The EU Commission consults on its BEFIT proposal

The European Commission has published a call for evidence and public consultation on its proposal for the introduction of a common corporate tax system in the EU. The consultation is open for responses until 5 January 2023.

This initiative aims to introduce a common set of rules for EU groups operating cross-border to calculate their taxable base, together with agreement on a method for allocating profits between EU countries based on a formula.

The Commission argues that the proposal will reduce compliance costs by creating a coherent approach to corporate taxation in the EU, but the proposal and its predecessor (the common consolidated corporate tax base) have long been controversial and resisted by a number of Member States.

Background

In May 2021, the EU Commission published a Communication to the European Parliament and the EU Council entitled "Business taxation for the 21st century" with its blueprint for new post-pandemic EU tax agenda to meet the social, financial and tax challenges of the years ahead.

One, unsurprising, aspect of the blueprint was the renewal of the broad aim for an EU wide common tax base for businesses. The EU Commission has previously presented similar proposals in 2011 and 2016 for a common corporate tax base (CCTB) and common consolidated corporate tax base (CCCTB), which were proposed to apply to corporate groups with consolidated revenue exceeding €750m, with an opt-in option for smaller groups.

The new proposal is for a framework for income taxation for businesses in Europe (BEFIT). BEFIT is to be a single corporate tax rulebook for the EU, based on the key features of a common tax base and the allocation of profits between Member States based on a formula. In particular, the EU Commission hopes to build on progress made in the global discussions around BEPS 2.0, where similar concepts are being negotiated, through the use of a formula for the partial reallocation of profits under Pillar 1, and common rules for calculating the tax base for the purposes of applying Pillar 2.

Public consultation

The Commission has now published a call for evidence for an impact assessment and asked for public feedback on its BEFIT proposal, which confirms that the Commission intends to table a legislative proposal for a new corporate tax system in 2023. More details of the proposal are provided within the questionnaire itself.

There is currently no common corporate tax system in the EU, despite the EU Commission's best efforts to promote its CCCTB proposal. Instead, taxpayers operating cross border have to deal with up to 27 different tax systems and the Commission points out that this lack of a common corporate tax framework makes EU businesses less competitive, both due to distortions in investment and financing decisions (when motivated more by tax optimisation strategies than other considerations) and also due to increased compliance costs for businesses operating in more than one EU country. This potentially puts EU businesses at a competitive disadvantage compared to businesses operating in markets outside the EU.

To address this problem, the Commission intends to propose a new, comprehensive, structural reform of the EU business tax framework consistent with, and partially based on, the principles that underpin the OECD/G20 Inclusive Framework Two-Pillar Approach. BEFIT will be a new set of rules to replace 27 different corporate tax systems for the businesses and companies affected and the questionnaire recognises that simplicity will be paramount in this regard.

BEFIT will apply to EU businesses or companies that are part of groups which, in most cases, are present in more than one EU country (the BEFIT Group). For compatibility with EU law and to maintain a level playing field, groups of companies that operate in only one country may also be included. BEFIT may apply to groups with global (consolidated) revenues above a certain threshold, or its scope could be broader than that, for a more inclusive system. These are options on which the questionnaire seeks to gather responses.

Initially, it will be necessary for the BEFIT proposal to establish the key principles that underpin the features of a common EU corporate tax base. There are two broad ways of designing the tax base. One is to create a comprehensive and detailed system of common rules for the tax base, as in the earlier CCCTB proposal. The other way, based on Pillar 2 of the OECD Approach, is to establish the tax base by applying limited tax adjustments to companies' financial accounts. This second option uses the financial accounts as a starting point for calculating the tax base of each company in the group of companies in question. The next step is to consolidate the individual tax bases of all the group members before apportioning them, using a formula, to the EU countries where group members have a taxable presence. The choice between these two systems is a key question for the public consultation.

The public consultation seeks the public's views on the BEFIT proposal, including the various policy options, to design the main features of BEFIT including:

• the scope of the new system including whether it should only apply to groups with over €750m of consolidated global revenues or also to smaller groups;
• how to calculate the common tax base;
• how to consolidate the individual tax bases of the members of the BEFIT Group and allocate the consolidated base across EU countries;
• how to allocate profit for transactions with businesses or companies outside the BEFIT Group; and
• what administrative simplifications could be introduced with the proposal.

