One-stop shop for EU SMEs with EU permanent establishment(s)
On 12 September 2023, the European Commission (“EC”) proposed a Directive establishing a Head Office Tax system for micro, small and medium sized enterprises and amending Directive 2011/16/EU.
The contemplated Head Office Tax (“HOT”) system intends to simplify tax obligations of standalone SMEs with one or more permanent establishments (“PEs”) in other EU Member States.
SMEs with PEs located in the EU can opt to compute the taxable basis of their PEs under the rules applicable to the head office, file a single tax return and pay of the tax liability to the head office Member State, thus interacting only with a single tax authority. The latter would apply the tax rate of the PEs’ relevant Member State, exchange the filed return and share tax revenue with relevant Member States. The proposal does not affect allocation of taxing rights applicable under relevant double tax treaties.
Scope of application
The Directive would apply to stand alone SMEs operating in other Member States only through PEs:
- SME definition: micro, small and medium-sized is defined by reference to Directive 2013/34/EU on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings.
- Legal form and taxation: the SME must be formed under the laws of an EU Member State, have a legal form listed in the appendix to the Directive (which includes corporate entities and certain partnerships) and be subject directly or at the level of its owners to a tax listed by the Directive (the list includes corporate taxes and personal income taxes).
- Tax residency: the SME must be resident for tax purposes in a Member State (under domestic legislation and relevant bilateral conventions for the avoidance of double taxation).
- Stand-alone status: the SME is not part of a consolidated group for financial accounting purposes and is an autonomous enterprise without being either (i) an associated enterprise as defined under Directive 2013/34/EU or (ii) a linked enterprise as defined under Commission Recommendation 2003/361/EC.
The above-mentioned SMEs are eligible where during the last two fiscal years (i) the joint turnover of its PEs did not exceed the double of the head office’s turnover, (ii) it has been tax resident in the head office Member State and (iii) it has qualified as a micro, small and medium-sized under Directive 2013/34/EU.
The option for the HOT system would apply to all EU PEs in existence at the time of the request and those created during the application of the regime.
Head offices deriving shipping income subject to a tonnage tax are excluded from the mechanism.
Mechanics of the HOT system
- Opting in: the head office shall notify its domestic tax authorities (i.e., filing authority). If the requirements are met, the latter inform the tax authorities of the PE’s Member State (the host Member State) which in turn provides the applicable tax rate.
- Tax return filing: the head office files one tax return with its domestic tax authorities computing its own tax liability as well as the tax liability of its PEs using the host Member State tax rules and rates.
- Tax assessments: the filing authority issues a tax assessment to the Head Office and draft tax assessments to the PEs. The latter documents, together with the tax return, documentation mandatorily filed under the laws of the head office Member State and relevant information for taxation under the host Member State are provided through automatic exchange of information to the host Member States.
- Review by host Member States: the latter can accept or reject the draft tax assessment. If the assessment is rejected, the host Member State must revise this draft tax assessment in connection with the attribution of profits rules under the relevant double tax treaty.
- Possible appeal by the head office: the head office might appeal against the PE’s tax assessment accepted by the host Member State before the filing authority and under its domestic rules. Appeal against the PE’s assessment revised by host Member State might take place before the Courts of the head office jurisdiction. Disputes on the attribution of profits to the PEs shall be settled under the relevant double tax treaty or the Directive on tax dispute resolution mechanisms in the EU.
- Collection of tax due: the head office settles with its domestic tax authorities its own income tax and the tax liability of its PEs. In turn, the filing authority transfers the relevant amounts initially collected with the host Member States.
- Tax audits: domestic rules governing tax audits, legal remedies and proceedings remain applicable. Host Member States can also request a joint audit on the computation of the taxable result of the permanent establishment in accordance with the head office taxation rules, the attribution of profits to the permanent establishment and/or the applicable tax rate.
Duration, renewal, and termination of the option
The HOT system applies for a five-year period and its renewal is subject to prior notification.
The mechanism ceases to apply within the five years period when (i) the head office transfers its tax residency outside the Member State or (ii) for at least two fiscal years the joint turnover of the PEs exceeded three times the head office’s turnover (the system no longer applies as from the fiscal year that follows the one in which the event takes place).
Transposal and application
Based on the current proposal, Member States must implement the Directive by 31 December 2025 and apply its provisions as from 1 January 2026.
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