Commission proposes BEFIT and Transfer Pricing Directives

The EU Commission has published proposals for two new Directives, the first covering its proposal for a common framework of corporate taxation (BEFIT) and a second on transfer pricing (TP) rules. Both are significant developments, but will require unanimity from all 27 Member States to progress.

In the longer term they offer the prospect of more harmonised approaches to the taxation of large cross-border groups within the EU, but perhaps at the cost of further short term administrative burdens. And whilst the BEFIT rules share some similarities with the Pillar 1 and 2 rules (the latter to be implemented in the EU by a Minimum Tax Directive), there are significant differences meaning that affected businesses (and tax administrations) would need to deal with yet another set of tax rules.

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 proposal involves 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 around BEPS 2.0, 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.

In autumn 2022, the Commission published a public consultation on its BEFIT proposals which are summarised in our article, The EU Commission consults on its BEFIT proposal.

Proposed BEFIT Directive

The BEFIT Directive is a lengthy and complex proposal running to 80 articles. However, broadly, it involves recognition of an EU wide group, a common basis for determining the profits of each member of that group and then a formulaic allocation of that profits to each member (to be taxed by the relevant Member State).

The BEFIT Directive would apply to EU entities (including PEs) that belong to an MNE group (based on a 75% ownership condition) with consolidated revenues exceeding €750m in at least two of the previous four years. However, there is an exception for smaller entities belonging to non-EU headquartered MNEs. These will not fall within the scope of BEFIT if the revenues in the EU do not exceed €50m or 5% of the total group revenues in at least two of the previous four years. Entities that do not meet this criteria may still opt into the regime.

The profits or losses of each entity in the MNE is then determined based on its financial statements used for consolidation purposes, making upward and downward adjustments in accordance with the provisions of the Directive in a manner similar to the Pillar Two. Section two covers a range of required adjustments, section three covers depreciation and section four timing and quantification rules.

Each profit / loss is then aggregated into an overall BEFIT tax base and (if positive) is allocated amongst the MNE entities. If there is a loss, then this is carried forward and set off against any future BEFIT profit. It should be noted that the result is a form of relief for cross-border losses.

The BEFIT tax base is then allocated amongst the group members in accordance with ratios based on the average taxable results in the previous three years of the particular member divided by the total taxable results of the whole BEFIT group over that period. Whilst transfer pricing is not strictly applied within a BEFIT group, the Directive does include provisions to enable risk-based approach to intra-group pricing with the ability to derecognise amounts in high risk scenarios for the purposes of the baseline allocation percentage unless the BEFIT group is able to provide evidence that the amounts concerned are arm's length.

Chapter IV of the proposed Directive includes a simplified approach to transfer pricing compliance for transactions between BEFIT members and non-BEFIT members of the MNE group in relation to low-risk distribution and manufacturing activities. In these cases, Member States will use public benchmarks for distribution and manufacturing activities to risk assess the intra-group activities. This is somewhat similar to the Amount B proposal within the OECD's Pillar 1 approach, but extended to manufacturing in addition to distribution activities.

The proposed Directive also includes detailed administrative and procedural rules for the application of the BEFIT approach, including the need to file one BEFIT return for the entire group and Member States concerned required to establish a BEFIT team within one month after filing the return to consider the return. Each BEFIT member is still required to file an individual tax returns including the BEFIT computations.

The EU Commission propose that these rules should come into effect from 1 January 2028.

Proposed Transfer Pricing Directive

The Transfer Pricing Directive is proposed to come into effect from 1 January 2026 and is designed to provide for a common approach to transfer pricing across the EU based on the OECD transfer pricing guidelines. Essentially, the Directive would require Member States to include in their national rules transfer pricing (TP) rules based on the OECD Transfer Pricing Guidelines 2022. However, the proposed Directive goes further in seeking to achieve a consistent approach to a number of aspects of these rules.

Firstly, the proposed Directive would provide a common definition of an "associated enterprise". This would be based on a 25% participation threshold (based on voting rights, capital or profits) or otherwise participation in the management by being in a position to exercise significant influence over the other entity. The 25% threshold is lower than the threshold normally applied by most jurisdictions.

Secondly, the Directive seeks to bring in procedures for dealing with corresponding adjustments. When a Member States makes an adjustment to the profits of a group entity, the counterparty's Member State would be required to deal with request for a corresponding adjustment to prevent double taxation within 180 days.

In the case of compensating adjustments (ie an adjustment that a taxpayer reports as an arm's length price even though it differs from the amount actually charged by the associated enterprise), the Directive would require Member States to accept these if certain conditions are met. These include the taxpayer making the adjustments symmetrically in all Member States, taking the same approach consistently over time, making the adjustment before filing a tax return and being able to explain why its forecast did not match the result achieved.

The Directive also includes provisions dealing with identifying the commercial and financial relations between associated entities, acceptable TP methods, determining the most appropriate method, comparability analysis and determining the arm's length range and TP documentation requirements.  

The Directive leaves open the possibility of further rules, consistent with the OECD Guidelines, on how the arm's length principle should be applied to specific transactions including transfers of intangibles, intra-group services (including marketing and distribution services), cost contribution arrangements, business restructurings, financial transactions and dealings between head office and PEs.

Comment

Both proposals with require unanimous approval of all 27 Member States in order to progress and it is uncertain at this stage whether that is realistic. Previous Commission efforts to introduce common corporate tax rules have been met with resistance, but the example of the OECD's Pillars 1 and 2 approach may make progress on BEFIT more palatable. On the other hand, the BEFIT proposal would not be fully aligned with Pillar 2, meaning yet another layer of complexity for both affected businesses and tax administrations to cope with.

In relation to the TP Directive, much may depend on whether Member States see the advantages of closer harmonisation of the application of TP rules within the EU outweighing the flexibility they currently have within the OECD Guidelines.