Further attempts to harmonise and simplify direct taxation in the EU
December 2023 | SPECIAL REPORT: CORPORATE TAX
Financier Worldwide Magazine
December 2023 Issue
On 12 September 2023, the European Commission (EC) adopted three new proposals for directives: a proposal called Business in Europe: Framework for Income Taxation (the BEFIT proposal) introducing a new, single set of rules to determine the tax base of groups of companies at European Union (EU) level; a proposal aiming at harmonising transfer pricing (TP) rules within the EU (the TP proposal); and another proposal establishing a head office tax system for micro, small and medium-sized enterprises (SMEs) (the HOT proposal), according to which the taxable results of each permanent establishment of an SME located in another EU member state would be calculated in accordance with the applicable rules of the state of the head office if the SME chooses to opt for this system. Thus, the rules for SMEs during their early stages of expansion would be considerably simplified. In this article we will only deal with the first two proposals.
BEFIT proposal
The BEFIT proposal introduces a common framework for calculating the corporate income taxable base at EU level, which will simply the process and reduce costs for multinational groups that currently must comply with different tax regimes across the EU.
However, the aim of establishing a common system for calculating the tax base in the EU is not new. The EC had already adopted two previous proposals for a common corporate tax base (CCTB) and a common consolidated corporate tax base (CCCTB) for the same purpose, neither of which were successful. The BEFIT proposal replaces both proposals by withdrawing them.
It is intended that the existence of a common set of rules to determine the tax base of EU resident companies that are part of certain groups will harmonise and simplify the tax environment in the internal market, thus reducing high tax compliance costs for businesses operating in the EU, and putting an end to tax uncertainty, discouragement of cross-border investment and competitive disadvantage for EU businesses.
The BEFIT proposal puts forth a hybrid scope for mandatory and optional application of its rules. EU tax resident entities, including permanent establishments located in the EU, of large multinational groups fall mandatorily within the scope of the BEFIT proposal, irrespective of whether the ultimate parent entity is resident in the EU, provided that certain requirements are met. These EU entities constitute what is known as the ‘BEFIT group’.
For groups headquartered in the EU, the amount of annual combined revenues of the group in at least two of the last four fiscal years must be at least €750m and the ultimate parent entity of the group must hold, directly or indirectly, at least a 75 percent shareholding. However, for those groups headquartered in third countries, it is additionally required that the revenues of the BEFIT group exceed 5 percent of the group’s total revenues or €50m in at least two of the last four years.
Smaller groups below the €750m threshold can voluntarily opt-in, provided they prepare consolidated financial statements.
Computation of the corporate income taxable base follows a fairly simple method starting from the financial accounts and arriving at a certain outcome, which is called the ‘preliminary tax result’, based on a limited number of adjustments. The individual preliminary tax results of all BEFIT group entities are then aggregated and subsequently allocated to each BEFIT group entity.
The financial accounts of the EU entities within the group are the starting point for calculating the corporate income taxable base. These financial accounts must follow the accounting standard of the EU ultimate parent entity, or the EU entity appointed by the BEFIT group if it is headquartered in a third country. The accounting standard must be accepted under EU law, meaning either the generally accepted accounting principles (GAAP) of an EU member state, or international financial reporting standards (IFRS)).
To obtain the preliminary tax results, subsequent additions, reductions, special depreciation rules, other adjustments and adjustments relating to entries and exits of BEFIT group entities will be necessary. For simplification purposes, the BEFIT proposal keeps such adjustments to the minimum necessary.
Once the preliminary tax results of all BEFIT group members have been obtained, they will be aggregated to obtain a BEFIT tax base, which will then be allocated to the BEFIT group members according to a transitional formula applicable for each fiscal year between 1 July 2028 and 30 June 2035 at the latest. This transitional allocation formula, which is more simplified than the allocation formula contained in the previous CCTB and CCCTB proposals, takes into account the average of the taxable results of each BEFIT group member in the previous three fiscal years. At the end of the seven-year transitional period, the transitional allocation formula will have to be reviewed, so the permanent formula may become very different from the transitional one.
