Tax Competition in Europe

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1 Professor dr juris Ole Gjems-Onstad Norwegian School of Management P O Box 580, N-1302 Sandvika Tel , fax Norway University of Oslo Ole.Gjems-Onstad@bi.no Tax Competition in Europe Norway National Report I General Aspects of the domestic tax situation: Norway a tax nation unto herself? Norway shares with the other Nordic countries a high tax burden as part of GDP (47.8 pct for 1998 no 7 on the OECD ranking) to a large extent due to extensive social welfare programs and a high level of support for agriculture and rural areas. Like her Nordic welfare state neighbours Norway is vulnerable to tax competition from other countries with lower tax burdens. The Norwegian Tax Reform 1992 illustrated that Norwegian tax policy is subject to the same international influences and ideological fluctuations as in many other industrialised countries. The Tax Reform reduced tax rates and widened the tax base in accordance with the widely adopted US script for tax reform (1986). Like the other Nordic countries undergoing tax reform at about the same time (Sweden 1991 and Finland 1992), Norway also adopted the so-called Nordic Dual Income Tax System with low nominal tax rates (28 pct) for capital and corporate income and progressive, and at the upper end of the scale much higher, tax rates for salary and small business income of physical persons (as of 2002, up to 55,3 pct with an additional payroll tax of up to 26,6 pct). Norway levies a net wealth tax at 1.1 per cent starting at a very low threshold. Through the use of intermediary companies and an 80 per cent-rule (limiting the net

2 wealth tax to 80 per cent of net income), this net wealth tax may be reduced to 0.6 per cent, and in some instances to 0.39 per cent even concerning financial assets and shares in listed companies. The net wealth tax is still considered a major reason why some wealthy Norwegians may consider leaving the country for tax reasons. The Nordic Dual Income Tax System is out of tune with the tendency in other countries to tax income at the same rates under the ability to pay-principle. This breach with the equlity principle has been criticised by commentators from other countries. In other parts of her tax system, Norway has, however, been more willing than even her Nordic welfare state neighbours, to develop a tax code that in many ways is a national tax law unto itself. Norway has a unique way of taxing active shareholders and active business earners at the same rates as earned salary. One might say, trying to tax, as the provisions are not very successful in practice. For the taxpayers, this legislation has become more of a way of obtaining taxing de facto active business income at the same low rates as capital income and business income from large corporations. Norwas has also developed a unique, intricate and costly way of taxing gains on equities through a cost adjustment system (called RISK with a Norwegian acronym). As a general tendency, one might ask whether the Norwegian Parliament and tax law drafters in the Norwegian Treasury are less concerned than their counterparts in other countries about Norwegian tax legislaton deviating from what is conventional tax wisdom in other states. Two recent incidents may be illustrative. As part of the budgetary process for the fiscal year 2001, the depreciation rates were reduced in November 2000, with full retroactive effect for the tax year The tax rates were set very low, e g 0 per cent for office buildings, 2 per cent declining balance for manufacturing facilities, storage buildings (with approx yrs as the estimated depreciation period). This reduction in depreciation rates took place just to obtain extra revenue. There was no effort in the Parliamentary preparatory papers to give any principled justification of the depreciation rates that e g were clearly much lower than in the other Nordic states.

3 One year later, in 2001, the reduction in depreciation rates was reversed. The Treasury argued that the tax depreciation rates no longer were in harmony with the economic rate of amortisation and therefore should be changed. The new tax depreciation rates are for industrial buildings still clearly lower than in neighbouring countries like Denmark and Sweden (Norway 5 per cent declining balance v. 4 per cent and 5 per cent straight line depreciation). As an indication of the Norwegian attitude regarding tax competition, the Treasury declared that it could see no reason why the depreciation rates in other countries should influence the depreciation rates in Norway. (Ot prp nr p 15). It might be said that this statement only indicates the Norwegian attitude towards tax competition regarding the tax base. The Treasury added that if the legislator might wish to reduce the tax burden for enterprises doing business in Norway, this should be done through lowering the tax rates and not by reducing tax depreciation rates beyond the true economic life of an asset. When the Government Jan 8 th, 2002 appointed a new Commission to look into the Norwegian tax system, a comparison with the tax systems of other countries were not high on the agenda. As a brief point # 5 in the mandate, the Commission was asked to evaluate the tax regulations and tax burden in Norway compared to other countries. A main focus should be the competitive ability of the business sector in an international perspective, and, as part of this, the importance of taxation as part of the factors deciding in what country an enterprise will decide to locate itself. To try to attract enterprises through the tax system has, in recent years, not been a part of Norwegian tax policy. Aggressive or offensive tax competition is not part of the official Norwegian tax idology. Trying to stop individual enterprises or industries to leave Norway due to tax considerations, has, however, in some sectors been highly influential in shaping Norwegian tax policy. This is especially so in the area of shipping taxation where Norway has enacted rules that allow an indefinite deferral of taxation as long as the profits are not distributed as dividends. Shipping taxation is the only area in which Norway has been subject to an Evaluation under the OECD work regarding potential harmful tax competition. The very lenient Norwegian tax regime for shipping may best be described as defensive tax competition trying to avoid the emigration of specific brances and not as offensive tax competion, e g trying to

