Tax Updates: September 26th 2023

Three new proposed Directives: "BEFIT" - Harmonization of Transfer Pricing Rules - Head Office Tax ("HOT") System for SMEs

On 12 September 2023, the European Commission (EC) issued a proposal for three Directives:

• A Council Directive on Business in Europe: Framework for Income Taxation (BEFIT)
• A Council Directive on the harmonization of Transfer Pricing Rules
• A Council Directive introducing a Head Office Tax (HOT) system for micro, small and medium sized enterprises (SMEs)

More specifically:

Directive proposal for Business in Europe: Framework for Income Taxation (BEFIT)

The proposal aims to replace the previous EC’s proposal for a Common Corporate Tax Base (CCTB) and a Common Consolidated Corporate Tax Base (CCCTB) and provides common rules for determining the corporate tax base for EU-based entities taking into consideration the principles agreed upon under the OECD Pillar One and Pillar Two solutions. Key aspects of BEFIT include:

• Scope: The rules would apply to EU-based entities that are part of a domestic or multinational group in scope of Pillar Two (i.e. revenue threshold of EUR 750 million). In addition, there would be an opt-in option for SMEs to enable them to benefit from the framework as well.
• Tax base calculation and consolidation: The proposed rules would require the calculation of a ‘preliminary tax result’ (PTR) by each member of a group by using a ‘simplified method’ (which will include less adjustments to financial statements than the GloBE Model Rules). The PTRs of group members would then be aggregated to form a single BEFIT tax base. The aggregation of PTRs would allow in-scope groups to (i) offset cross-border losses, (ii) avoid paying withholding taxes on certain transactions (e.g. interest and royalty payments within the group), and (iii) simplify transfer pricing compliance in intra-group transactions.
• Allocation of profits: The rules would require the BEFIT tax base to be allocated to Member States. The allocation to the eligible group members would be based on their percentage of the aggregated tax base (calculated as the average of the taxable results in the three prior fiscal years). Once allocated, Member States may apply any further base increases, tax incentives, or deductions to the company’s allocated part as long as they comply with the Pillar Two requirements. The adjusted allocated profits would then be subject to the corporate income tax rate of the respective Member State.
• Administration: BEFIT would establish a one-stop shop as a central authority to administer the regime. The ultimate parent entity of the group would generally be required to submit an information return for the entire group with its local tax authority no later than four months after the end of the fiscal year. In addition, each individual BEFIT group member would also be required to file an individual tax return to their local tax administration. The procedural rules in respect of tax return filling, audits and appeals would generally be governed by national law.

Previous experience with discussions on the C(C)CTB proposals shows that it may prove challenging for all Member States to reach agreement on a common corporate tax base framework.

The EC proposes that Member States should transpose the BEFIT proposal into domestic law by 1 January 2028, and that the provisions of the Directive should apply as of 1 July 2028. 

Proposal for Transfer Pricing Directive

The proposal relates to the implementation of common rules for determining the transfer pricing approach for EU-based entities, based on OECD principles. In brief, the EC proposes to incorporate the OECD arm’s length principle and ‘OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’ in EU law, alongside the gradual development of common approaches in the EU to the practice of applying transfer pricing. The rules would apply to all EU-based companies and permanent establishments.

The EC proposes that Member States should transpose the TP proposal by
31 December 2025 at the latest and that the provisions of the Directive should apply from 1 January 2026.

Directive proposal for Head Office Tax system for SMEs

The Directive proposal allows certain standalone small and medium sized entities (SMEs) with permanent establishments (PEs) in other EU Member States (host Member State) to calculate their tax liability based only on the tax rules of the Member State of their head office. Qualifying SMEs would only need to file a single tax return with the tax administration of their head office and this return would then be shared with other host Member States. The Member State of the head office will apply the rates applicable in the Member State(s) where the SME maintains PEs and, subsequently, transfer the resulting tax revenues to the respective host Member States.

The EC proposes that Member States should transpose the proposal by
31 December 2025 at the latest and that the provisions of the Directive should apply from 1 January 2026.