I. Introduction

Niclas Virin is one of Sweden’s most
prominent experts on business taxation. He has participated in numerous
government business tax investigations and he still serves as a judge on the
very respected Tax Advance Rulings Board. In government service for many years
he rose to head of the business tax department of the National Tax Board and,
over the last 20 years or so, has worked for Svenska Handelsbanken as their
Chief Executive Tax Officer. He has authored innumerable articles and
publications on business taxation matters, last but not least the Swedish
national report to next year’s IFA congress (in Sydney) on the subject: “Trends
in company/shareholder taxation: single or double taxation?”1

Therefore, whenever Virin speaks up on Swedish
business tax matters, one should pay very careful attention. And he has indeed
spoken up very clearly and eloquently on the matter of single or double
taxation of company profits! He did so initially in an article already in 1996,
(Svensk Skattetidning 9/96 ) titled “Is business taxation worth its
price?” (Är företagsbeskattningen värd sitt pris?) taking strong
inspiration from the Chilean tax expert Milka Casanegra de Jantcher’s memorable
intervention at the IFA congress of 1996 in Geneva on the subject of taxation in the next
millennium. An English version of Virin’s ideas was published in the June 1999
issue of Tax Planning International Review.

II. The discussion in Sweden on
non-taxation of companies.

Virin is by education an economist and
therefore in the relation between tax law and economic realities has come to
the conclusion that the taxation of company income gives rise to not only
technical, legal and intellectual hazards, it also represents from an economic
standpoint “an unnecessary and harmful evil”. He points out that from a
national and international perspective, business taxation in particular is
becoming ever more complicated and resource-consuming. In Sweden, 70-75
percent of the resources of the tax administration are occupied with business
tax matters. The revenues, however, from this type of taxation in Sweden only
account for about 5-6 percent of total tax revenues and about 2-3 percent of
GNP. Private tax practitioners, charging exorbitant fees for their services,
are in endless pursuit of interpreting and, yes, even circumventing the tax
laws, driving this “art” to such levels of sophistication that it is even
considered a virtue. Virin predicts that business taxation is growing into an
elephant on clay feet and will not keep pace with the changes in strategies and
management of business and the structure of transactions. Even worse, business
taxation “may become an obstacle to necessary restructuring and modernising
of businesses and industries”. His arguments are particularly strong in his
analysis of business taxation in the macro-economic system, criticising the
general misunderstanding of the economic difference between business and
household income. It rests on the false assumption that the taxation of
business profits

“is an indispensable part of a comprehensive
economic system. We tax the employee, so we must also tax the self-employed
person. If we tax the self-employed person, then we must also tax the company.
This is wrong. As long as the assets of a company or a sole trader are not used
by the shareholder or the business person for his or her personal consumption,
there is no need to tax him or her. As regards the company, there are legal
restrictions as to how the owner can use company assets for his or her personal
needs. That may not be the case as regards the self-employed, but as long as
the assets are kept in the owner’s enterprise and balance the assets of the
accounts, there is no need to tax him or her. This is purely a technical issue.
The profits of a business is simply not comparable to the income of an
individual. The income of an individual is the counter-value of his or her
participation in the production process. The income the individual receives is
the prerequisite for his or her living … Corporate income, on the other hand,
is something completely different. It is the difference between to estimates of
present values of future payments. Each estimate consists of in turn of two
estimates: inflow of income payments and outflow of cost payments. If there is
a positive difference, i.e., the present net value at the second time of
measuring is larger than the first one, then there is a profit (I disregard
capital injections and withdrawals) or, in other words capital wealth has been
accumulated. The capital base for future activities has been strengthened. That
is – including the capacity to pay wages and dividends – the only purpose of a
business … The company income is created to build up a capital to improve its
capacity to earn still more money and to pay still more wages and dividends … A
company does not consume for its own sake … The false parallel between company
income and household income creates a completely absurd consequence in the
obligation to pay tax on company profit. The mere idea of taxing businesses for
their profits is absurd. It’s like shooting yourself in the foot. It’s like
shortening the pole for the pole-vaulter. The asymmetry increases the business
risk. The main and traditional reason for subjecting enterprises to taxation
was based on the fact that this, in more primitive economies, was the only way
of collecting taxes efficiently … Today everything is completely different, at
least in developed countries … Enterprises are no longer symbols and economic
strongholds for political power but tools for individuals to create goods and
services and to accumulate real capital … In a modern society it is also
possible to charge individuals with tax. What was earlier impossible is today
not only possible but also an efficient way to fair taxation of individuals.
The taxation of companies and entrepreneurs not only fails to hit the formal
taxpayer but hits the ultimate payer in an unpredictable way. And it is
detrimental to the productive capital”.