4 attract new businesses to Norway. According to this terminology, stimulating Norwegian owned businesses that have emigratet due to tax reasons, to return home, is part of what is called defensive tax competition. As part of this picture, one should mention that, in contrast to many other countries, since the Tax Reform 1992, Norway has increased the tax rates for individual wage earners, and, partly also for business income. During the late 90s there was a tendency to increase the tax burden as part of GDP. Perhaps due to the lack of interest from the government in offensive tax competition, few Norwegian scholars have published any research on tax competition. The most noteworthy contributions have been published in Norwegian as part of the Nordic Tax Research Council Yearbook 2001 with reports for the Nordic Seminar on Tax Competition - Nordic Regimes and Responses in Oslo in the year There are no official statistics regarding the effects of tax competition on the Norwegian economy. The political atttitude of the Norwegian government is in line with the policy adopted by the OECD. High ranking officials from the Norwegian Treasury are taking part in the OECD Forum on Harmful Tax Practices. II Elements of tax competition in the domestic tax system: No incentives for foreign investments no expatriate taxation 1 Favorable tax rates for domestic investors when all profits are distributed or utilised through capital gains The nominal Norwegian tax rate of 28 % for capital income and business income from big corporations is not as low as it might seem. The tax base under Norwegian tax law is quite wide with few tax incentives for investment. The most substantial temporary difference to financial accounting is due to tax free roll over on capital gains on physical and immaterial business assets (but not on gains on financial assets). The effective tax rate is not much lower than 28 per cent - estimated at 25.8 % as Effective Average Tax Rate under the methods used in the recent EC commission Study (COM(2001)582 final, see paper for Norway by Lothar Lammersen and Christoph Spengel, December 2001). The Norwegian taxation of distributed dividends is, however, more moderate than in many other countries. Norway allows a full credit so that the effective tax rate for distributed profits to Norwegian shareholders is zero

5 per cent. Foreign shareholders are subject to withholding taxation at a rate of 25 per cent that is often reduced through the approx 80 DTAs to which Norway is a party. Like many other countries, Norway has an imputation system for taxing dividends that result in discrimination of foreign shareholders, not tax competition. The unique Norwegian system of adjusting the cost basis of shares with undistributed profits is open to both Norwegian and foreign shareholders. Shareholders that are not subject to Norwegian taxation on capital gains on the sale of shares in Norwegian corporations, will, however, not be able to benefit from this adjustment as no other country recognizes this adjustment in computing the capital gain on shares. Of course, if the foreign shareholder takes up domicile in Norway, she will be able to benefit from the Norwegian provisions on cost adjustment. But this is not an incentive of any importance in inducing foreign shareholders in Norwegian corporations to move to Norway. It was no intended effect when enacting the rules. Again, there is no tax competition, only tax discrimination. Summing up the last two paragraphs: For Norwegian shareholders in Norwegian corporations, the tax rate is nominally 28 per cent, and effectively about the same for distributed taxed profits that have to made out of taxable income not to incur a kind of equalization tax on distributed, untaxed profits (called korreksjonsskatt). Through the cost basis adjustment system, the tax cost is neutral regardless of the taxed profit being distributed as dividends or taxed as part of a realized gain on the sale of the shares. This nominal total tax rate of 28 per cent on distributed and realized profits are not high when comparing with other industrialized countries. There is no doubt that the Norwegian legislator was keenly aware of the tax rates in other countries when fixing the rate at 28 per cent on capital and big business income. The driving force when making comparisons was to avoid any substantial flight of mobile tax bases like capital. The tax rates were not set at this level to attract foreign corporations to set ut operations in Norway. It was more a matter of trying to find a tax burden that did not stop businesses from setting up operations in Norway, where the location decision was motivated by other primary considerations than tax.

