Background
The Commission’s view is that businesses having to comply with up to 27 different national tax systems increases uncertainty and tax compliance costs for those operating in more than one Member State. However, the idea of developing a single tax base in the EU is not new and the Commission’s previous attempts to secure agreement on this have been unsuccessful. There was the Common Consolidated Corporate Tax Base (CCCTB) proposal in 2011, which was found to be “too ambitious to be adopted in a single step”. So after years of discussion and little progress, the Commission re-launched this in 2016 in the form of a two-step approach, with the first step being a common base (Common Corporate Tax Base or CCTB), and the second step relating to consolidation (the second “C” in CCCTB, i.e. the aspect that proved most problematic in negotiations) to follow later. However, even this was not enough for the proposal to get off the ground and another five years later, in May 2021, as a part of its Communication on Business Taxation for the 21st Century, the Commission announced its intention to withdraw the 2016 CCCTB proposals and to replace them with a new BEFIT proposal in 2023.
So, the obvious question is why would BEFIT succeed where other proposals have failed? The Commission hopes that the answer to this lies in the fact that the international tax landscape has shifted with the OECD’s two-pillar project, as to which see our webpage here. Things that were previously unimaginable, such as formulary apportionment, have become part of the global conversation on pillar one. In addition, there has been international consensus across over 135 jurisdictions on a single method for calculating the effective tax rate of multinationals based on consolidated financial statements under pillar two. This, importantly, includes buy-in from all EU Member States, resulting in the adoption of the Pillar Two Directive (2022/2523) in 2022.
So, what is the Commission’s latest proposal and how would it work?
Who is in scope and what is a BEFIT group?
The new rules would apply to EU tax resident companies and EU located permanent establishments (PEs) and will be mandatory for domestic or multinational groups operating in the EU with an annual combined revenue of at least EUR750 million in at least two of the last four fiscal years (irrespective of whether this combined revenue is realized within the EU or not).
The BEFIT group would include all relevant EU companies and PEs of a group (BEFIT group members), where the ultimate parent entity holds, directly or indirectly, at least 75% of the ownership rights or of the respective rights giving entitlement to profit. Non-EU headed groups are only in scope of the mandatory rules if their BEFIT group raises at least EUR50 million combined revenue in the relevant period and this accounts for at least 5% of total group revenues.
The rules will be discretionary for other groups, which may opt in for a five year period as long as they prepare consolidated financial statements.
Whilst the EUR750 million threshold has intentionally been aligned with the pillar two threshold to help ease compliance, the composition of the group that you test the threshold against is not the same. The BEFIT group uses a 75% ownership test, whereas the pillar two group turns on accounting consolidation, which in general requires control (>50%). This, together with the additional threshold for non-EU headed groups, means that falling within pillar two does not necessarily mean that BEFIT will apply and separate computations may need to be done to work out if your pillar two group is also within BEFIT.
Calculating the preliminary tax result
To calculate the tax base or “preliminary tax result” of a BEFIT group member, you start with the consolidated financial statements, in particular, the financial accounting net income or loss for the year, and then make various adjustments.
Adjustments are required in relation to (amongst other things): dividends and capital gains or losses on certain ownership interests; profits or losses from PEs; borrowing costs in excess of national interest limitation rules (i.e. in accordance with ATAD, the Anti-Tax Avoidance Directive) but only in respect of amounts paid to parties outside the BEFIT group; and financial assets or liabilities treated as being “held for trading”. Plus, account is taken of amounts already accrued in respect of corporate taxes, as well as pillar two top up taxes and domestic top up taxes.
A set of common rules in relation to depreciation are to be introduced, plus certain adjustments to address timing and quantifications issues, such as when provisions are allowed and how gains and losses on hedging instruments should be treated. There are rules setting out what happens when entities leave or join the BEFIT group, as well as rules governing reorganisations.
The adjustments to be made are intended to be considerably simpler than those required under pillar two, which is potentially helpful, but in practice will require another separate set of computations to be made. This does raise the question of whether having an imperfect alignment with pillar two will aid compliance or just lead to more complexity.
