A harmonized taxable basis for the EU
On 12 September 2023, the European Commission (“EC”) proposed a Directive on Business in Europe: Framework for Income Taxation (“BEFIT” or the “Proposal”). The Proposal replaces to a certain extent the Common Corporate Tax Based and Consolidated Corporate Tax Base proposals and essentially leverages recent developments with respect to (i) Pillar 2 which also starts from a common tax base, (ii) Pillar 1 which proposes formulary apportionment to reallocate certain profits and (iii) the increased administrative capacity of tax authorities across the EU. The EU Member States envision an implementation of BEFIT by 1 January 2028 with an application as from 1 July 2028.
This Proposal follows the EC communication “Business Taxation for the 21st Century” on 18 May 2021 and has been issued together with the EC proposal for Directive on Transfer Pricing.
In addition to a set of common rules to determine the taxable basis of group of companies that have annual combined revenues exceeding EUR 750 million, the Proposal provides for a simplified risk assessment procedure for low-risk distributors and contract manufacturers.
BEFIT clearly provides that an entity in scope “shall cease to be subject to the national corporate tax law in all Member States where it is established in respect of all matters regulated by this Directive” while Member States retain the possibility to determine adjustments applicable to their allocated share of taxable profits.
BEFIT scope
BEFIT should apply to EU tax resident companies and EU permanent establishments belonging to a domestic or multinational (“MNE”) group that prepares consolidated financial statements and have combined annual revenues of EUR 750 million or more in at least two of the last four fiscal years.
Where the ultimate parent entity (“UPE”) of the group (i.e., the entity consolidating line by line the assets, the liabilities, income, expenses and cash flow of other entities), is not located in the EU, the combined revenue of the group in the EU must exceed either (i) 5% of the total revenues for the group based on its consolidated financial statements or (ii) the amount of EUR 50 million in at least two of the last four fiscal years.
Where the combined revenue threshold is not met, the domestic or MNE group may opt-in subject to the preparation of consolidated financial statements. The option is binding for a five-year period and should be renewed at the end of the period.
The BEFIT rules are limited to situations where the UPE holds, directly or indirectly, at least 75% of the ownership rights or profit rights in an EU entity during the fiscal year and their EU permanent establishment(s). Sectors such as shipping, international transport and extractive industries are not per se benefiting from a scope exclusion, but their specifics are considered for the purposed of the computation and/or allocation of the tax base.
Preliminary tax result computation for each group member
The computation of the individual tax base of group members starts from the financial accounting net income or loss determined using the same acceptable accounting standard (standard applied by the EU UPE or EU filing entity for groups with a non-EU based UPE).
A set of specific adjustments is then to be applied, notably the exclusion of (i) 95% of dividends and distributions, and capital gains and losses when the BEFIT group member held for more than one year an ownership interest carrying a right to more than 10% of the profits, capital, reserves or voting rights, (ii) ownership interests gains/losses resulting from fair value adjustments, or (iii) the profit or loss of permanent establishments. Interest deduction limitation rules (ATAD regulations), should be restricted to transactions carried out with non-BEFIT group members. Furthermore, specific rules regarding depreciations, stocks, provisions, bad debts, result from long term contracts and hedging instruments are considered.
Change in the BEFIT group size (entities entering or leaving the group) and business reorganizations are also apprehended through special rules.
Aggregation into a single tax base, allocation, and domestic adjustments
Preliminary tax results of the BEFIT group entities should subsequently be aggregated to form the BEFIT tax base. EC puts forward that such aggregation benefits are threefold: (i) offsetting losses across jurisdictions, (ii) simplified transfer pricing rules for intra-BEFIT group transactions and (iii) withholding tax relief on interest and royalties paid within the BEFIT group if the beneficial owner is part of such group (to be assessed at national level).
BEFIT tax base should then be allocated to each group member by application of an allocation key corresponding to the average of the three prior taxable bases of a group member over the sum of the individual average. During the first year of application, the taxable basis considered should be the domestic tax base to be progressively replaced by the preliminary tax result as computed under BEFIT.
As intra-BEFIT group transactions of the members might affect the allocation key, the proposal includes a simplified transfer pricing assessment based on the variation of income or expenses from these transactions for a given fiscal year compared to their average amount in the previous three fiscal years. A variation of less than 10% will be deemed low risk and at arm’s length. Where the 10% threshold is reached or exceeded, pricing will be presumed not at arm’s length leading to denial of the portion exceeding 10% for the allocation key purposes (reversal of proof lies with the taxpayer).
This allocation key should be applicable until 30 June 2035. Afterwards, the EC should determine a permanent allocation rule that could be based on formulary apportionment taking into consideration the experience from the first years of BEFIT application and the potential impact of Pillar 2 Directive.
Allocated portion of the tax base should be subject to a common set of adjustments (technical adjustments and commonly accepted tax adjustments within the provisions of domestic legislation). The Proposal foresees possibilities for Member States to set further adjustments (increasing or decreasing the allocated portion) for BEFIT group members resident in their jurisdictions. The Explanatory Memorandum provides that domestic adjustments must respect the rules set by Pillar 2.
BEFIT filings and local assessment
BEFIT will in practice require two levels of filings: (i) one information return for the BEFIT group to be filed by the EU UPE or a designated entity when the UPE is non-EU based and (ii) one local BEFIT return to be filed locally by each individual member of the BEFIT group.
BEFIT teams composed of representatives of the tax authorities from relevant EU jurisdictions should be responsible for the review of the information return and referred to where domestic adjustments might affect such information return.
Local tax authorities should remain responsible for the issuance of individual tax assessments. Tax rate and enforcement rules should continue to rely on domestic legislation. BEFIT group member should be entitled to an administrative and judicial appeal against the individual tax assessments which would be governed by the laws of the BEFIT group member’s jurisdiction.
Simplified transfer pricing compliance for low-risk distributors and contract manufacturing
Distribution activities taking place through low-risk distributors and manufacturing activities through contract manufacturer (as defined in the BEFIT proposal) within a BEFIT group or with associated enterprises outside of such BEFIT group should be subject to simplified TP reviews. Entities engaged in additional activities might still benefit from such simplification to the extent that other activities can be segregated or are ancillary and immaterial.
With respect to these activities, the EC intends to publish public benchmarks on which the harmonized risk assessment will be based. Depending on the positioning of the taxpayer within the public benchmark, it will be classified as low risk (above 60th percentile), medium risk (below 60th but above 40th percentile) or high risk (below 40th percentile).
Finally, the Proposal includes a harmonized set of incremental actions local tax authorities may take depending on the risk exposure:
- Low risk: no allocation of resources is needed but adjustment for profits outside the low-risk zone is possible.
- Medium risk: monitoring of the results and seeking information from the taxpayer before initiating risk assessment and audits.
- High risk: recommendation to the taxpayer to review its TP policy and initiating a review or audit.
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