6 There are no special tax rates for foreign investments in Norway. Foreign financed enterprises doing business in Norway through subsidiaries or permanent establishments are taxed at the same rates as domestic businesses. Foreign shareholders in Norwegian corporations may, as explained above, be subject to a higher total tax burden through source taxation of distributed dividends and no cost adjustment when realising the shares. Upon bringing assets into Norway, and exporting them at a later point in time, there are special valuation and depreciation rules. These provisions apply in the same way to Norwegian and foreign taxpayers, and are not intended to offer any tax incentives. The aim is not to hand out any tax incentives when bringing assets into Norway, but simply to have technical and manageable rules on how to calculate depreciation deductions and losses or gains. Norway has no expatriate taxation allowing managers of subsidiaries of foreign corporations etc a more lenient taxation to Norway under the tax rates and tax accounting that apply to their Norwegian counterparts. Foreigners with temporary residence in Norway may, for the first four years that they are taxable to Norway, be allowed a 15 per cent standard deduction. This deduction is, however, only worth 28 per cent as it may only be taken against the basic rate of 28 per cent, and not against the rates of 7,8 % and up to 19,5 % for salaried income. The purpose of the deduction is not to offer an incentive, but to make the assessment easier both for the taxpayer and the Norwegian tax authorities through substituting for five more clearly defined deductions for Norwegian taxpayers. 2 Tax accounting There are no special tax accounting rules for foreign business in Norway. The tax base is calculated in the same way as for Norwegian taxpayers. There is no special tax deferral or tax free roll-over for foreign investments. 3 Double taxation relief flow through tax haven for royalties and interest Norway has entered into nearly 80 double taxation treaties. As a basic rule, Norway adheres to the OECD Stanard Model as the point of reference when entering into treaty negotiations.

7 Norwegian domestic tax law contains a general transfer pricing provision. The Norwegian Supreme Court ruled in 2001 that this provision should be interpreted according to the OECD Transfer Pricing Guidelines. Norway prefers a far reaching exchange of information policy when entering into new DTAs, also on an automatic basies, and has a number of treaties that allow for assistance in collection. In her domestic tax law, Norway has no provisions for applying source taxation to outbound royalties or interest. The result is that Norway may be used for setting up companies with the sole purpose of receiving royalties and interest from affiliated companies in countries with which Norway has entered into DTAs that do not allow source tax on outbound royalties and interest going to Norway. The Norwegian domiciled recipient may then pay these royalties and interest payments to another affiliated company resident in a tax haven. It is not known how much royalty and interest that flow through Norway each year as part of such conduite operations. From a Norwegian point of view no tax revenue is lost. This policy is, however, not due to a wish to attract foreign companies that might use Norway for such flow through operations. The consistent Norwegian policy of not having any domestic law provisions for the source taxation of interest and royalties supposedly is due to a hypothesis that such a policy, if widely adopted by other countries, would benefit Norwegian companies receiving inbound interest and royalties. It is hard to see, however, that this reasoning may justify a policy that makes Norway suitable for such flow through operations. One reason that Norway may not be so interesting as a flow through country is that a number of her DTAs contain provisions regarding exchange of information, and, as indicated, often automatic exchange of information relating to interest and dividends. There is, however, no automaic exchange of information concerning royalties. 4 Procedural advantages In force from late 2001, Norway has introduced a system of advance rulings in tax matters.there is, however, no special advance ruling system for foreign investments,

8 nor for taxpayers with a limited tax liability to Norway. In 1991, a system with advance rulings for taxpayers operating on the Continental Shelf and taxable under the Petroleum Tax Act, entered into force. Taxpayers operating on the Continental Shelf are often owned by foreign investors, but this has never been a condition for obtaining an advance ruling under the Petroleum Tax Act. Under Norwegian tax law, there are no special rules for tailor-made-decisions nor secrecy provisions applying solely to foreign taxpayers. The Norwegian tax authorities are bound by the general and rather strict secrecy provisions applying to all tax cases. 5 Shipping taxation In 1996, Norway introduced a special tax regime for shipping based on the model of tonnage tax enacted earlier the same year in the Netherlands. Basically, taxation of shipping income for qualifying taxpayers is deferred until profits are distributed as dividends. Instead, a tonnage tax is levied. It may be somewhat telling that for the first year of the shipping taxation regime, the sum of the tonnage tax was somewhat lower than the total membership fees paid to the Norwegian Shipowner Association. Later. The tonnage tax has later been increased. As many shipping corporations during the most recent years have been running into deficits, the tonnage tax has turned into a kind of gross tax on losses. In Norway, the shipping tax regime has been argued against and held to be in breach of the neutrality principle that was a very central part of the Norwegian Tax Reform It appears to be fairly clear from the preparatory papers and the political processes leading up to the tax, however, that the shipping tax regime cannot be undersood as offensive tax competition. It is defensive, in the sense that its supposed function was to prevent ship owners from moving their operations out of Norway, and, in some cases, to encourage Norwegian shipowners to move their shipping business from low tax jurisdictions back to Norway. The shipping taxation rules have been made somewhat stricter and are, at present, considered fairly restrictive when compared to similar special shipping taxation systems in other countries. The controversial part of the shipping taxation is that it excludes domestic shipping and therefore may be considered to include a ring fence element. Norway, like

