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EU Accession and the Romanian Tax System

Valentin Tic-Chiliment, Senior Tax Manager KPMG Bucharest
European Taxation (Number 5 - 2007)
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1. Introduction

1.1. Opening remarks

The Romanians claim to be the descendents of Roman occupiers of the province of Dacia, whose territory approximated to modern Romania. The modern Romanian state was created in 1918, when the historic provinces of Wallachia, Moldavia and Transylvania came together following the First World War.

Romania's democratic and economic reforms after the fall of the communist regime in December 1989 were initially slow. Elections took place in May 1990 and a new constitution was adopted in 1991 (updated in 2003), which confirmed the principles of democracy, private property and the market economy. Romania's progress was, however, marred by the violent suppression of anti-government protests. Economic reform was sporadic in the 1990s, with initial resistance to foreign investment and privatization. After the election of a centre-right government in 1996, greater liberalization followed, but progress was hindered by coalition infighting. High inflation and low levels of growth contributed to declining living standards. Under the centre-left government that took office in 2000, significant economic growth occurred, encouraged by greater interest from foreign investors due to Romania's forthcoming EU accession. Nevertheless, high levels of corruption remained a serious impediment to stable development. Romania joined NATO in 2004 and acceded to the European Union on 1 January 2007.

Whilst the economy continues to show strong progress, the ongoing disputes between members of the current centre-right coalition government have impeded stable law making. Investors are also still confronted by a lack of transparency, with overcomplicated taxation, as well as a legislative framework that can be uncertain and subject to frequent change. In the long term, Romania, however, shows significant potential for profitable investment.

1.2. History of EU accession negotiations

Romania was the first Central and Eastern European state to have an official relationship with the European Community, as, in 1974, Romania was included in the Community's Generalized System of Preferences. In 1993, Romania signed an Association Agreement with the European Union, which came into force on 1 February 1995. Three months later, in June 1995, Romania submitted its official application for EU membership.

Following several reports on Romania's progress towards the fulfilment of the accession criteria, the European Council decided in December 1999 to open accession negotiations. The negotiation process officially commenced in February 2000.

On 25 April 2005, Romania signed the Accession Treaty to the European Union. On 25 October 2005, the Commission issued the Comprehensive Monitoring Report on Romania*1. This document confirmed the progress made in respect of Romania's internal preparation for accession and indicated the measures to be undertaken to enable accession on 1 January 2007.

1 See http://delegatie.infoeuropa.ro/
ROMR2005.pdf.

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In May 2006, the Commission issued the Monitoring Report on Romania and Bulgaria*2, which listed the areas in which progress was expected to be made for these states to be able join the European Union on 1 January 2007. With regard to Romania, these areas related to food safety and the establishing of agencies to pay EU farm aids.

2 See http://eur-lex.europa.eu/
smartapi/cgi/sga_doc?
smartapi!celexplus!prod!
CELEXnumdoc&lg=en&
numdoc=506DC0214

In September 2006, the Commission issued its final Monitoring Report on Romania and Bulgaria*3, which recommended accession on 1 January 2007. In December 2006, the European Council confirmed the accession of Romania to the European Union on 1 January 2007. Accordingly, Romania acceded to the European Union on 1 January 2007.

3 See http://www.epha.org/IMG/
pdf/report_bg_ro_2006_en.pdf.

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1.3. Tax chapter

Romania opened negotiations on the Tax Chapter in October 2001 and provisionally closed the Chapter on 2 July 2003. As a result of the negotiations, Romania has been granted several derogations in applying the acquis communautaire*4, including:
-- a derogation from Art. 285 of Directive 2006/112/EC*5,6, regarding the special scheme for small undertakings in respect of the application of the threshold for VAT payers with an annual turnover of EUR 35,000;
-- a derogation from Art. 371 and Annex X Part B of Directive 2006/112/EC*7 regarding the application of the exemption from VAT in respect of the international transport of persons;
-- a three-year transitional period to 31 December 2009 in relation to the application of the overall minimum excise duty on the retail selling price (inclusive of all taxes) for cigarettes of the price category most in demand, provided that, in this period, Romania gradually adjusts its excise duty rates to the overall minimum excise duty set out in Directive 92/79/EEC*8; and
-- a derogation to create a special scheme in respect of excise duty on alcoholic beverages distilled from fruit homemade by farmers and intended solely for personal consumption equivalent to 50 litres of alcoholic drink per household per year with a concentration of 40% alcohol by volume by way of the application of 50% of the standard Romanian rate of excise duty.