Should the proposal take the Pillar 2 approach, the questionnaire seeks feedback on the range of issues that should give rise to tax adjustments, including:

• depreciation of fixed assets;

• exemption of received profit distributions (non-deductibility of linked expenses);

• exemption of the income and non-deductibility of the losses of a permanent establishment;

• non-deductibility of corporate taxes and similar profit-based taxes;

• rules on addressing the debt bias;

• tax credit on income already taxed outside the EU (other than exempt income) such as interest, royalties and other income paid to a company within the scope of BEFIT;

• anti-abuse rules on common issues such as a general anti-abuse rule (GAAR), controlled foreign company (CFC) rules, interest deduction limitation and hybrid mismatches;

• rules on entering and leaving BEFIT (corporate restructuring and transition phase).

As a next step, the individual tax bases of all group members (i.e. EU tax-resident companies or EU-located permanent establishments of companies established outside the EU) would be added together to form a consolidated tax base. Given consolidation eliminates intra-group transactions in the EU, it would no longer be necessary to apply transfer pricing to transactions between a consolidated group's companies. Instead, a formula would be used to allocate profits between the different EU countries in which the group operates with a taxable presence. Another outcome of such consolidation would be the relief of cross-border losses if one group member is, or two or more group members are, loss-making for tax purposes.

Finally, to ensure that BEFIT is as simple as possible, the Commission notes that it would be preferable to have only limited sectoral carve-outs. This is why the consultation looks at how the BEFIT formula for profit allocation could be put to best use in certain sectors, such as the financial services sector. The questionnaire also seeks feedback on how to apply such sector carve outs. For example, one possibility would be that where revenues arising from excluded activities exceed 50% of a company's total revenue, the company's full income is excluded from the BEFIT tax base for the tax year in question.

One of the most difficult aspects to reach agreement on historically has been the apportionment of tax revenues between Member States under any common tax base. The questionnaire notes that the Pillar 1 formula only uses one factor, but envisages that the more complex BEFIT would use at least three factors. Formulary apportionment is a mechanism for allocating the tax base among eligible jurisdictions (EU countries) on the basis of a set of pre-determined weighted factors. This formula would replace the existing transfer pricing rules for allocating profit among eligible EU countries.

The basic factors suggested for use are tangible assets, staff numbers, payroll and sales by destination. The higher these are in an EU country, the greater the share of profit that will be allocated to this country. However, the questionnaire notes that an alternative would be to also include intangible assets in the formula.

Transfer pricing

Under BEFIT, the arm's length principle will continue to apply to pricing transactions between companies of the BEFIT Group and group companies that are tax-resident outside the EU. The questionnaire suggests that the initiative could simplify the methods for applying transfer pricing rules, to give taxpayers greater legal certainty but without deviating from the arm's length principle. In particular, it suggests that to provide tax certainty, the a system based on industry benchmarks could be used to determine whether a tax authority would be likely to investigate transactions. This would not replace the arm's length principle, and companies would still need to carry out the necessary transfer pricing analysis. But it would provide guidance on how tax authorities would assess the risk of certain transactions without departing from the OECD rules.

Under such a system, the transaction between a company of the BEFIT Group and one outside it would be assessed as being of low, medium or high risk for not complying with the arm's length principle. This would depend on how payment for the transaction compares to a series of benchmarks for each category of industry and type of activity.

Comment

Comments and responses on the questionnaire are required to be submitted by 5 January 2023. The Commission plans to adopt a legislative proposal for BEFIT, after taking into account comments from the public consultation, in the third quarter of 2023.

The proposal is clearly an important and far-reaching one for all multinationals doing business in the EU and careful attention should be paid to its progress. The UK was, in particular, a stumbling block for the CCCTB proposals and, following Brexit and the agreement in principle of formulary apportionment in the BEPS 2.0 negotiations, the Commission may have more success this time around. However, the proposal will of necessity be complex and agreement in principle may not necessarily translate into agreement in detail -- at least in the short term.