By way of example, articles 8 and 9 of the BEFIT proposal provide for an adjustment in relation to ownership interests to exclude 95% of dividends or distributions (article 8), 95% of gains or losses on disposition (article 9) and 100% of fair value gains or losses (article 10). In each case, the ownership interests must have been held for over a year and must carry a right to more than 10% of profits, capital, reserves or voting rights. It is curious that whilst there is some alignment with pillar 2 (with the 10% threshold), there are important differences. For instance, whilst the one year holding period applies for Excluded Dividends (the pillar two equivalent of article 8), it does not apply to Excluded Equity Gains or Losses (the pillar two equivalent of articles 9 and 10). And the adjustment under pillar two is for the whole amount of the dividend, gain or loss, rather than 95% as applies to articles 8 and 9, but confusingly not article 10. These differences will unfortunately require additional computations to be made for BEFIT purposes compared to pillar two, even in situations where on the surface it might appear that the rules are aligned.
That said, on the whole the computations for BEFIT do appear much simpler than those required under pillar two, which would be a great benefit if groups were not required to do those calculations anyway (on the basis that a group that meets the BEFIT group criteria is likely to be a group for pillar two purposes, given the pillar two grouping test is wider).
What is the BEFIT tax base?
Once the preliminary tax results of all BEFIT group members are calculated, these are aggregated to produce the BEFIT tax base which is then allocated between the members of the group.
The Commission sees various benefits to this aggregation, one of which is the ability to set off losses across borders, a goal the Commission has been striving to accomplish since the days of the original CCCTB proposal.
In addition, there would be no withholding tax on intra-BEFIT group transactions unless the beneficial owner of the payment is outside the BEFIT group. This concession may well encourage groups that are below the mandatory thresholds to consider opting in. Beneficial ownership is not defined for these purposes but is intended to be determined under national law. Interestingly, withholding taxes collected on payments of interest and royalties made to those outside the BEFIT group are to be shared between Member States according to the general allocation method (as to which see below).
Similarly, if a BEFIT member derives income that has already been taxed in another jurisdiction, a tax credit is to be granted in accordance with treaties or national law and this is also to be shared between BEFIT members.
Allocation of the BEFIT tax base
Once you have added together your preliminary tax results to produce the BEFIT tax base, this is allocated based on each entity’s portion of the BEFIT group’s taxable results in the last three years. This is a temporary allocation method that will be replaced by 2035 at the latest.
When the Commission consulted on BEFIT back in 2022, the focus when it came to allocation of profits was on formulary apportionment and whether intangible assets would be included as a factor in addition to tangible assets, labour and sales by destination. However, the inclusion of this transitional method of allocation in the proposal released on 12 September indicates that Member States are not there on formulary apportionment and, perhaps fearing this aspect could sink the entire project, the Commission has opted to defer this aspect of the rules, with a mechanism for its potential inclusion in the future.
There are also special rules dealing with attribution and adjustments to the tax base for extractives, shipping and aircraft activities. Again, there is alignment, but not quite, with pillar two, with special rules applying to shipping income for pillar two purposes, although what is excluded under those rules is not the same.
In addition, the rules provide for a number of post-allocation adjustments that have to be made, for instance amounts that do not make sense to be allocated under the rules, such as amounts accruing or losses incurred before BEFIT came into effect. Further, not wanting to cut across rules incentivizing pension provisions and charitable donations, so national rules providing for these to be deductible are to be respected.
However, the biggest challenge to the whole concept of alignment comes in the form of article 48, paragraph 2, which essentially allows national tax administrations to introduce whatever adjustments to the allocated part (whether up or down) that they want under national law. As noted by the Commission in the introduction to the proposal, the only restriction on Member States in this regard is to respect the rules of the pillar two directive (and, although not specifically mentioned in the proposal, presumably other general rules of EU law such as state aid).
Transfer pricing
The proposal also includes provisions to simplify transfer pricing compliance (note that this is in addition to the separate proposal for a Directive on Transfer Pricing that was released on the same day as the BEFIT proposal).
