Taxation "red line" – a figment of the Government’s imagination

Yesterday, their Lordships held a formal debate on the EU constitution. The full debate transcript runs to 72 pages (in Word format), so its is difficult to summarise the whole debate and do it justice. As an alternative, therefore, we propose to publish edited highlights from the key speeches. The first of these extracts, from Baroness Noakes on direct taxation by the EU, makes compulsive reading.

The Baroness opens with an apology for her ignorance of more general EU matters, but then tells the noble Lords that she intend to cover her “more natural territory” taxation and economic policy. On this, she is very far from ignorant. She continues:

The Government have often asserted that taxation is a red line area. For example, the Prime Minister said:

"Issues to do with taxation . . . will remain the prerogative of our national Government and Parliament".—[Official Report, Commons, 25/6/03; col. 707.]

But such statements, like so many that relate to the draft constitution are at best harmless spin and at worst positively misleading.

Article 93 of the treaty on European Union deals explicitly with harmonisation of indirect taxation and that requires unanimity. To date, we have managed to keep several of our very important derogations, despite a number of attempts by the Commission to take them away from us. We have our veto and it is clearly important that it is retained. But there is no specific reference to direct taxation in Article 93 or elsewhere in the treaty, so there is no explicit veto at present. When the Prime Minister said a few weeks ago that:

"The national veto must remain in areas such as taxation".—[Official Report, Commons, 20/4/04; col. 155.]

he could not have been referring to direct taxation since no veto exists. He was perhaps using "veto" in a colloquial sense but that is, in my view, misleading.

It is generally argued in relation to direct taxation that the fact that there is no reference in the EU treaty means that there is no competence for the EU and there being no competence there is no need for a veto. That is very nice theory but it is not the position in practice, which is why accepting the draft constitution does not achieve the strong defence of the UK's position in relation to direct taxation that the Government would have us believe.

The commission has long had ambitions to get its hands on direct taxation. It has tried several times since the 1970s to introduce directives to harmonise various aspect of income tax and corporation tax. Fortunately, it has failed to date but it has not given up. One example is its formal opinion on the draft constitution last year, which made clear its ambitions for a more precise demarcation of the Union's authority in relation to taxation. For "more precise demarcation" we have to read "more power to the commission".

It is against this backdrop that the UK Government's apparent defence of their taxation powers needs to be examined. The most important current threat to our taxation autonomy is the European Court of Justice. The lack of reference to direct taxation in the EU treaty would reasonably lead to the conclusion that the ECJ has no role.

But the ECJ has embarked on a stealthy extension of its jurisdiction, under the cover of enforcing fundamental freedoms in EU law. In particular, Article 43, which deals with the freedom of establishment, has been used as a Trojan horse to attack national tax laws. The ECJ has only really got going on this in the past 10 years and there have been several cases where UK tax law has been found to be in breach of EU law, forcing a change in our law. It started with a case brought by ICI and, for the sake of form, I declare an interest as a director of that company.

It was a case on consortium relief that cost British taxpayers quite a lot of money. Recently, the Chancellor had to devote a great chunk of this year's Finance Bill to introducing a raft of bureaucratic and costly intra-UK transfer pricing rules following the German case of Lankhorst Hohorst. Most professional advisors think that a lot more UK tax law will need to change in the wake of that decision and there are many other cases in the pipeline.

Against that background, the lack of formal competence of the EU in direct taxation matters looks like a side show. If the Government are serious about taxation remaining a prerogative of the government and Parliament it is not a question of defending existing EU treaty provisions. It actually requires a change to the treaty to ensure that the ECJ cannot interfere through the back door in matters for which they have no entry rights through the front door.

The draft constitution does not appear to tackle tax directly and that is what the Government appear to be pledging to uphold. But there is one area of the draft constitution that holds massive dangers both to our fiscal freedoms and to our economic freedoms. Article 14 deals with the co-ordination of the economic policies of member states…

This is another Trojan horse. Economic policy cannot be separated from taxation policy. It would, I assume, cover the overall level of taxation and quite possibly some detailed provisions. The very lack of definition of what is meant by "co-ordination of economic policy" should be a cause for major concern.

Article 14 is not merely for those who want to join the euro-zone. That club already has economic rules, as we know. With the growth and stability pact they are observed in the breach as much as in the observance. Euro-zone countries should already be on notice that they are on the slippery path to tax harmonisation. Former commissioner Solbes is reported to have said that member states within the euro-zone cannot be allowed to pursue whatever tax and spending policies they want after joining the euro. The danger in Article 14 is that the rest of Europe, and in particular the UK, will be sucked into that abyss.

The Government's talk of red lines in taxation is misleading. Our country is already in danger of losing taxation powers through existing treaty rules and will be further at risk if Article 14 is allowed to remain in the final constitution. What we actually need is a robust and unequivocal statement of the commission's lack of competence in relation to national taxation matters, coupled with the ECJ being firmly removed from this territory.

Anything less than that will show that the Government's red line on taxation is no more than a figment of their imagination.

To read the whole debate, click here.