The re-launch of the discussion on a proposed common tax framework for EU groups operating cross-border, through the “Business in Europe: Framework for Income Taxation”, or “BEFIT” Tax Initiative, follows the EC’s long-held assumption that replacing different corporate tax systems with a single one is definitely a simplification tool for the tax system. Although compelling at first glance, this assumption should be considered cautiously, as such an outcome largely depends on the final design framework adopted and the balance of fairness and effectiveness concerns with simplification objectives, which, if not properly weighted, might pose a risk of increased administrative burdens for businesses.
General Framework
The European Commission has, on several occasions, raised concerns regarding the lack of a common corporate tax system in the EU, which in its understanding creates a competitive disadvantage compared to third-country markets. According to the EC, such a disadvantage results from distortions in investment and financing decisions driven by tax optimization strategies and higher compliance costs for businesses due to different tax systems in the EU.
The EC has therefore been actively endorsing the idea of a common consolidated corporate tax base since 2011, which was then re-launched in 2016. In 2021, the EC announced intentions to withdraw the pending CCTB and CCCTB proposals in light of the new BEFIT initiative which was presented as part of its Communication on Business Taxation for the 21st Century to promote a robust, efficient, and fair business tax system in the EU.
BEFIT is not yet a legislative proposal but the adoption of a proposal seems to be a priority item for the EC in 2023, being its key objectives: to increase businesses’ resilience by reducing the complexity of tax rules and the compliance costs faced by EU businesses operating cross borders; to remove obstacles to cross-border investment and make the Single Market a more attractive location for international investment; to create an environment to fair and sustainable growth by clearing the way for administrative simplification; as well as to provide sustainable tax revenue.
Even if the key features of BEFIT are not yet disclosed and the initiative is in a nascent stage, considering the consultation document released by EC it is possible to recognize, in the abstract, the potential of this initiative in addressing the complexity and the high compliance costs that businesses running cross-border activities face because of having to comply with 27 different corporate tax systems, being the lack of a common corporate tax system in the EU not only a burden for multinational companies but also for Member States’ tax administrations. It is unequivocal that the existence of different tax systems and a lack of interfaces renders administrative cooperation between Member States difficult and that declarations of cross-border companies are subject to a higher susceptibility to error if they are submitted under different tax systems. Thus, BEFIT could be a step towards addressing tax mismatches between Member States more comprehensively and consistently, while providing a consistent framework for corporate tax compliance and promoting greater transparency and certainty.
Challenges to be addressed
Nevertheless, multiple challenges should not be overlooked.
Most prominent at this point in the design thinking of the proposal, given the interplay between, to some extent, opposing principles, namely, fairness and efficiency vis-à-vis simplification.
Apart from this, other challenges include: how the BEFIT initiative fits into international tax reforms, whose implementation is currently underway in the EU; how to ensure compliance with the EU’s proportionality and subsidiarity principles; how to address complex transition issues; how to lock in the avoidance of economic distortions; how to ensure compatibility with international tax standards and tax treaties; and how to enable rapid responses to changes concerning the economic and political level as well as trade environments.
Regarding the timing of this initiative, it is undoubted that BEFIT appears in a scenario where the business community is already overwhelmed by the changes underway because of BEPS and OECD’s Pillar One and Two. Although the objective of BEFIT is to provide relief from the administrative burden faced by MNEs when complying with their corporate tax liability in multiple Member States, its introduction will add a new layer of complexity, so it should focus on methods to achieve a simple, predictable, and stable tax regime in the EU. Considering the stated intention in the BEFIT consultation documents to draw inspiration from rules of OECD’s Pillar One and Two, we believe that the EC should consider deferring further consideration of BEFIT until such rules have had sufficient time to be operationalized. Only then should the EC proceed with a process to analyze whether BEFIT would provide a benefit to MNEs and tax authorities.
In terms of subsidiarity and proportionality, the EC should thoroughly undertake a quantitative and qualitative assessment of the investment and revenue impact for all Member States, including sustainable revenues for the EU budget, and it should also analyze the impact of BEFIT on small open economies and EU competitiveness. The impact of requiring tax authorities to run two different tax systems in parallel should also be considered since this does not meet the stated objective of administrative simplification.