In conclusion, Virin’s reasoning rests on three
pillars: First, and most importantly, business taxation, for economic and
fiscal purposes, is not only unnecessary but even harmful. There is no need to
subject business income to tax in order to prevent part of the economic flow to
escape taxation. There is a general misunderstanding of the concept of profit
and a false analogy between business income (profit) and household income
(production factor remuneration). Investments are based on after tax
calculations giving rise to delays of investment decisions and economic
inefficiencies. Secondly, business taxes are so complicated that, yes, they
tend to endanger the Rule of Law. Formal legal concepts lack practical content
in reality. Thus, similar transactions are not treated equally by the courts.
Business taxation is also extremely expensive. Thirdly, business taxation is
simply an outdated form of taxation. In the distant past when taxes to a great
extent were paid in kind there were no other means of collecting taxes in an
efficient manner. Then, in the more sophisticated economic environment of the
industrial era, the balance sheet and the profit and loss account became a
“natural” (and tempting) base for taxation. But today, and certainly in a
modern and developed society, the conditions for imposing taxation have changed
dramatically. Employers withhold taxes on salaries and wages on a current
basis. Banks collect taxes at source on interest and capital gains. Social
security charges, VAT etc. are also collected automatically and at
practically no cost. In Sweden
these taxes and charges account for more than 90 percent of all tax revenues.

Naturally, Mr Virin realises that the abolition
of company (and business) taxation will reduce tax revenue, at least in the
short run. Part of that tax amount, however, would instead be distributed as
dividends or paid out as wages and subjected as such to normal income taxation.
Also – which constitutes a very significant saving – the costs for tax
administration, compliance and control would be drastically reduced. Both
economic double taxation and international double taxation would disappear, not
to mention triple taxation, i.e., company tax for dividends and capital
gains from shares. Moreover, and of special interest in this context, a number
of international tax issues such as transfer pricing, permanent establishment
determinations etc. would disappear. Lastly, and probably most
importantly, the abolition of corporate tax would allow international
investment and business establishment decisions to be made without any tax
effect considerations.

Apart from responses from two representatives
of the Swedish academic sector, professors Nils Mattsson, University of
Uppsala, (Svensk Skattetidning 1/1997) and Leif Mutén, Stockholm School
of Economics, (Skatter & Välfärd 2/98), both of which have rejected
the suggestions by Virin to abolish business taxation, there have been very few
reactions hereto. This is quite surprising considering that the elimination of
double taxation of corporate profits has been high on the political agenda of a
number of political parties in Sweden
for a very long time. In fact, double taxation of companies was indeed
abolished – at the shareholder level – in 1994, which, as it turned out, was
the last year in which the right-wing coalition government at that point in
time remained in power. In the general election of that year, however, the
social democratic party regained power and promptly restored double taxation
(and put a stop on the phasing out of the net wealth tax).

The Swedish business sector has also turned a
deaf ear to Virin’s ideas of restructuring the Swedish company tax system.

But the issue of single or double taxation of
companies persists. This is evidenced not the least by the aforementioned
choice of this problem as a main topic of discussion for the 2003 IFA congress.
Also, of course, single or double taxation has been at the forefront of tax
policy issues of the European Community throughout its whole history. However,
the minimum corporate tax rate suggested by the Ruding Committee some years ago
seems to be all but forgotten. In practice several countries have significantly
reduced the overall tax burden on corporate investments, a development
sometimes referred to as “the race for the bottom”. Estonia for instance has introduced
a quite radical deferred single company tax based on the distribution of
profits (at a rate of 26/74 of the net amount of the distributions). Ireland has
gradually slashed its regular corporate income tax down to 12.5 percent over
the last couple of years. (Both of these states have also enjoyed quite
significant increases of economic growth since then.) In the United Kingdom
a zero-rated corporate income threshold of 10 000 GBP was recently introduced.
The present U.S.
administration has shown an interest in the idea of totally abolishing business
taxes. The total tax exemptions of corporate incomes and other tax incentives
in a number of (tax haven) jurisdictions and indeed several E.U. Member States,
sometimes accused for representing harmful tax practices and tax poaching, are
also well known phenomena.