4 Annex III and Annex VI Accession Treaty.

5 References are to Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, accompanied by references to Council Directive 77/388/EEC of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes -- Common system of value added tax: uniform basis of assessment (the Sixth VAT Directive), as appropriate.

6 Art. 24(2) Sixth VAT Directive.

7 Art. 28(3)(b) and Annex F(17) Sixth VAT Directive.

8 Council Directive 92/79/EEC of 19 October 1992 on the approximation of taxes on cigarettes.

The following transitional periods apply in respect of Directive 2003/96/EC*9:
-- Until 1 January 2011 to adjust the national level of taxation on unleaded petrol used as propellant to the minimum level of EUR 359 per 1,000 litres. The effective tax rate for unleaded petrol used as propellant must not be less than EUR 323 per 1,000 litres from 1 January 2008.
-- Until 1 January 2013 to adjust the national level of taxation on diesel used as propellant to the minimum level of EUR 330 per 1,000 litres. The effective tax rate for gas oil used as propellant must not be less than EUR 274 per 1,000 litres from 1 January 2008 and EUR 302 per 1,000 litres from 1 January 2011.
-- Until 1 January 2010 to adjust the national level of taxation on natural gas used for non-business heating purposes to the minimum level of taxation set out in Annex I, Table C.
-- Until 1 January 2010 to adjust the national level of taxation on heavy fuel oil used for district heating purposes to the minimum levels of taxation set out in Annex I, Table C.
-- Until 1 January 2009 to adjust the national levels of taxation on heavy fuel oil used for purposes other than district heating to the minimum levels of taxation set out in Annex I, Table C. The effective tax rate for the heavy fuel oil products concerned must not be less than EUR 13 per 1,000 kilogram from 1 January 2007.
-- Until 1 January 2010 to adjust the national level of taxation on electricity to the minimum levels of taxation set out in Annex I, Table C. The effective tax rates for electricity must not be less than 50% of the relevant Community minimum rate from 1 January 2007.

9 Council Directive 2003/96/EC of 27 October 2003 restructuring the Community framework for the taxation of energy products and electricity.

Until 31 December 2010, a four-year transitional period also applies in respect of the Interest and Royalties Directive*10. During this transitional period, the rate of withholding tax on payments of interest or royalties to an associated company of another Member State or to a permanent establishment situated in another Member State of an associated company of a Member State cannot exceed 10%.

10 Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States.

2. Indirect Taxes

2.1. VAT *11

Pre-accession, Romania's VAT legislation had already been significantly harmonized with the provisions of the Sixth VAT Directive. The new Value Added Tax Law*12, applicable from 1 January 2007, which is harmonized with Directive 2006/112/EC and the Sixth, Eighth*13 and Thirteenth*14 VAT Directives, implements most of the options in Directive 2006/112/EC and the Sixth VAT Directive.

The provisions that have been enacted on EU accession introduce improvements not only with regard to intra-Community trade, but also in respect of trade with non-EU countries. Specifically, persons registered for VAT purposes in Romania importing goods into Romania from 1 January 2007 do not have to pre-finance import VAT, as both intra-Community acquisitions and imports from outside the European Union no longer involve a cash outflow because VAT is accounted for via a reverse charge mechanism.

From 1 January 2007, it is also possible for "large taxpayers" that are closely connected by financial, economic and organizational links to form a single taxable person for VAT purposes, i.e. a VAT group, provided that each of the group's members is registered for Romanian VAT purposes. Currently, companies, the turnover of which exceeded ROL 70 million (approximately EUR 20.5 million) for the years ended 31 December 2004 and 31 December 2005 and companies active in specific business sectors, such as insurance companies and financial investment companies, irrespective of their annual turnover, qualify as "large taxpayers".