Another feature of extreme relevance is the comparison of the advantages BEFIT would bring vis-à-vis the current transfer pricing rules. Taxpayers have invested heavily over the last few years in complying with OECD Transfer Pricing requirements, so if the EC moves away from that approach, it should provide a rationale for doing so. Especially considering that MNEs will still be subject to traditional transfer pricing rules outside of the EU, i.e., there will be a two-tier system, leading to increased complexity and compliance costs both for companies and tax administrations.
The exercise of Member States’ tax sovereignty is also critical. Demanding Member States to switch to a common corporate tax base could risk undermining the overall tax revenues of all Member States and may not represent their best interests or of the companies operating in the EU. As regards the tax rate, we welcome the fact that the Commission is not proposing to harmonize tax rates, since allowing EU members to determine their respective tax rate is paramount to maintaining and developing investment and employment in eligible Member States, also promoting the competitiveness of the EU compared to other jurisdictions.
The transition from 27 different tax regimes to one framework also poses a significant challenge, since there might be serious issues, which should be addressed by the European Commission, namely regarding differences between the timing of tax deductions. Pre-existing tax attributes such as tax losses carried forward and any existing differences between the tax basis of assets as a result of different rules in different countries must also be addressed.
The BEFIT framework should also provide for appropriate safeguards to ensure the compatibility of the BEFIT framework with current international tax standards, existing tax treaties, and future changes to the international tax landscape, with the primary objective of ensuring that double taxation is fully eliminated in a timely and effective manner in all circumstances so that the proposal can work alongside with other initiatives.
Interaction with foreign tax credit rules might also be a trial to this initiative since the co-existence between the BEFIT tax base allocation and foreign tax credit provisions under bilateral tax treaties or national law might result in the risk of double taxation, which is why some recommend the development of a harmonized system for relieving double taxation that would not run counter to any bilateral treaty obligations or domestic law of Member States.
Furthermore, it is essential that BEFIT allows for sufficient flexibility since an inability to swiftly handle a changing environment will hinder competitiveness at the EU level and hamper EU Member State’s ability to use tax policy to respond to changing conditions and crisis situations.
The design
As Brian Reed put it “Everything is designed. Few things are designed well.”Whilst the abovementioned policy objectives of BEFIT might be noble, the final design of the proposal will be determinant in the challenge of effectively reducing complexity and costs for both MNEs and tax authorities.
According to the EC, the structure of the future BEFIT proposal will involve five building blocks: scope; tax base; formulary apportionment; transactions with parties outside the BEFIT group, and administration.
Regarding the scope of the proposal, the EC is considering two different options: applying BEFIT on a mandatory basis where the group’s consolidated global revenues exceed a threshold of EUR 750 million or reducing the revenue threshold below EUR 750 million. This may also include an opt-in possibility for SMEs with cross-border activities. In our understanding, it would be better to opt for an optional application instead of a mandatory framework, since each carve-out or quantitative threshold implies the risk of ring-fencing BEFIT and a mandatory inclusion could impose an improper “one-size-fits-all” approach. Considering that this is a shift in the tax system that could pose fundamental challenges, that would be particularly difficult to overcome for smaller companies as well as for non-internationally oriented companies, a mandatory system without a threshold could therefore be disproportionate. Adopting an opt-in approach could, therefore, provide sufficient flexibility for taxpayers facing different economic and commercial conditions.
If the Commission forgoes optionality, then we suggest maintaining the threshold at EUR 750 million of consolidated annual global revenues to align with BEPS Action 13 (country-by-country reporting) and the Pillar Two GloBE rules, and consider it would be advisable to foresee sector-specific carve-outs for example by taking into account carve-outs used under the OECD BEPS 2.0 rules (i.e., with the exclusion of certain natural resources, financial service, and shipping businesses where this does not create competitive distortion). In those cases where the framework would be applied on a mandatory basis, it would be vital that the compliance burden on groups that are not in the scope of BEFIT is minimized to the greatest extent possible and that access to tax certainty procedures is granted to avoid multiple audits in several jurisdictions.
In what concerns the calculation of the tax base, the EC is considering building upon Pillar Two and using the financial accounting net income or loss of a group member as a starting point for calculating the tax base under BEFIT. This would be brought into line with a single EU-acceptable accounting standard for the whole group, to ensure that all group members use the same accounting standard as a basis for computing their tax base under BEFIT. The financial accounting net income or loss of group members would then be subject to a limited number of tax adjustments, from a defined list of adjustments.
