2. The Council has presented progress reports on its work on the code of conduct and the two proposals mentioned above, often referred to as the tax package, as well as in the field of energy taxation, to the European Council meetings in Vienna and Cologne. As the Council noted in its first report, the single currency will increase the transparency of the internal market and its potential for enhancing competition and efficiency. However, the transparency brought about by the euro will also accentuate the effects of remaining distortions, including those related to tax systems. The introduction of the single currency on 1 January 1999 thus adds to the importance of appropriate tax policy coordination.

3. The European Council in Vienna and in Cologne called for the Council to pursue work on the tax package so that agreement on its key components be reached before the Helsinki European Council, and the Council was invited by the European Council to produce a third report on reinforced tax policy cooperation to its meeting in Helsinki. This report is in response to that remit. For reasons set out below, however, it cannot report the agreement that the European Council in Cologne asked for. Instead, this report takes stock of the work done on the tax package and reviews, notably, the situation with regard to the main outstanding issues.

4. It is recalled that the Council at its meeting on 25 May 1999 took the position that the Directive on interest and royalties will only be adopted in the context of a decision on the whole tax package. In the context of discussions of the outcome of the work on the code of conduct, several Member States have underlined that the three elements of the package are indissolubly linked.

5. In the resolution on the code of conduct on business taxation (the Code), Member States commit themselves to refrain from new and to roll back existing harmful tax measures within the meaning of the Code in the area of business taxation. For competition to be efficient and fair, the location of business activity and investment should not be unduly affected by such tax measures. The purpose of the Code is to identify and curb the use of tax measures which are considered harmful from this point of view. The Code consequently concerns those harmful tax measures which affect, or may affect, in a significant way the location of business activity in the Community. Tax measures covered by the Code include both laws and regulations and administrative practices. Tax measures are to be regarded as potentially harmful and covered by the Code if they provide for a significantly lower effective level of taxation, including zero taxation, than those levels which generally apply in the Member State in question. The Code specifies criteria and procedures to be used when assessing whether tax measures are harmful.

6. In the Code Member States commit themselves not to introduce new tax measures which are harmful within the meaning of the Code. Also, Member States commit themselves to amend existing laws and established practices where necessary, having regard to the principles underlying and the review process provided for in the Code, with a view to eliminating any harmful tax measures as soon as possible and taking into account the Council's discussion following the review process.

7. As provided for in the Resolution, a Code of Conduct Group was established within the Council in order to assess the tax measures that may fall within the Code. The Group was requested to report regularly on the measures assessed and forward its reports to the Council for deliberation. Interim reports by the Group were presented to the Council on 1 December 1998 and 25 May 1999, and a comprehensive report was submitted to the Council meeting on 29 November 1999.

8. The Group, assisted by the Commission, has made great efforts, which are described in detail in the report of the Group to the Council, to accomplish the assessments of tax measures as provided for in the Code. The Commission, with the help of Member States, set up an (initial) list of measures that might fall under the scope of the Code. The number of potentially harmful tax measures to be assessed by the Group subsequently expanded considerably to take account of measures in Member States' dependent or associated territories and of requests by Member States to consider a wide range of additional measures.

9. The Group divided the initial list into five categories and a further category covering dependent or associated territories. The Commission Services produced short summaries of the measures under consideration and the Group agreed (in all but a few cases) the summaries as accurate and complete descriptions of the measures. The Group then undertook an initial assessment of the measures against criteria 1 to 5 of paragraph B of the Code. The Group further considered whether the measures provide for a significantly lower effective level of taxation, including zero taxation, than those levels which generally apply in the Member State in question, and whether tax measures aimed at the economic development of outermost regions and small islands are proportionate and targeted.

10. The Group has discussed thematic papers on issues relevant to its work. The Commission, to assist the Group in the evaluation process, presented a cross-country review of the tax treatment of holding companies in the Member States and commissioned a comparative study across Member States of administrative practices in taxation. It has been agreed that certain issues regarding the scope of the Code should be considered further in the Taxation Policy Group.

12. A main outcome of the work so far undertaken by the Group is that 66 of the tax measures assessed were considered by the Group to be harmful in the sense that they affect or may affect in a significant way the location of business activity in the Community. The measures relate to, inter alia, financial services, group financing, insurance, intra group services, holding companies, and offshore companies, and there are measures identified for almost all Member States and a number of associated and dependent territories. The measures and the reasons for the evaluation are set out in detail in the Group's report to the Council. Where unanimity was not achieved, the report reflects the broad consensus and alternative views are detailed in notes as appropriate. References to "the Group" should be construed in this way.

13. With regard to the proposal for a Directive on the taxation of savings, intensive discussions have taken place within the competent Working Party (at technical and high level), within an ad hoc meeting at political level convened by the Presidency and in the Council itself. Discussions have focused upon a number of issues and substantial progress has been achieved, yet views of Member States have not converged on some of the key issues. The most important unresolved issues may be set out as follows:

15. Subsequent discussion has focused notably on the paper on international bonds, presented in early September 1999 by the United Kingdom delegation. The paper proposes solutions which would effectively mean that all existing bonds and almost all new bonds (those held in a clearing system and other bond holdings above 40 000 euros) would be outside the scope of the Directive. The majority of other Member States would be willing to consider the exemption for some or all existing bonds ("grandfathering"), but consider that granting all the exemptions requested by the UK delegation would amount to a solution which is unjustified, as it does not meet the objective of the Directive of ensuring a minimum level of taxation, and as it does not provide an appropriate means of distinguishing between wholesale and retail markets. It is also considered unfair and it would distort competitive conditions by giving a tax privilege to bonds as compared to, e.g., bank deposits. Most Member States consider that the concerns underlying the UK position can best be tackled by appropriate ways of minimizing the administrative costs for market operators, bearing in mind also that payments made by issuers' paying agents to clearing systems are anyway outside the scope of the Directive.