Virin’s main line of thinking is focused on the
domestic macroeconomic effects and merits of abolishing the taxation of
corporate profits. Considering however that, today, the Swedish economy is so
tightly and inextricably integrated to such a significant number of states and
that free trade and the free flow of capital in general has reached such
enormous proportions, the idea of abolishing corporate taxes will have quite
significant effects on both investor behaviour and tax policies not only in
Sweden but also abroad.

An abolishment of company tax in Sweden may well
also give rise to counteracting measures by our trade nations and tax treaty
partners. Some of these aspects have indeed been considered by Virin and also
by Mutén in his aforementioned article. Quite some time, however, has passed
since then, and developments in the international tax community over the last
couple of years has been of such a nature and intensity in this field that the
international repercussions to (any state considering) an abolition of company
tax as suggested by Virin merits a further and broader investigation in an
international context. The purpose of the remainder of this paper is therefore
to embark on such an analysis. What new problems may arise from such a sweeping
tax reform? What benefits and pitfalls would follow therefrom? It is humbly
recognised that the following thoughts and considerations are far from
comprehensive. But if they can give rise to further inspiration and debate,
this in itself will be sufficient reward. And Virin’s case is too good to be
left to sink into oblivion!

As mentioned above Virin has advocated the
cancellation of taxation not only of companies but indeed of all business
profits, i.e., also those of individual non-entity tax payers.
Considering, however, that this latter class of taxpayers is not subject to
double taxation this paper will focus only on the international aspects of the
abolishment of this type of taxation. The pretention that this article may have
some interest also abroad is the reason for it being written in English.

III. Harmful Tax Practises

A spontaneous and immediate reaction from
foreign trade and tax treaty partners may well be, as already implied, that Sweden, by
putting an end to company tax, is embarking upon a policy of harmful tax
practises inviting counteracting measures from abroad. This indeed is one of
Mutén’s strongest objections against a no-company tax. This however is no
longer a valid argument. Over the last couple of years it has been made quite
clear, both in the European Union and especially in the OECD proceedings on
harmful tax practises, that the determination of tax rates or the level of
taxation in any jurisdiction including also a zero-rate tax is a decision which
is totally up to this jurisdiction itself. The OECD thus has no objections to
the introduction of a low or no tax in any jurisdiction as such. Only when such
a tax is combined with distorting elements such as ring-fencing etc. may
a harmful tax situation arise. And this will certainly not be the case in Sweden. On the
contrary, Sweden
is a staunch supporter of measures to counteract harmful tax practises and,
which will be further discussed below, a strong defender of the principles of
equal treatment and non-discrimination in international tax matters. Also, and
this is a strong requirement for escaping harmful tax practises accusations in
the opinion of the OECD, Sweden has a quite transparent economy in general, not
the least in the field of taxation, supervised by strong regulatory
institutions.

Also, the other state will benefit from a
no-tax situation in Sweden.
This occurs where a double taxation situation is at hand, and where the other
state operates a credit of foreign tax mechanism for relief thereof. In this
case the benefit of the Swedish tax cut will go straight into the pocket of the
treasury of the other state i.e., there will be no Swedish tax to
relieve from double taxation! This, admittedly, as far as Sweden is concerned offsets the relative
advantage of competition but an investment in Sweden is still of interest since
there are no local tax problems.

The suggestion that foreign jurisdictions may
nevertheless enforce counteracting measures against Sweden in the form of
CFC-regulations or the imposition of taxes on dividends etc., can of
course not be neglected. But if so, this is not a problem for Sweden! The
decision for introducing such measures would be something that is totally up to
the other State according to its tax policy and tax system.

Undeniably, an abolishment of the corporate tax
will make Sweden
a very favourable location for foreign (and domestic) investments. But, as
mentioned, this does not constitute harmful tax practise. Open, honest and
non-discriminatory tax competition is perfectly legitimate and a healthy
ingredient in an international market economy. It creates a win-win situation for
everybody!

IV. Equal Treatment and Non-Discrimination.

Virin’s ideas encompass full respect for equal
treatment and, in contrast to the imputation system adopted by several European
jurisdictions, do not have any discriminating elements regarding foreign
investors. The tax exemption of company profits shall thus apply also to
foreign investments in Sweden.
Consequently, for instance, the very complex problems regarding the
determination of permanent establishments disappear.