We understand that the EC should explore ways to ensure that the calculation of the BEFIT tax base can work alongside other EU legislation, namely by aligning the calculation of the tax base with that applied for GloBE purposes, to the extent possible. At the same time, we believe that policy choices for determining the tax base are an essential element of Member States’ tax sovereignty, affecting tax revenues and social and other policy choices. The risk of BEFIT limiting the ability of Member States to choose the most efficient and cost-effective means of encouraging business activity in their jurisdiction – whether through granting aid, providing other business support, or tax-related measures should, thus, not be understated. Tax systems are generally designed according to certain principles embedded in Member States’ national legislation, even at the constitutional level, but they are not exclusively based on simplification (e.g., liability to pay, efficiency, and universality). Hence, it is necessary to not overvalue simplification and to have clear assumptions on how BEFIT would contribute to a fair and efficient environment that reflects differences between taxpayers, to guarantee that the result achieved by BEFIT does not face constitutional challenges to its implementation.
In relation, to tax base consolidation, and according to EC consultation papers, following the determination of the tax base, the individual tax bases of all EU group members would be consolidated. In our understanding, the framework should curb the complexities in relation to the transition to the BEFIT framework and to entering and leaving the consolidation group, as well as provide for an unambiguous and practical definition of a consolidated group.
The area of cross-border losses is prone to several disparities and inconsistencies across Member States, as the case law of the Court of Justice demonstrates. BEFIT would thus provide an occasion to address this key area more coherently. Where group entities with existing tax losses or temporary book-to-tax differences join the BEFIT group, rules should clarify how such tax attributes should be recognized at the group level. Likewise, where the consolidation results in an overall loss at the group level, rules should clarify how such loss may be offset and allocated to those group entities that leave the BEFIT group.
In what concerns the distribution of the tax base across EU countries using formulary apportionment, based on the EC’s consultation documents, according to the EC, the consolidated tax base would be allocated to the Member States by applying an allocation formula that would consider tangible assets, labor, sales by destination and potentially intangible assets in the Member States.
The BEFIT initiative foresees a three-factor apportionment formula: assets, labor, and sales by destination. While it may be most straightforward to give equal weight to each factor, such an approach is neither necessary in light of the Policy Objectives nor likely to be the best approach to ensure acceptance by the Member States. However, we understand that in assessing the proper weight to be given to each factor it may be appropriate to assign a different weight to each one for different areas of the economy. Based on the specifics of some industries (i.e., financial institutions, oil and gas industry, IT services, etc.), it may be reasonable to provide specific regulations in terms of each factor of the formula. Nonetheless, reaching an acceptable apportionment formula that accurately reflects the added value creation factors and the contribution of the market jurisdictions for all industries might be difficult.
In the end, how exactly the formula is structured and how the individual factors are to be weighted is, in our view, primarily a political decision.
Also based on the published consultation documents, the EC is considering issuing guidance on how tax authorities should assess the risk of certain transactions in accordance with the OECD’s arm’s length principle, with a view to simplifying compliance and reducing uncertainty in relation to transfer pricing and the application of the arm’s length principle. The guidance would provide clarifications on whether a related-party transaction is at low, medium, or high risk of not complying with the arm’s length principle based on how it compares to a series of benchmarks for each category of macro-industry and type of activity. Although we recognize the effort of the EC, it is possible to anticipate that if a taxpayer falls under the last two categories of risk, this will function as a red flag for tax authorities and therefore require additional resource investment for tax authorities and added compliance work for taxpayers.
The EC consultation papers also explore ways to simplify the filing of tax returns, simplifications related to interactions with tax authorities, and alternative methods of dispute prevention and resolution.
In our view, the successful implementation and application of the BEFIT framework is dependent on a simplified and effective compliance and reporting process. Requiring taxpayers to deal with tax reporting and payment obligations in multiple jurisdictions could outweigh the administrative benefits of operating under the BEFIT framework. We, therefore, welcome the one-stop-shop approach where the group would be in contact exclusively with the tax authority of the Member State where the parent entity or a designated filing entity is located.