16. Scope, investment funds. Luxembourg has repeatedly advocated the exclusion of investment funds and similar instruments. It recalled this position in a statement to the ECOFIN Council of 25 May 1999

The reasons for the Luxembourg request were outlined in a paper presented to the Council on 28 October 1999. Luxembourg notably pointed out

While some Member States either supported or are prepared to consider the Luxembourg request, the majority of other Member States considered that investment funds should be covered by the directive. In any case, a solution to this question should be sought in the light of the decisions on the treatment of international bonds.

18. Geographic coverage. The position of the UK delegation is related to its view that implementation of the Directive would cause the bond market to move outside the European Union, because the UK delegation considers that certain third countries are unlikely to introduce "equivalent measures" along the lines foreseen in the Council conclusions on 1 December 1997. Other Member States have considered that there are, in the light of the exploratory discussions pursued in early 1999 with five European non-EU countries, better prospects for coming to satisfactory agreements with third countries, provided that equivalent measures are applied also in dependent or associated territories of Member States. It should also be noted that for certain Member States it is an essential condition for the adoption of the directive that equivalent measures are applied in third countries and dependent or associated territories with important financial markets. It is in this perspective that the Presidency has suggested a sequence in which Member States first seek agreement on the substantial content on the Directive. In this respect, the UK delegation made it clear that their position on these issues remains as set out in their paper on international bonds. And then, in cooperation with the Commission, Member States would pursue discussions to enhance implementation of equivalent measures in dependent or associated territories. The Presidency and the Commission would deliberate with third countries to enhance the implementation of equivalent measures in these countries, and the Council would decide on enforcement of the Directive once sufficient reassurances with regard to equivalent measures have been obtained.

19. Tax rate. The Commission proposal provides for Member States that have opted for the withholding tax for a minimum rate of 20%. Member States are of the opinion that the problem of setting the rate of the withholding tax should only be taken when the other problems have been resolved.

20. Revenue sharing. This matter was not included in the original proposal from the Commission. Three Member States consider that the introduction of the Directive based on a model under which Member States may opt for a withholding tax system or an information system will lead to an unbalanced result. They argue that Member States that opt for the information system will be obliged to communicate information about interest payments to residents from other Member States. However, these Member States may in fact not receive information which is necessary to tax interest income of their own residents from Member States that have opted for the withholding tax-system. In general, these residents will not declare income received from paying agents in other Member States; as a rule the withholding tax will function as a final levy. In order to overcome this problem, these Member States were asking that the withholding tax which under the proposed Directive has been levied in the source State, will be transferred to the state of residence of the beneficial owner of the interest income. This means that no matter what system the state of residence has opted for, the tax shall be transferred to the state of residence. The opinion of the other Member States on this request is divided. While some Member States consider that this issue should make part of an overall solution to the present proposal, other Member States either do not support the request or prefer to discuss this item at a later stage, within the framework of a review of the Directive. One Member State suggested that receipts could be allocated on a macro-economic basis.

21. The points mentioned above and also other more technical issues require further clarification. Nevertheless, the most obvious prerequisite for successful work on the Directive is a resolution of the present deadlock due to the incompatibility between the position of the UK delegation on bonds and the considerations of other delegations. The Council considers that once a solution to this issue has been found, it should be possible to resolve the other outstanding issues.

22. It should finally be noted that at an ad hoc meeting at political level, Luxembourg suggested as an alternative to the present proposal a final withholding tax of 10%.

23. With regard to the proposal for a Directive on the abolition of withholding taxes on interest and royalties between associated companies, the Council at its meeting on 25 May 1999 already agreed on a number of key issues, and since then the competent Working Party has agreed on the technical details of the Directive. For some of these issues, it has so far not been possible to bring the examination to a conclusion. These issues include notably the non-application of the Directive in certain specific cases and the transitional rules requested by Greece, Spain and Portugal.

24. In addition to emphasising the need to make tax systems in Europe more employment-friendly and to combat harmful tax competition, the European Council in Cologne also reaffirmed the conclusion of the Vienna European Council by calling for the Council to continue its work on a framework for the taxation of energy on the basis of the ECOFIN Council report, bearing in mind the impact it will have on the environment.

25. Work subsequently done indicates that there still are a number of problems to be solved. It has notably emerged that there is an urgent need to resolve the problems of the relationship between state aid rules and the proposed Directive. All Member States are concerned notably about the consequences of Community state aid rules for the treatment of tax refunds, reduced tax rates or tax exemptions within the framework of the proposed Directive.

26. The application of state aid rules is an issue of Community competence. The Council considers that the Commission should prepare clear guidelines concerning their application with regard to tax exemptions or reductions as foreseen in the proposal. Problems related to the interpretation of state aid rules should be given top priority in subsequent work on the framework for energy taxation.