These consequences are not only desirable but
also a result of the non-discriminatory obligations of Sweden visavi our tax
treaty partners and our relations to the other Member States of the European
Union, all of which, since the recent ratification of the Sweden-Portugal
treaty, indeed are tax treaty partners. (In fact Sweden also has tax treaties with
all of the ten present applicant states to the European Union) The abolishment
of company tax shall also apply to foreign investors of non-treaty states, of
which incidentally there are very few of importance, although Sweden has no
equal treatment obligations to such states. This may give rise to certain tax
planning opportunities which will be further discussed below in the context of
capital gains taxation.

V. Credit of Foreign Tax

Sweden
adheres to the credit of foreign tax method for relief of foreign tax. This
system as such will of course be maintained also after an exemption from tax on
company profits but will of course apply only to other categories of Swedish
taxpayers. Doing away with company taxation will have the added benefit to the
Swedish treasury in that it will no longer suffer from having to give relief
for foreign taxes thereby also offsetting the shortfall of company tax
revenues. The Swedish present credit of tax method in an international
comparison is extremely generous allowing both an overall method for
determining the credit limitation and a three year excess credit carry forward
of unrelieved tax thus effectively rendering Swedish companies quite immune to
high foreign taxes. A new no-tax situation in Sweden would make them more
concerned about such foreign taxes.

Moreover, as already mentioned, the state of
residence of a foreign company established in Sweden will also benefit from the
abolishment of the Swedish company tax in that there will be no Swedish tax to
credit. In addition the base for taxation of dividends and capital gains will
also be broadened to the benefit of the treasury of the state of residence of
the shareholder. (It should be mentioned that already Sweden levies
no taxes on outgoing interest payments and most treaties reduce Swedish source
royalty taxes also to nil kronas.)

VI. Inter-Company Pricing

The problems of inter-company pricing in Sweden will of
course also disappear. In this Virin naturally sees another blessing: Mutén
another threat.

Certainly, a no-tax situation in Sweden may escalate the incentive for
unwarranted transfers of income to Sweden for tax purposes thus
increasing the concern of the tax authorities of the other country.

Most importantly, however, and this is a bonus
to all parties, double (economic) taxation problem will cease and there will be
no need for corresponding adjustments etc. A further advantage is that
advance pricing arrangements will not require bilateral approval (from Sweden) to
become fully reliable.

As aforementioned, Sweden can be relied upon to fulfil
all its treaty obligations regarding exchange of information and cooperation
regarding joint tax audits in inter-company pricing matters etc.

Anyway, and in the final analysis, it would be
absurd for Sweden
to refrain from a sensible tax reform just because some foreign taxpayers may
disregard the principle of the arm’s length rule!

VII. CFC-Legislation

This type of extremely complicated legislation
will of course also be unnecessary in Sweden. There will simply be no
further incentive for Swedish investors to consider foreign low-tax
jurisdictions for their foreign investments. On the contrary, in a situation
where foreign source taxes represent a final cost, Swedish companies will be
more inclined to invest directly from Sweden in order to pick up the
benefits of the reduced withholding taxes of the Swedish tax treaties.

Again, other states may find it necessary to
impose CFC-legislation vis-á-vis Sweden, but this not our concern
and should not stop us from scrapping company taxes.

VIII. (Second Level) Shareholder Taxation

The consequence of Virin’s “model” of company
taxation is of course that the profits of the company shall be taxed only upon
distribution to its shareholders (or paid out as wages to its employees etc.)

Sweden
operates a schedular tax system on capital income including capital gains at a
flat rate of 30 percent. The domestic withholding tax on dividend distributions
to foreign shareholders (kupongskatt) is also 30 percent. Personal
income taxes are levied by both municipal jurisdictions and the State at
progressive rates running to a top marginal tax of about 60 percent (including
social security charges).

Under Swedish tax treaties the withholding tax
on dividends paid to shareholders resident in the other contracting state are
reduced normally to 15 percent or to 5 or even 0 percent for shareholders with
substantial holdings in Swedish companies. These commitments will of course be
maintained resting on the normal treaty principle of reciprocity and the
sharing of tax sacrifices. Shareholders of non-treaty states will of course pay
the 30 percent domestic withholding tax on their dividend receipts.