In addition, from 1 January 2007, simplification measures are available in several cases, which means that there is no requirement for a non-Romanian entity residing in the European Union to register for Romanian VAT purposes in respect of supply and installation contracts, call-off stocks and consignment stocks (subject, however, to certain conditions). The simplification measures also include the supply by an entity not established in Romania of goods situated in Romania (VAT is accounted for by the customer via the reverse charge mechanism, with no VAT obligation for the supplier) and certain toll manufacturing arrangements (there is no requirement for the non-Romanian owner of the goods to be registered for Romanian VAT purposes).

It should also be noted that, from 1 January 2007, the transfer of a business i.e. "the transfer of going concern" is outside the scope of VAT. This is expected to facilitate "asset deals" in respect of Romanian mergers and acquisitions.

11 Correct as at 1 March 2007.

12 Law 571/2003 (the Fiscal Code), published in the Official Gazette of Romania, 23 December 2003, with subsequent amendments.

13 Eighth Council Directive 79/1072/EEC of 6 December 1979 on the harmonisation of the laws of the Member States relating to turnover taxes - Arrangements for the refund of value added tax to taxable persons not established in the territory of the country.

14 Thirteenth Council Directive 86/560/EEC of 17 November 1986 on the harmonisation of the laws of the Member States relating to turnover taxes - Arrangements for the refund of the value added tax to taxable persons not established in Community territory.

2.2. Excise duties

Romania's accession to the European Union necessitated the introduction of a harmonized structure for excise duties in respect of tobacco products, alcoholic beverages, energy products and electricity, and minimum rates and rules on the production, movement, storage and monitoring of excise goods. The current scope and structure of Romanian excise duties was introduced into the Fiscal Code*15 via Law 343/2006, which entered into force on 1 January 2007. The tendency has been to increase the minimum excise duty rates, but, as noted in 1.3., Romania has negotiated several transitional measures with regard to the timing of the increases.

15 Law 571/2003, published in the Official Gazette of Romania, 23 December 2003, with subsequent amendments.

2.3. Tax on motor vehicles

A special registration tax has been enforced by the Romanian authorities from 1 January 2007. The Commission has questioned the conformity of these provisions with EC law. Specifically, the Commission decided to send Romania a formal request to amend the registration tax rules, which allegedly discriminate against second-hand cars brought from other Member States into Romania*16. The request is in the form of a "letter of formal notice", which is the first stage of the infringement procedure set out in Art. 226 of the EC Treaty. If Romania fails to provide a satisfactory response, the Commission may proceed with the second stage of the procedure and ultimately bring the case before the European Court of Justice (ECJ).

16 European Commission Press Release IP/07/372, 21 March 2007.

2.4. Indirect tax on the raising of capital

Currently, the raising of capital (both equity and debt) is not subject to capital duty in Romania.

3. Direct Taxes

3.1. Company taxation

3.1.1. Taxation of dividend payments between parents and subsidiaries
The EC Parent-Subsidiary Directive*17 has a double effect. On the one hand, it abolishes withholding taxes on dividend payments to qualifying EU resident parent companies and, on the other, it requires either an exemption from taxation for these distributions on receipt in the parent company Member State or, alternatively, the granting of a credit in the parent company Member State in respect of the underlying tax paid by the subsidiary. Accordingly, Romania exempts foreign dividends received by a Romanian resident and dividends paid to an EU parent company are exempt from withholding tax.

17 Council Directive 90/435/EEC of 23 July 1990 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States.

The EC Parent-Subsidiary Directive had already been implemented in the Romanian Tax Code prior to Romania's accession to the European Union, but only applies from 1 January 2007*18. The Directive applies to dividends paid both between companies resident in Romania and between companies resident in Romania and companies resident in other Member States. For the provisions of the EC Parent-Subsidiary Directive to apply, the minimum shareholding required by the Romanian law is 15% (to be reduced to 10% from 1 January 2009) with a minimum holding period of two years. If at the time of a dividend payment from a Romanian company to a qualifying EU parent, the two-year holding period has not been satisfied, the withholding tax exemption can still apply as long as the shares continue to be held after this date for sufficient time so as to enable the two-year holding period to be satisfied. In this case, however, the withholding tax must be paid and, once the two-year holding period has been satisfied, the tax paid can be reclaimed.