For intra-BEFIT group transactions, during the transitional period, the requirement for compliance with the arm’s length principle will be retained. Where expenses or income from intra-BEFIT group transactions remain within a limit of less than 10% increase compared to the average of the previous three fiscal years (the ‘low-risk zone’), there is a presumption that the arm’s length principle has been applied. For those in the remaining ‘high-risk zone’, there is a presumption that the pricing does not comply with the arm’s length principle and (subject to provision of evidence to the contrary) the relevant increase beyond 10% threshold will not be recognized when computing the respective baseline allocation percentage.
For transactions with associated enterprises outside the BEFIT group, again, a risk-based approach is proposed in relation to qualifying distribution and / or manufacturing activities. This is referred to as a ‘traffic light system’ as it features low, medium and high risk categories. The risk categories will be determined based on public benchmarks (profit markers to be set at the EU level). For those in the low-risk zone, Member States “may not dedicate additional compliance resources to further review the transfer pricing results” but will have a right to perform adjustments of the profit margins. Those in the high-risk zone may be subject to review or audit and those in the middle may be monitored before deciding whether to dedicate resource to investigate further.
BEFIT returns and BEFIT teams
The proposal aims to create a “one-stop-shop” to allow businesses to deal with a single tax authority in the EU for filings. However, the reality is more complex than that. Although the BEFIT return is to be filed in a single jurisdiction (which would be shared with other Member States where the group operates), the proposal does not do away with the need for individual tax returns to be filed with the local tax administration of each BEFIT group member. Local tax authorities would remain responsible for BEFIT group members settling of tax liabilities.
New BEFIT teams with representatives from different tax authorities would be created to help ease communication and resolution of issues between tax authorities as well as enabling amendments to the BEFIT tax base to be made across the BEFIT group through a coordinated process.
Audits can only be initiated by the Member State of the relevant entity in accordance with national law, but other Member States can request a joint audit. Interestingly, although other Member States can “express a view” on the results of an audit carried out that impacts the BEFIT tax base, it does not say what happens if different Member States disagree on the right approach.
Appeals on BEFIT questions are to be made to the BEFIT filing administration, whereas appeals on individual tax assessments would still be to the Member State of the relevant entity. Whereas, judicial appeals on both BEFIT returns and individual tax assessments are to be made to the Member State of the relevant entity.
This hybrid “one-stop-shop” approach to administration is, according to the Commission’s Impact Assessment Report, required to deal with those elements of the administration of BEFIT which touch upon national tax sovereignty, such as audits and dispute resolution. The Commission notes that, it is therefore “unavoidable that local tax authorities have to maintain most part of their current role” in those areas and therefore that a more limited “one-stop-shop” approach has had to be adopted.
Concluding thoughts and what comes next?
There is a clear tension throughout the proposal between, on the one hand having co-ordinated aligned provisions to achieve the stated aim of reducing the compliance burden for multinationals, and on the other hand preserving national sovereign, as no doubt required by Member States and therefore needed to achieve unanimity. The ability to make national adjustments to the allocated part, the need for individual tax returns to be filed, all pull in the opposite direction to the aims of the proposal and the more divergence there is between Member States, the less effective BEFIT will be in achieving simplicity.
Similarly, the reduction in compliance burden that could stem from an alignment with pillar two, potentially diminishes with every step that BEFIT departs from the pillar two rules.
Interestingly, there is no sign of the proposal that was intended to mitigate the debt-equity bias in corporate investment decisions (DEBRA or the Debt Equity Bias Reduction Allowance initiative). This was supposed to be wrapped up in the BEFIT initiative but the BEFIT proposal simply states that it is “in line with and complements a number of recent proposals made by the Commission”, including DEBRA. Thus, one can only suppose that this was put in the too difficult for now category.
If adopted by the Council, the proposal would come into force on 1 July 2028. But will BEFIT stand any more chance of achieving unanimity than the previous attempts? Possibly. The international tax landscape has moved on. Formulary apportionment (and DEBRA) have been put off till later. There has been a bid to preserve national sovereignty. Things previously thought impossible have become reality. Never say never. The EU may actually be fit for BEFIT.
The authors would like to thank Mykhailo Razuvaiev for his contribution to this article.
