(ii) Savings Directive (2003):

The Savings Directive (2003/48/EC) was finally adopted in June 2003 for implementation by end of 2004. The aim of the Directive is to ensure that savings income is effectively taxed when paid within the European Union. The EU Directive also applies to associated and certain dependent territories of EU Member States.

They include Jersey, Guernsey, Isle of Man, Cayman Islands, British Virgin Islands, Montserrat, Turk and Caicos Islands and Anguilla among the British dependencies and the Netherlands Antilles and Aruba as Dutch dependencies.

The Directive requires Member States to permit automatic exchange of information for monitoring the tax collection on cross-border interest payments to European Union residents without requiring reciprocity.

The Directive applies only to the savings income of individuals and not to the interest payments made to companies or trusts. Moreover, it excludes interest paid to beneficial owners who are nonresident in the European Union.

The Directive has a broad scope, covering interest from debt-claims of every kind, including cash deposits and corporate and government bonds and other similar negotiable debt securities. The definition of interest extends to cases of accrued and capitalized interest.

This includes, for example, interest that is calculated to have accrued by the date of the sale or redemption of a bond of a type where normally interest is only paid on maturity together with the principal (a so-called “zero-coupon bond”).

The definition also includes interest income obtained from indirect investment via collective investment undertakings (i.e. investment funds managed by a specialist fund manager who places the investments made by individuals in a diverse range of assets according to defined risk criteria).

As a transitional measure, three States (namely, Austria, Belgium and Luxembourg) are permitted to apply a withholding tax on interest payments. The rates are 15 percent for the first three years (2005-2007), 20 percent for the next three years (2008-2010) and 35 percent thereafter (2011 onwards). Those three countries will transfer 75 percent of the revenue to the residence country.

This arrangement will be reviewed in 2010 or later. The recipient of the interest income has the option to avoid the withholding tax if he gives his consent to exchange of information. Otherwise, the final paying agent must provide the details of the beneficial recipient within the European Union to the tax authorities.

The transitional period continues unless certain conditions are met. Firstly, the European Union must have reached agreement with five non-EU countries, namely Switzerland, Liechtenstein, San Marino, Monaco and Andorra, to exchange the information about interest payments.

These countries must adopt measures equivalent to those in the Directive for the EU Member States to be bound by their agreement. The European Union has accepted that the commitment by the United States to disclose information upon request (not automatic) constitutes “equivalent measures”.

The EC Council announced in June 2004 that the exchange of information should be on as wide a basis as possible in line with international developments. Moreover, this Directive should be introduced as part of the Member States national laws. The Commission reached agreement with the five non-EU countries, including Switzerland, subsequently. On July 19, 2004, the Council announced that the Directive should be applied as from July 1, 2005.

(iii) Interest and Royalty Directive (2003):

The European Commission issued its Directive (2003/49/EC) on cross-border payments of interest and royalties between associated companies in June 2003. It eliminates the taxes levied by source States, through either withholding or assessment, on qualifying intra- group payments of interest and royalties between associated companies and permanent establishments of Member States.

Under the Directive, the interest and royalties are taxable only in the Member State where the companies receiving the payments as beneficial owner are located. The Directive does not apply on payments to entities outside the European Union or in cases of tax avoidance or abuse, or to a permanent establishment of a Member State located in a third State.

The Commission made amendments in December 2003 to provide that the exemption applies only if the recipient is subject to tax on the income. No specific level of taxation is required. In addition, the Directive now includes entities covered under the 2003 amendments to the Parent-Subsidiary Directive.

The Directive is enforceable as from January 2004, except for the late 2003 amendments for which the latest implementation date is December 31, 2004. Transitional periods have been granted to Greece, Portugal and Spain, and also to Latvia, Lithuania, Czech Republic, Poland and Slovak Republic, who joined the European Union in May 2004.

To qualify as an associated company under the Directive, there must be a direct minimum holding (or voting rights) of 25% of the paying company by the receiving company or vice versa, or a third company must own at least 25% of both companies. All the companies must be tax resident in the Member States. The Directive, however, provides for certain exclusions (Articles 4 and 5) when the Directive is not applicable.

(iv) Merger Directive (1990):

The Merger Directive (Directive Number 90/434/EEC of July 23, 1990) deals with the taxation applicable to mergers, divisions, transfers of assets and exchange of shares by companies within the EU Member States. It provides for a tax-free transfer of assets and shares on mergers by companies that are resident in the European Union.