18 Law 571/2003, published in the Official Gazette of Romania, 23 December 2003, with subsequent amendments.

3.1.2. Taxation of corporate reorganizations
The EC Merger Directive*19 facilitates cross-border mergers, acquisitions and divisions as well as related operations, such as transfers of assets or share exchanges, by exempting these operations from tax the capital gains that may arise as a result of the transactions. Although the benefits of the EC Merger Directive consist of a deferral of the capital gains tax (rather than a full exemption), the Directive helps to ensure that restructuring operations carried on by companies resident in Member States are treated as tax neutral.

19 Council Directive 90/434/EEC of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States.

The provisions of the EC Merger Directive (as amended by Directive 2005/19/EC*20) have been implemented into the Romanian Tax Code, with effect from 1 January 2007*21. The provisions apply to both reorganizations between domestic companies and to cross-border reorganizations involving companies resident in Member States. Accordingly, the merger of a Romanian company with an EU company should, in principle, be tax neutral in the same way as is a merger between two Romanian companies.

In practice, it is, however, difficult for a cross-border merger involving a Romanian company to be effected, as Romania's domestic legal provisions governing mergers have not been updated to reflect the implementation of the EC Merger Directive. A potential method to achieve such a merger, but which only applies in limited cases, would be the conversion of the Romanian company into a European Company (Societas Europaea), the seat of which could then be transferred from Romania to a different Member State so that the merger could be carried out.

20 Council Directive 2005/19/EC of 17 February 2005 amending Directive 90/434/EEC 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchange of shares concerning companies of different Member States.

21 Law 571/2003, published in the Official Gazette of Romania, 23 December 2003, with subsequent amendments.

3.1.3. Taxation of interest and royalty payments between associated enterprises
The Interest and Royalties Directive is intended to eliminate withholding tax on qualifying interest and royalty cross-border payments between related parties. In Romania, the Interest and Royalties Directive has not yet been implemented into domestic legislation. According to the provisions of the Accession Treaty to the European Union signed by Romania, following Romania's accession but, at the latest, by 1 January 2011 (the date on which the Interest and Royalties Directive will become applicable in Romania), a 10% maximum withholding tax rate will apply to interest and royalties originating from Romania if the recipient holds at least a 25% shareholding in the income payer for a minimum holding period of two years, unless the income earner benefits from a more favourable rate under a tax treaty in force between Romania and the Member State in which the beneficiary has his fiscal residence (see 1.3.).

If at the time the interest or royalty payment is made, the two-year holding period has not yet been satisfied, the withholding tax exemption can still apply if the shares continue to be held for sufficient time to enable the two-year holding period to be satisfied. In these circumstances, however, the withholding tax must be paid and, once the two-year holding period is satisfied, the tax paid can be reclaimed. From 1 January 2011, interest and royalties paid by a Romanian company to an associated EU company (i.e. at least 25% direct ownership, with the recipient being either a direct subsidiary or a direct parent or owned by a common direct parent) will not be subject to withholding tax.

3.1.4. Harmful tax competition
Romania has not been formally criticized by the European Union regarding "harmful tax competition". It may, nevertheless, be worthwhile noting that Romania's tax law currently provides for a "micro-enterprise tax regime", under which companies qualifying as "micro-enterprises" (fewer than nine employees, an annual turnover of less than EUR 100,000 and deriving more than 50% of their revenue from activities other than consulting and management) may choose to pay tax on turnover (at a rate of 2% in 2007) instead of paying profit tax (at the regular rate of 16%). Whilst it is questionable whether or not this regime is fully compliant with EU legislation, it should be noted that the regime is currently being phased out and will no longer be available from 1 January 2010.

3.1.5. State aid
Romania has a new legal framework regulating State aid, i.e. Government Emergency Ordinance No. 117/2006, which applies from 1 January 2007. The new legislation is intended to regulate the national procedures on State aid, with a view to applying Art. 87 to Art. 89 of the EC Treaty, as well as the secondary legislation adopted on the basis of these articles. Specifically, under Government Emergency Ordinance No. 117/2006, the Romanian Competition Council ensures the relevant contact between the Commission and Romanian public authorities and institutions, other providers of State aid, and the beneficiaries of the State aid. It should, however, be noted that State aid in respect of agriculture and fisheries, which is granted according to the provisions of Art. 32 of the EC Treaty, does not fall within the provisions of Government Emergency Ordinance No. 117/2006.

