The new “EU tax group” for company groups: BEFIT proposal for a directive has been published
On 12 September 2023 the European Commission has published the proposal for a directive for a European framework for corporate income taxation (“Business in Europe: Framework for Income Taxation”; BEFIT). BEFIT contains a proposal for the introduction of a Europe-wide tax group including a partially single tax base for certain large groups of companies in the EU. If applicated, the directive would be a game changer and bring about further profound changes to international tax law for company groups.
Background/objectives
In the past years several attempts were made regarding the introduction of a common corporate tax base within the EU. In the Communication on Business Taxation for the 21st Century in May 2021, the Commission has proposed for the first time the project BEFIT as measure to unify corporate income tax regulations within the EU (see hereto our Newsletter from 26 May 2021). By decision of the directive on a global minimum level of taxation (Pillar Two directive) this topic picked up speed leading to the current publication of the BEFIT proposal. By introducing a common corporate tax base the Commission expects among other to eliminate discrepancies arising from the interaction of different tax systems within the EU, to reduce bureaucracy as well as to generally strengthen the internal market. The directive is to be applied by the member states as of July 2028.
Furthermore, the Commission has published on 12 September 2023 a proposal for an EU Directive on Transfer Pricing in order to harmonise transfer pricing guidelines. In the following we give an overview mainly on the proposal for the BEFIT directive. Regarding the proposal for a directive on transfer pricing please see our separate newsletter.
Which companies are affected?
BEFIT will be mandatory for national and international company groups with an annual combined revenue of at least EUR 750 million. This corresponds in large part to the scope of the Pillar Two directive. However, it is a prerequisite that the company groups (i) are headquartered in the EU or have permanent establishments in the EU and (ii) have a participating interest of at least 75%.
If the ultimate parent of the company group is headquartered in a third country, the directive only applies if the revenue of the company group within the EU amounts to at least 5% of the total revenue based on the consolidated financial statements or to EUR 50 million in at least two of the last four tax years (so-called materiality threshold).
Company groups which do not meet the size criteria but prepare consolidated financial statements may choose to opt in and optionally apply the BEFIT regulations.
Following the application of the regulations a so-called “BEFIT group” is formed, consisting of all companies and permanent establishments (so-called BEFIT group members) falling within the scope.
The proposal for a directive is applied to all sectors but includes special schemes for certain sectors such as international transport and extractive industries.
How is the taxable profit calculated within the BEFIT group?
1. Calculation of the preliminary tax result of each BEFIT group member
As a first step for each BEFIT group member a preliminary tax result is calculated based on the standalone financial statements prepared according to the relevant accounting standard. Generally, the relevant accounting standard is the accounting standard of the ultimate parent entity, or, if the ultimate parent entity is headquartered in a third country, the accounting standard of the so-called “filing entity” (the entity filing the return instead of the ultimate parent entity) applies.
The tax base is subject to several “BEFIT adjustments”. Like in Pillar Two certain items are added to or subtracted from the result (e.g. profits/losses from the sale of participating interests, write-downs of/write-ups to participating interests, dividend income).
Furthermore, the proposal for a directive includes special regulations (among others) regarding:
- interest deduction limits
- handling of fines
- tax depreciation rules
- recognition of foreign currency exchange profits/losses
- timing and quantification issues regarding
- method of inventory valuation (stocks, work-in-progress)
- setting up provisions
- deduction of bad debts
- accruals and deferrals of revenues and costs
- hedging instruments
Finally, the directive also includes rules on entities entering or leaving the BEFIT group.
2. Aggregation of the preliminary tax results into a single tax base and allocation to BEFIT group members
As a next step, the preliminary tax results of the BEFIT group members are aggregated to a single BEFIT tax base. Several advantages, such as:
- cross-border loss relief,
- facilitation of transfer pricing compliance and
- no withholding taxes on transactions within the BEFIT group
are expected from the aggregation.
Next, – in case of profit – the aggregated BEFIT tax base will be allocated based on a transition allocation rule to the BEFIT group members in their various states of residence. The transition allocation rule is calculated by comparing the average of the taxable results of the previous three tax years of the BEFIT group member and the BEFIT group as a whole. This simplified allocation method is only temporary and applying for a period of 7 years (until 2035). In the long term, the transition allocation rule may be replaced by an allocation method based on a formulary apportionment.
If a loss for the group is resulting from the calculation of the BEFIT tax base, this loss is carried forward and reduces positive BEFIT tax bases of future periods.
After allocation of a positive tax base, every BEFIT group member will have to apply additional adjustments (e.g. in connection with pre-BEFIT losses). These adjustments mostly include technical corrections.
Important note: The member states are allowed to provide for own local adjustment matters (e.g. regarding donations, expenses for representation, passenger vehicles recognised on the asset side of the balance sheet, pension provisions).
“Traffic light system” to facilitate transfer pricing compliance with associated entities outside the BEFIT group
Next to a common corporate tax base the BEFIT proposal includes reliefs regarding transfer pricing compliance with entities outside the BEFIT group. Even though the arm’s length principle will still be applied to such transactions, a traffic light system for certain low-risk activities (e.g. LRDs, manufacturing activities) based on public benchmarks will be introduced. Depending on the deviation from the benchmarks the activity is assigned a risk level which will have effects on the scope of the local tax administrations regarding this transaction.
Contrary to the transfer pricing proposal, the BEFIT proposal does not include substantive rules regarding the compliance of a transaction with the arm’s length principle and the scope is limited to low-risk transactions.
Who files tax return(s)?
In line with a one-stop-shop approach, the proposal provides that the ultimate parent entity will file a common “BEFIT information return” for the whole BEFIT group with its own tax administration (the filing authority) – until four months after the end of the financial year. The tax administration will share this information with the other member states in which the group operates. Each BEFIT group member will also file an individual local tax return to be able to apply domestically set adjustments to their allocated BEFIT part. The local tax administration will issue a local tax assessment notice.
For each BEFIT group, there will also be a so-called “BEFIT Team”, consisting of representatives of the local tax administrations, which assesses the completeness and accuracy of the BEFIT information return.
Furthermore, the proposal provides for joint audits of the tax administrations and provides information on appeals against the BEFIT information return and individual tax returns.
Outlook
Once unanimously adopted, the proposal for a directive is to be transposed into domestic law before 1 January 2028 and enter into force from July 2028 pursuant to the proposal of the Commission. For financial years corresponding to the calendar year, the new system will be applied as of the financial year 2028.
Company groups which potentially fall within the scope of the new directive are recommended to keep an eye on its development. If political consent on this long-time project will be reached, the new regulation will definitively be a “game changer” in international tax law and force affected company groups to completely rethink and restructure their tax compliance processes.
We are happy to keep you updated on current developments.
Author: Sophie Schönhart