9 countries with similar shipping taxation systems, have argued that it would be easy to circumvent general shipping rules by simply moving the shipping corporation to a jurisdiction that has no coastal line and therefore no reason do distinguish between domestic and international shipping. Foreign investors in a Norwegian shipping company under Norwegian management, but with maximum 34 per cent Norwegian ownership, are exempt from Norwegian tax under domestic tax law. This rule is partly meant as an incentive for foreigners to invest in Norwegian shipping. 6 The Svalbard tax

10 According to domestic law, the Norwegian tax jurisdiction encompasses Svalbard and Jan Mayen. To a certain extent, the Norwegian tax sovereignity is limited by international treaties concerning Svalbard. To keep up the Norwegian population at Svarbad which has a very harsh polar climate, the taxation of income, both business income and salaried income, made through business operations and salaried employment at Svalbard, is very low: 6 per cent income tax (pluss social security fees) for salaried income, and 10 per cent for business income and capital income. The low tax rate might encourage tax planning both against mainland Norway and other countries. The Assessment Tax Office for Svalbard is aware of this possibility. The Svalbard Tax Act is quite clear. Any corporation claiming the 10 per cent tax has to be a resident of Svalbard, og and then prove that the income is made through business operations in Svalbard. As far as this reporter knows, there have been no serious efforts of any interesting magnitude to make use of this theoretical window to a 10 per cent tax on business income. Some years ago, a well known Norwegian lawyer made a try, but from the press reports the whole operation looked more like a flop. III Measures against unfair competition in the domestic tax system 1 General anti-avoidance rules Norway has not any general statutory tax rules on anti-avoidance. The Tax Act contains one provision on transfer pricing. The burden of proof that the pricing is not tax motivated, is on the taxpayer if the tax authorities have been able to demonstrate that the price is not at arm s length and one of the parties is domiciled or resident abroad. There is also one statutory provision on anti-avoidance in connection with tax free mergers and divisions. As tax free mergers and divisions are not allowed under Norwegian law when one of the corporations are resident abroad, this provision has no specific interest for the current subject. As an EEA-member, Norway is not obliged to introduce into her tax legislation the EC Merger Directive. The Norwegian general anti-avoidance rule is based on extensive case law. It is debated how the general anti-avoidance rule is constructed. It may sometimes be quite

11 hard to predict what conclusion the Supreme Court may reach. Compared to other countries, there appears to be no doubt, however, that the Norwegian general antiavoidance rule is quite far-reaching. Among the numerous cases before the Supreme Court, a substantial number has involved cross-border transactions, foreign taxpayers and schemes to avoid Norwegian taxation to the favor of more liberal foreign tax regimes. 2 CFC legislation For the first time, Norway put CFC legislation into the Tax Act as part of the 1992 Tax Reform. The Norwegian acronym is NOKUS-taxation (Norwegian Controlled Foreign Corporation). The practical impact of the NOKUS-rules has been less than anticipated as Norway in 1996 introduced the special tax regimes with effective zerotaxation for shipping income that has not been distributed to the shareholders. Many of the companies that might have been subject to NOKUS-taxation would have been shipping corporations. For the income tax year 1999, a total of 207 corporations were taxed under the NOKUS-legislation. The basic requirement for the NOKUS-rules to apply is that the foreign corporation should be controlled by Norwegian shareholders holding a minimum of 50 per cent of the shares in the corporation. There are alternative ownership requirements that it is not necessary to go into here. The Norwegian NOUKUS-rules do not apply a black list of the relevant low tax jurisdiction. The deciding criteria is that the general income tax applying to the corporation in the foreign tax jurisdiction should amount to less than two thirds of the corresponding Norwegian tax if the corporation had been domiciled in Norway (e g 2/3 of 28 per cent). Norway has been critised for using nominal rates instead of effective rates in applying this rate-criteria. The Norwegian NOKUS-rules in general apply regardless of what kind of income, active or passive, the foreign corporation has. The rules apply not only to holding companies and passive base companies or investment companies, but also to ordinary operating companies. Only passive income is taken into consideration, however, if Norway has entered into a double taxation agreement with the country in which the

