Last year, I praised two reports about the EU’s economic challenges by former Italian prime ministers Enrico Letta and Mario Draghi — but wrote that “Brussels is the place where good reports come to die”. I am pleased to admit that I was wrong in this case. Neither report has died, even though far too little of either has been implemented. This week’s anniversary of the Draghi report’s publication received due attention at the highest levels in Brussels. A high-level conference took stock of progress. Research appeared about what remains to be done. Draghi himself warned of complacency.
A common thread throughout both the Letta and Draghi reports is that Europe has failed to let its companies get the full benefit of the scale of the EU’s single market, and of its vast amount of saved capital. Addressing this shortcoming will take a range of bold policies. But there is one particularly useful step advocated by both Letta and Draghi: establishing what is known as a “28th regime” of corporate law. This is already on the European Commission’s work programme, and a public consultation is under way. But more political urgency is needed.
Proponents of the idea have an uphill battle to fight: very few people know what the 28th regime is and why it matters. So at this stocktaking moment of how the EU is adapting to the new and more cut-throat world, Free Lunch’s contribution will be to nudge that appreciation along.
The rhetorical commitment to the 28th regime is there. In her State of the Union speech last week, commission president Ursula von der Leyen namechecked the plan: “for innovative companies . . . the so-called 28th regime”. In a speech to the stocktaking conference, Draghi repeated that:
A true ‘28th regime’ must become reality — allowing innovative firms to operate, trade and raise financing seamlessly across all 27 member states, just as competitors can in other large economies. This is especially important to give young Europeans a chance in their continent. The commission is moving in this direction. But with uncertain backing from the member states, the first step will likely be limited to a digital business identity.
What is more, some of Europe’s most innovative entrepreneurs are backing the idea through a campaign for an “EU-Inc”.
An idea raring to be realised, then, if only enough political force was rallied behind it. So below is your cheat sheet to the 28th regime if you are not feeling up to scratch, followed by some questions that need to be resolved soon by those already committed to the proposal.
What is the 28th regime?
Letta’s report on the single market explains that the idea is to create a “European business code” that companies could opt into as an alternative to being regulated by one of the 27 national legal systems under which they happen to be incorporated. By incorporating directly under a pan-EU code, a company and its investors could embrace pan-EU activity while complying with only one set of rules, floating above the thicket of different national codes.
The 28th regime would, in other words, permit something akin to the “passporting” rights that allow companies registered in one EU country to operate in another. The companies that adopted it would be, as it were, passporting in from nowhere to all EU member states.
Why is it needed?
Largely because the single market does not do what it promises at the moment. In most activities, companies have to comply with a new set of rules every time they expand into a new EU country. The consequences are huge. It makes it much more costly to expand than in more uniform markets such as the US (which Letta points out has a Uniform Commercial Code) or China. As a result, many European companies, especially small ones, cannot realistically aim for the 450mn-strong EU single market that is in theory on offer. And if scale is unachievable, then the productivity and profits that come with scale remain out of reach too, as both Letta and Draghi warn.
This could be seen as a case of too much regulation — each country having its own different rules — but could just as well be seen as not regulating enough, as policymakers resist agreeing new, common EU rules to replace pre-existing 27 national rule books.
So what may present itself to businesses as an administrative and bureaucratic “red tape” problem is in reality a political problem. Or multiple political problems. One very highly placed official in an influential EU finance ministry once told me to remember that the real obstacle to harmonising EU rules was not political differences between member states, but within member states between government departments and their culture. (My interlocutor was proud of finally vanquishing opposition over justice ministry officials so as to be able to strike agreements with counterparts in other EU countries — but since that conversation, political changes in several countries mean the work may need to start all over again.)
For this and other reasons — such as every country thinking its own system is best — it is extremely difficult to wipe away national laws. The 28th regime presents an elegant solution: if countries can at least agree on an optional system of rules hovering somewhere above national ones, and if (a big if, this one) that system is attractive to businesses, then one may be able to get harmonisation as businesses voluntarily converge on the common rules, sidestepping national differences without having to abolish them.
How does it need to be designed?
The upshot of all the above is that a 28th regime for the corporate code holds the tantalising promise of many more European companies scaling up and raising finance inside the EU rather than crossing the Atlantic to take advantage of better opportunities there. But fulfilling this promise requires that any new pan-EU corporate code actually works, both in attracting the best companies and in really making funding and scaling up easier. A 28th corporate code so complicated and onerous that no company would choose to use it would not help anyone. So the devil is in the detail of how the scheme is designed. Here are some questions of principle that need to be answered at the outset.