The two principal provisions include:

(a) The State of the transferring company will not recognise any taxable gains upon the transfer of assets and liabilities in a merger or asset transfer. The profits of the transferring company will continue to be taxed as income of a permanent establishment in that State. Moreover, its losses will be retained for future offset against the profits of the permanent establishment.

(b) The State of the shareholders of the transferring company will not recognise any capital gain in a share-for-share exchange. It will retain the tax basis of the old shares in the new shares.

Other Multilateral Agreements:

Some other multilateral agreements concluded by the Member States of the European Union include:

(a) The Arbitration Convention (Arbitration Convention 90/436/1990 of 23 July 1990) permits the optional use of arbitration procedures to resolve transfer pricing conflicts within the Member States of the European Union. The Convention has adopted the arm’s length principle contained in OECD MC Article 7(2) and Article 9. The Convention entered into force in October 1999.

(b) The Undertakings for Collective Investment in Transferable Securities (“UCITS”) Directive 85/611 harmonizes the regulations over collective open-ended investment funds. If a Member State meets the UCITS criteria, its funds can be freely marketed in other European Union countries.

(c) The Mutual Assistance Directive (Directive Number 77/799/EEC (as amended in 1979 and 1989) harmonizes Article 26 provisions under the bilateral tax treaties. The Directive deals with the exchange of information to assist in the assessment of taxes on income and capital and value added tax.

European Human Rights Convention:

The European Human Rights Convention of the Council of Europe is not a EU Convention and includes non-EU members as well. It was concluded in Rome in 1951 and currently has 46 members. These members are subject to the European Court of Human Rights (ECHR) based in Strasbourg, France.

Over the past 50 years, the European Court has given its decisions on several tax cases affecting human right issues. The commonly used Articles for taxpayers include the right to a fair trial and public hearing (Article 6), the right to respect for private and family life (Article 8), the prohibition of discrimination (Article 14) and the protection of property (Article 1 of the First Protocol to the Convention).

The Convention resembles the International Covenant on Civil and Political Rights (“ICCPR”) of the United Nations. Out of the 154 States, which are party to ICCPR, 104 UN members allow taxpayers in their State to challenge the government.

Under the Convention, the right to a fair trial (Article 6) has been applied in several tax disputes. It has been cited in both civil and criminal cases. They include cases involving the presumption of innocence and the right to legal aid and certain guarantees in criminal cases. According to the European Court, although Article 6 does not usually affect civil tax proceedings, it does apply to criminal tax penalties or fines.

For example, in a Swiss case, the Court held that 400% penalty for tax evasion was a criminal charge. A similar decision was given in another case where UK tax authorities imposed substantial penalties for filing negligent or fraudulent tax returns.

The most commonly used right under this Article has been the right to a tax decision within a reasonable time. In several “delay” cases, the Court held a period of over five years as unreasonable.

The European Court has taken up tax cases in several situations under Article 1 of the First Protocol. They include unreasonable tax objectives, disproportionate taxes and unfair balance between the interests of the taxpayer and the community.

The cases filed by taxpayers that tax rates were excessive have so far not been successful in the Strasbourg Court. However, the Court has been more sympathetic in cases where the tax rules were either not published properly or were unclear or they were a breach of law.

Article 14 guarantees non-discrimination in tax matters while Article 8 provides for a right to privacy, including in tax matters. The latter Article has been raised by taxpayers when required to provide tax information to the revenue authorities. Article 9 on freedom of thought, conscience and religion has been raised in relation to church taxes.

Article 4 of the Seventh Protocol disallows double or multiple punishments for the same tax conduct. Since heavy penalties are considered as a criminal offence under Article 6, further criminal prosecution for tax evasion may lead to double punishment.

So far, there have not been many cases where the taxpayer has been successful under the ECHR rulings.


The European Union has achieved significant harmonisation of indirect taxes, particularly value-added tax, but its success in direct taxes has been limited. Its efforts so far have been directed towards tax base harmonisation. Apparently, Member States are relatively free to compete on tax rates provided there is no ring fencing (i.e. the same rates apply to resident and nonresident taxpayers).

Although the ECJ decisions are slowly helping to create an internal market with more harmonized tax systems, the measures undertaken so far appear to be largely to eliminate harmful tax competition in the Member States.

It is expected that the increasing need for tax revenues in the future, particularly to finance the rising social security costs in the Member States, will continue to put pressures on them to look at measures to protect their tax base.