12 Norwegian controlled corporation is situated. In practice, it may be hard to determine what is passive and active income. One of the question tax practicioners find unsettled is how many employees should a holding company have before it is no longer characterized as passive, but an active company. 3 Residence Rules To try to make shifting tax residence to low tax jurisdictions more difficult for physical persons, the Norwegian Treasury in a Draft Paper 30 th Aug has proposed more strict criteria for being accepted as emmigrated from Norway for tax purposes. Under current law, the person wishing to be considered emmigrated, should be subject to an evaluation where many factors may be taken into consideration. The overall deciding criteria is whether the person should be regarded as having severed definitely her ties to Norway as a domiciled person. Under the new proposed rules, the burden of proof is shifted. Any taxpayer who has been considered a tax resident to Norway, must submit proof that she does not any longer have substantial connection to Norway for her tax residence to be terminated. It is not a most substantial connection test, simply substantial connection. If the person has been tax resident to Norway for at least 10 years, she has to satisfy this not-any-longer-substantial connection test for four consecutive years. First after these for years have passed, she may be considered as no longer a tax residence of Norway. The proposed new rules do not explicitly mention tax havens and low tax jurisdictions. They will, however, create a strong incentive to move to countries with which Norway has entered into Double Taxation Agreements with an article corresponding to the OECD Model Tax Convention Art 4 on Double Tax Residence. Then the deciding criteria, as now, will be in what state the taxpayer has a permanent home available to her. And this test will decide already for the first year such a permanent home may be established outside Norway. For persons moving into Norway, the proposed new rules will establish tax residence to Norway under domestic law as soon as the person has stayed in Norway for at least 183 days during a 12 month period. Tax residence to Norway may also be effective as soon as the person has a substantial connection to Norway. For countries with

13 which Norway has DTAs according to the OECD Model, the permanent home test under art 4 will overrule the proposed new domestic law. Emigrating from Norway is not in general considered as a taxable event making it necessary to report unrealized gains. There are some special provisions for realized, but unreported salary income etc, and for the recapture of depreciation charges on certain assets when moving these out of Norway. 4 Restrictions of deduction of payments to tax-haven entities Under domestic law, Norway has not enacted any restrictions on payments to taxhaven entities. The general transfer pricing rules will apply. If the OECD recommends that such restrictions on deductions for payments to tax havens be introduced, it is likely that Norway will adopt this policy if a certain number of other member states do the same. Norway is not likely to accept the role of spearhead in combatting tax havens. But Norway will probably be quite loyal to any mainstream measures recommended by the OECD. IV Measures against unfair tax competition at the international level in which Norway is involved 1 Double Taxation Agreements As a high tax burden welfare state, Norway has been willing, interested, and at times a driving force, in the work against unfair tax competion through international organisations and double taxation agreements. As the business interests of Norway are fairly international, it is probably not to be expected that Norway will accept any avantgard role that may ending up putting her international business corporations at a disadvantage compared to other, fairly similar OECD member countries. Norway may be considered positive to the approach adopted in the 14 Nov 2001 Progress Report from the OECD stating that co-ordinated counter measures would not apply to uncooperative tax havens any earlier than it would apply to OECD Member countries with harmful preferential tax regimes. Norway has entered into limited double taxation agreements with certain tax haven jurisdictions to obtain access to information exchange. In her DTA negotiations,

14 Norway is generally willing to insert clauses and articles to prevent the abuse of low tax jurisdictions. Norway has limitation of benefit clauses of various kind in her tax treaties with Barbados, The Netherlands Antilles, Luxembourg, Jamaica and Switzerland. It has been suggested that Norway should have limitation of benefit clauses also in other treaties, e g with Singapore that has a taxation regime for shipping with zero-tax and no withholding tax on dividends to a Norwegian holding company. 2 EC (Code of Conduct) Norway is not a member of the EU/EC. Under the EEA Agreement to which Norway is a party, taxation is not a part of the treaty. Norway is not formally obliged under the EC Code of Conduct, but her tax policy would probably not be considered in breach of the guidelines established therein. 3 OECD Norway has taken an active part in the OECD work on harmful tax competition. As indicated above, Norway most probably will be willing to adopt defensive measures in her tax legislation that is accepted also by a certain number of other OECD Member states. Finland is the last country to put forward a proposal for taxing shipping in much the same way as Norway does. Like many other countries, Norway is being subject to an evaluation regarding her zero-taxation for shipping Other parts of Norwegian tax legislation has not received any negative attention from the OECD.