3.1.6. Transfer pricing
3.1.6.1. Arbitration Convention and Code of Conduct on effective implementation
Romania has not yet formally ratified the EC Arbitration Convention*22.

3.1.6.2. Code of Conduct on transfer pricing documentation for associated enterprises
Currently, there are no provisions in Romanian legislation requiring the taxpayer to prepare documentation justifying the group transfer pricing policy. It is, however, anticipated that the tax authorities will, in the near future, release guidelines with this objective in mind, which are expected to be in line with the recommendations in the Code of Conduct on transfer pricing documentation for associated enterprises.

22 Convention 90/436/EEC of 23 July 1990 on the elimination of double taxation in connection with the adjustment of profits of associated enterprises.

3.1.7. ECJ case law
The ECJ's decision in Denkavit International BV, VITIC Amsterdam BV and Voormeer BV*23 has been implemented into Romania's domestic legislation via the Norms for the application of the Fiscal Code*24 and, therefore, the two-year period required for the exemption from Romanian withholding tax in respect of dividend, interest and royalty payments to an associated enterprise should be interpreted in the light of this ruling.

As noted in 2.3., the Commission has taken the view that the Romanian legislation on car registration tax fails to meet the standard of complete neutrality and must, therefore, be changed to comply with the EC Treaty. Failure to do so could result in the first ECJ case regarding Romania.

Potentially, Romania's legislation contains provisions that could be challenged. One such provision exists in the Norms for the application of the Fiscal Code, according to which transactions between Romanian residents are excluded from challenge by the tax authorities on transfer pricing grounds, as opposed to transactions between residents and non-residents. Whilst the author considers this to be discriminatory, an analysis of the implications and the potential remedial actions are outside the scope of this article.

23 ECJ, 17 October 1996, Joined Cases C-283/94, C-291/94 and C-292/94, Denkavit International BV, VITIC Amsterdam BV and Voormeer BV v. Bundesamt für Finanzen.

24 Approved by Government Decision No. 44/2004, with subsequent amendments, published in the Official Gazette of Romania No. 112/2004.

3.2. Individual taxation

3.2.1. Savings
The Savings Directive*25 has been transposed into the Romanian Tax Code with effect from 1 January 2007*26. Specifically, the Savings Directive provides for no withholding taxes to be levied in the source Member State and introduces into Romanian domestic legislation various relevant terms and definitions.

3.2.2. ECJ case law
Romanian tax legislation is generally framed so as to treat all persons equally, irrespective of nationality. It is, therefore, unusual to encounter provisions that could be regarded as discriminatory for EU nationals in comparison with Romanian nationals.

25 Council Directive 2003/48/EC of 3 June 2003 on taxation of savings income in the form of interest payments.

26 Law 571/2003, published in the Official Gazette of Romania, 23 December 2003, with subsequent amendments.

4. Administrative Cooperation and Mutual Assistance

The Mutual Assistance Directive*27 has been transposed into the Romanian Tax Code with effect from 1 January 2007*28. In particular, the domestic provisions corresponding to the Mutual Assistance Directive set out guidelines regarding the exchange of information between the tax authorities of the Member States (exchange on request, automatic exchange and spontaneous exchange) and clarify that the Romanian competent authority for the purpose of the exchange of information provisions is the Ministry of Finance or its authorized representative.

5. Conclusions

Romania has been largely successful in adapting its taxation system to meet EU requirements and in establishing transitional periods, if necessary. There are, however, still a number of steps that must be taken before Romania will be fully in line with established Member States, such as the introduction of effective documentation requirements in respect of transfer pricing. Many investors also complain that Romanian tax legislation is too complicated and lacks transparency. In addition, the instability of the legal framework sometimes makes it difficult for companies to plan their business. If Romania is to develop to its full potential, it must, therefore, concentrate not only on harmonizing its tax system with EU requirements, but also on providing a simple, transparent and stable taxation and legislative framework.

27 Council Directive 77/799/EEC of 19 December 1977 concerning mutual assistance by the competent authorities of the Member States in the field of direct taxation and taxation of insurance premiums.

28 Law 571/2003, published in the Official Gazette of Romania, 23 December 2003, with subsequent amendments.