To ensure that member states are fully competent in their tax policies, they can freely apply additional deductions, tax incentives or increases to the allocated tax base.
This method of calculating the tax base applicable at EU level provides companies with several benefits, the most important of which is cross-border loss relief, so that if some companies are loss making within a group, they can offset their losses against the profits of other companies within the group. In other words, it allows for cross-border netting of profits and losses.
Other benefits are that no withholding taxes will be levied on transactions, such as interest and royalty payments within the BEFIT group, unless the beneficial owner is not a member of the BEFIT group, and that certain TP simplifications will apply.
The EU ultimate parent entity, or the EU entity appointed by the BEFIT group if the ultimate parent entity is not resident in the EU, is obliged to file the BEFIT information return with the tax authorities in the member state where it is resident within four months of the tax year end.
Where a BEFIT group exists, tax authorities will form a BEFIT team, composed of representatives from each of the tax authorities of the EU member states where the BEFIT group has members. Its task is to examine the integrity and accuracy of the data provided in the BEFIT information return and reach a consensus on its content within four months.
After approval of the BEFIT information return, each member of the BEFIT group will have to file its individual tax return with its national tax authority within three months.
The BEFIT proposal, if approved, will have to be transposed by EU member states by 1 January 2028 and will enter into force on 1 July 2028.
TP proposal
Regardless of the existence of a political commitment to implement the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines, the application of this non-binding instrument and its actual implementation currently differs between EU member states.
Therefore, a new proposal for an EU directive on TP, the TP proposal, has been adopted for the first time ever with the aim of clarifying the role of the OECD Transfer Pricing Guidelines in the EU, harmonising member states’ rules on TP, and ensuring a common and uniform application of the arm’s length principle across the EU.
The TP proposal will apply to all companies resident in a member state, as well as to permanent establishments located in the EU.
The TP proposal contains a common definition of ‘associated enterprise’ and also a definition of ‘the arm’s length principle’ without explicit reference to the OECD standard.
With regard to the arm’s length price charged in a controlled transaction between associated enterprises, the TP proposal provides that it should be determined by applying one of the following valuation methods: the comparable uncontrolled price method, the resale price method, the cost-plus method, the transactional net margin method, or the profit split method. Only in exceptional cases may other valuation methods be applied.
The proposed directive does not suggest a specific order of application, but states that the most appropriate TP method should be used, taking into account the circumstances of the case.
In addition to these more general rules, the TP proposal also includes provisions on comparability analysis, determination of the arm’s length range and TP documentation.
The TP proposal, if approved, will enter into force on 1 July 2026.
Final remarks
The BEFIT and TP proposals will have to be agreed unanimously by the member states in the Council of the EU to go through. It remains to be seen whether they will be approved in view of the difficulties faced by other proposals, such as the CCTB and the CCCTB proposals, which were ultimately not adopted, and the fact that a substantial harmonisation of the corporate income taxable base of EU resident entities has already taken place in recent years through the anti-tax avoidance directives.
Finally, it is doubtful that the simplification sought by the BEFIT proposal will be achieved, given that its rules will only apply compulsorily to large groups of companies, so that two sets of rules for determining the taxable base (i.e., EU and national rules) will essentially coexist in all member states. This situation will not help to achieve the desired simplification, unless many small groups decide to switch from national to European tax rules, making national tax rules unnecessary.
Eduardo Gracia is head of the tax practice group and Lorena Viñas is a senior tax expertise lawyer at Ashurst. Mr Gracia can be contacted on +34 91 364 9854 or by email: eduardo.gracia@ashurst.com. Ms Viñas can be contacted on +34 91 364 9417 or by email: lorena.vinas@ashurst.com.
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Eduardo Gracia and Lorena Viñas
Ashurst
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