The filing of the BEFIT tax return and the assessment of the tax liability with the principal tax administration would need to satisfy all local compliance obligations in all EU jurisdictions. For this simplified declaration and payment process to be effective, it would be necessary to design a common template for the BEFIT declaration and establish an automatic exchange of information between the tax administrations concerned. This would also require providing support to tax administrations to overcome potential obstacles, with a focus on improving their efficiency and capacity to deal with the implementation of new international standards and increased data flows that will result from the proposed rules, in order to make their tax audits and assessments more effective.
When it comes to preventing disputes arising from BEFIT’s application, it is important to have in mind that certainty is of paramount concern to business and should be the focus of attention in the legislative design of the proposal. If BEFIT leads to tax uncertainty, increased compliance burden, and increased disputes, it will not be successful. Hence, the establishment of a steady and certain tax framework will be key to its success. In this aim, it would be necessary to define a common method to provide upfront clarity on certain key issues related to the BEFIT framework and to prevent disputes between taxpayers – on the one side – and different local tax administrations on the other. The completion of the certainty process should be done within a short timeframe and should allow the participation of the taxpayer, who is, most of the time, best placed to explain the reasoning and purpose of the situation at stake.
In what relates to tax audits, it is clearly important to ensure good coordination among the relevant tax authorities, to minimize conflicts and prevent any need to resort to Courts. As concerns the enhancement of the relationship between taxpayers and tax administration, EC’s Consultation Document lays down the intention of coordinated tax audits, including the use of joint tax audits by tax authorities of the Member States where taxable presence has been established. In our opinion, coordinated audits could reduce the burden placed upon taxpayers, as the audit or inquiry cycle will run concurrently such that taxpayers can address issues relating to the same transaction or structure across jurisdictions contemporaneously. Notwithstanding, it remains to be clarified by the EC whether a leading tax authority would be considered and how it should be selected, so the EC should provide more clarity on how, at a practical level, audits would be conducted and how assessments would be amended, among other relevant features.
Regarding dispute resolution, it is predictable that disputes will arise, especially in the early years of BEFIT implementation. Such disputes might be minimized depending on the form and quality of the proposed legislation, accompanying guidance, and dispute prevention tools. Said disputes might arise among the Member States and between taxpayers and the tax administrations involved, being likely to arise in relation to transition questions, tax base determination, formulary apportionment, and interaction with third countries.
Currently, Member States can rely on the Tax Dispute Resolution Directive 2017/1852 and on specific provisions in bilateral tax treaties to resolve double taxation disputes. However, the TDRD only applies to disputes that arise from the application of agreements and conventions that provide for the elimination of double taxation of income and capital. By the same token, double taxation dispute resolution will only be available under some bilateral treaties that Member States have entered and will only be relevant for issues related to income allocated under BEFIT where the respective tax treaty allows for the resolution of disputes on taxes not covered by it.
A potential solution would be to establish an EU multilateral convention to incorporate BEFIT dispute resolution provisions into existing bilateral tax treaties between Member States. Another possibility would be to broaden the scope of the TDRD to include disputes arising from differences in the interpretation and application of the BEFIT rules. Whichever solution is adopted, what is essential is that the BEFIT group should be entitled to submit a request for dispute resolution to its lead tax administration, in case of conflicting outcomes as a result of differences in the interpretation and application of the BEFIT rules. In that case, the tax administrations concerned would be required to enter discussions to resolve the case within a clearly defined deadline.
One must not forget, however, that this dispute might still reach domestic courts, which will inevitably feel compelled to ask preliminary questions to the CJEU, particularly in the early years of implementation. In our opinion, it could be interesting to find an alternative to this proceeding, since if no alternative is foreseen, the implementation of BEFIT will likely require the CJEU to significantly expand its relevant capacity.
Conclusions
Having covered the main features of the fledgling BEFIT initiative, we hope that forthcoming work and discussions will address in more detail the issues raised above.
To the extent already publicized by the EC, we believe that the benefits of a common corporate tax system in the EU can be significant if Member States and tax authorities are aligned in the interpretation and application of its rules. It is also highly relevant that sufficient means exist for taxpayers to obtain tax certainty and effective dispute resolution mechanisms. The interaction of BEFIT rules with third countries and the tax treaties concluded on a bilateral basis with those countries is also a mandatory point to be addressed.
Without these safeguards, BEFIT risks further complicating, rather than streamlining, corporate tax rules and the administrative tax burden for taxpayers as well as tax authorities, which would be contrary to the Policy Objectives.
Dalila Mendes Leal
February 2023