Europe sets new corporate tax challenge

The European Commission has published a proposed directive with a new EU framework for corporate taxation to simplify the tax rules and ensure fairer tax distribution among member states. However, its Business in Europe Framework for Income Taxation (Befit) proposal also raises potential challenges for business groups operating in the EU.

Befit would be compulsory for large European groups that prepare consolidated financial statements and have an annual combined revenue of at least €750m. Smaller groups that prepare consolidated financial statements could also opt to use Befit. For Befit to apply, the ultimate parent entity would have to hold, directly or indirectly, 75% or more of the ownership rights of its subsidiaries.

Befit would also apply to groups that are not EU-headquartered where the combined EU revenue of the group either exceeds 5% of total group revenues based on the consolidated financial statements or €50m in at least two of the preceding four fiscal years.

Single tax base

The calculation of the Befit tax base would start with the determination of the preliminary tax results of each group member based on financial accounts prepared under accepted accounting standards in an EU member state or IFRS. Subsequently, these results would be subject to a number of important adjustments, aggregated into a single tax base and allocated on the basis of a transitional rule (which has not yet been agreed).

In the first seven years of Befit, the expectation is that the tax base will be decided using a ‘baseline allocation percentage’ based on the average taxable results of the previous three fiscal years. In essence, Befit replaces previous proposals for harmonising corporate taxation in the EU, such as the common consolidated corporate tax base (CCCTB) and the common corporate tax base (CCTB). Neither the CCCTB nor the CCTB were ever approved by the European Council.

Loss set-off

Since group members’ tax results are to be aggregated into a single tax base, cross-border loss set-off would be allowed and withholding taxes on interests and royalties would not be required within the group. While allowing cross-border loss set-off is commendable and consistent with the proposal’s design, it will probably face the same challenges that plagued the CCCTB, such as the lack of political consensus for its approval. Nor will Befit replace the arm’s length principle and transfer pricing rules for multinational enterprises. Groups will therefore have to deal with a dual system and comply with both Befit and traditional transfer pricing rules.

Besides these more substantive issues, adopting and complying with Befit will generate additional costs for groups. While a single rule set should in theory simplify tax systems for group companies, group company reporting systems will still need to be adapted to the new rules. Group companies will also have to ensure the consistency and comparability of the tax base, which may prove a difficult exercise, as accounting standards may vary among group members, affecting the calculation and aggregation of the tax base.

Even though a one-stop-shop mechanism for administering Befit is envisaged, each group member would still need to file local returns so that local tax authorities can ensure that adjustments to the Befit tax base have been applied correctly. Groups will in fact continue to file returns locally as well as a Befit return, similar to the GloBE information return required under the global minimum tax rules (ie pillar two of the OECD’s BEPS tax-base erosion and profit-shifting project), putting additional burden on taxpayers. It is therefore unclear whether Befit will effectively reduce the tax compliance and administrative burdens faced by groups.

Cost of complexity

As indicated above, Befit aims to simplify European corporate taxation by setting common rules for determining the corporate tax base of groups. However, this objective comes at the cost of introducing further system-level complexity and uncertainty, especially in relation to its interaction with pillar two. For instance, although the adjustments to be applied to the Befit tax base are intended to be much simpler than those required under pillar two, their introduction means that two different sets of computations will likely be required. As a result, taxpayers will have to ensure consistency and compliance with both Befit and pillar two. In the end, Befit may not achieve its intended objectives of simplification and fairness but simply add another layer of taxation on top of existing tax systems within the EU.

Befit is an ambitious European Commission proposal to harmonise corporate taxation in the EU. It aims to simplify tax rules, reduce compliance costs, and ensure a fairer allocation of taxing rights among member states. However, it also raises challenges for business groups operating in the EU that may undermine the effectiveness and feasibility of the proposal.

After consultation and review by the European Parliament and the European Council, the directive will need unanimous approval by the member states. The Commission expects to adopt the proposal by 2028, but first it should evaluate and address Befit’s remaining challenges to ensure its compatibility with pillar two and to avoid repeating the mistakes made with the CCCTB.