Is it only for ‘innovative’ companies? The way Draghi and von der Leyen talk about it, the 28th regime is seen as a boon for the companies of the new frontier economy, in artificial intelligence, quantum technology and the like. The Letta report makes it sound like a much broader policy, where “the true game-changer lies in the impact on SMEs”. So which is it to be?
A paper by Anne Sanders, law professor at Bielefeld University, gives what is surely the sensible answer. A formal restriction to a certain type of innovative company only creates a need to verify if a company that is interested in pan-European incorporation meets whatever criteria bureaucrats concoct for being “innovative” enough. But some companies need a common European code more than others — and it is most urgent to create one for the promising companies that move to the US for the best chance of scaling and funding. So, as Sanders concludes, the regime should be designed to serve the needs of innovative tech start-ups, but be general enough and open to any company that may wish to use it.
The EU-Inc initiative echoes this. In their very useful list of “things we DON’T want”, the promoters reject a regime that is “only for start-ups” because that would require defining a start-up and tests of eligibility. (They also reject a legal requirement for notaries, rules that can be interpreted differently by different countries, and government subsidies that entail additional bureaucracy to check eligibility.)
Sanders suggests a framework that welcomes “exit-oriented business with venture capital investments as well as long-term oriented businesses”, gives “access to qualified courts that decide cases quickly ensuring a uniform application of the law across Europe”, and offers “standardised shareholder agreements and articles of association of high quality”. EU-Inc wants “one new pan-European legal entity”, “one central EU-level registry”, “standardised investment documents” for early-stage funding and “standardised EU-wide stock options”. The campaign also asks for a “dedicated EU-wide fast-track court system specialised in EU-Inc’s matters”.
What elements of the corporate code should be included? Earlier discussions of the 28th regime focused on insolvency law and fundraising rules, since the problem to be addressed was seen as the fragmentation of the banking and capital markets. But it could make sense to include many more areas of law. The Letta report, for example, argues that a European Business Code could involve:
the establishment of a Simplified European Company to provide a more adaptable legal structure for businesses . . . scope may be expanded to include the following areas of law, where applicable: general commercial law, market law, e-commerce law, company law, securities law, enforcement law, insolvency law, banking law, financial market law, intellectual property law, employment law and tax law.
It’s best not to get too excited. There is an obvious trade-off here between comprehensiveness and the likelihood of getting a common European corporate code off the ground at all. So it may be best to keep it lean, focus on the elements that are definitively needed, and work on making those as growth-friendly as possible.
But no matter how lean you want to be, it seems unavoidable to include an element of tax law. That’s because a 28th regime cannot but raise questions of corporate tax residence. Under standard (national) rules, the country of incorporation (headquarters) has a claim on taxing corporate profits. So what to do with a company that’s not incorporated in any country? The corporate profit tax is, of course, not going to disappear. But that makes it imperative to resolve the taxing rights question at the pan-EU level so that the new company status is not suffocated at birth by overlapping and contradictory national rules.
This means, at the very least, that the corporate tax base of profitable 28th-regime companies is clearly and uniformly defined in a way that allocates the tax based definitively to national taxing authorities. That would leave countries free to choose their corporate tax rate like today (even better would be to agree on a single tax rate, but that should not be allowed to hold up the establishment of a 28th regime). They would have to define the amount of profit on which that rate is applied, however, according to the uniform pan-EU rules. There are also other cross-border tax obstacles to clear away, for example, relating to VAT differences or withholding taxes on capital income.
The tax should be predictably allocated between EU countries based on a simple formula. The start-up founders behind EU-Inc, for example, favour the following:
A transparent and consistent methodology for allocating profits based on where an EU-Inc entity conducts its business will ensure transparent, equitable taxation across jurisdictions. This could involve considering factors like headcount, assets and sales in each jurisdiction, preventing disputes and ensuring fairness in taxation across Member States.
Any mention of tax sharing causes ructions in most EU decision-making forums, but there is nothing particularly exotic about such “formulary apportionment”. It is how US companies operating across multiple US states are treated for the purposes of determining state corporate income tax liability. And, frankly, there is no other logical option once the opportunity exists for EU companies not to be incorporated in any member state.
Other readables
● It’s time for the gloves to come off in the EU’s digital policy, argues Daniel Mügge for the Brussels Institute for Geopolitics.
● The Paris authorities are taking radical steps to make housing more affordable.
● How the Swiss central bank turned into a veritable sovereign wealth fund with large stakes in US tech.
● Dan Neidle has a good list of sensible tax changes a UK government could adopt if it were committed to comprehensive reform (as I have argued makes sense both economically and politically).