For tax policy reasons, it is suggested that
the Virin model requires stringent rules for upholding the second level
taxation of company profits in order to preserve tax neutrality. In Swedish tax
planning, and particularly in international tax planning, a lot of efforts are
concentrated on circumvention, deferral or complete avoidance of this second
level tax, the main strategy being that the shareholder shall move to a
suitable foreign tax jurisdiction, before cashing in on his capital gain. Sweden does
however have a “quarantine” rule subjecting emigrants to capital gains tax on
alienations of Swedish securities during a period of 10 years subsequent to
moving abroad. This rule is however notoriously ineffective and subject to
massive and successful abuse. The rule has been tucked into a number of Swedish
tax treaties which may reduce the quarantine period by a number of years as the
case may be.

Even if the overall tax burden on company
profits will be substantially reduced under Virin’s model, the temptation to
circumvent the second level shareholder tax will probably increase. Efficient
measures should therefore be considered to prevent this in the form of, for
instance, a capital gains exit tax primarily on substantial holdings (combined,
it is suggested, with a reversed credit mechanism). The rules for taxation of
hidden distributions may need further consideration. Also one should consider
rules for taxation of (foreign) company-to-shareholder loans which presently is
a quite popular means of “immortalising” tax deferrals on foreign low tax
jurisdiction profits which are not caught by the present Swedish
CFC-legislation. Sweden
may also consider shoring up its capital gains taxation allowing source tax on
the gains of companies whose assets mainly consist of Swedish situs immovable
property, which incidentally is in line with the new thinking of the OECD Model
Treaty.

IX. Treaty Recognition of Tax Exempt Swedish Companies

A question that may raise some doubt is: “Will
Swedish companies that are not subject to tax be recognised under our treaties
as persons resident in Sweden
and thus entitled to treaty benefits?” It is a well-known fact that treaties
only apply to residents of one or both of the contracting states and that such
residence status is granted only to persons who, under the domestic tax laws of
the contracting states, are “liable to tax” in either or both of those states
by reason of their domicile, residence, place of management etc.

In Sweden
the above question has, however, been answered by the Supreme Administrative Court itself in a
landmark decision in 1996 (RÅ 1996 ref 84) regarding the (former 1983) treaty
between Sweden
and Luxemburg. The main question that arose in this case was whether or not a
Luxemburg company, which, although it was formally subject to world wide tax
liability, by specific exemption was relieved thereof, and therefore did not in
fact pay any tax. The Court found, by emphasising the intentions of the
contracting states as being not only to avoid double taxation and to prevent
tax avoidance but also to divide taxing rights between the two states, that it
was enough for the said type of Luxemburg company to “have such an
attachment to Luxemburg which normally would result in it becoming subject to
full tax liability” in order to be considered a resident of Luxemburg. It
was thus not required to actually pay any tax.

One should also take into consideration that
there are numerous other types of persons deriving income and who, by certain
privileges, are exempted from taxation, for example, pension funds, charitable
organisations etc., but nevertheless are entitled to treaty benefits.

Therefore, in order to prevent the residence
article of treaties from depriving future non-taxable Swedish companies from
treaty benefits, they should thus simply be technically encompassed by but then
exempted from the regular business income tax .

X. Conclusion

As concluded from the aforementioned there are
no serious or insurmountable international tax obstacles to abolishing
corporate taxation in Sweden,
not as long as it applies also to foreign companies and thus is
non-discriminatory.

In its international context the main and quite
stupendous advantage hereof is of course that international double taxation
will be rendered a relic of the past! Certainly, also, it will give the Swedish
economy an injection of foreign investment of maybe quite significant
proportions. The longstanding criticism by the opposition parties of the
present government’s inaction in sustaining economic growth will be completely
nullified. And finally we shall be able to say that the legislator has lived up
to his ever repeated commitment to simplify taxation!

In informal discussions with Swedish tax
expertise on removing company/business taxation, the single most persistent
objection that keeps popping up – and with such frequency and insistence that
indeed it seems quite serious – is: “But that would put us all out of our
jobs!” That, of course, is the ultimate proof of the benefits of the Virin
Model!

Certainly every effort should be made to render
all tax practitioners jobless – including myself!

Niclas Virin is also a  member of the board of the Swedish IFA
Branch.