Business in Europe: Framework for Income Taxation

Through the Business in Europe: Framework for Income Taxation (BEFIT) proposal, the European Union (EU) is proposing a comprehensive solution for business taxation in the EU. This initiative aims to introduce a single corporate tax rulebook within the EU which will be based on a common tax base and formulary apportionment of profits to Member States (MS) resulting to a more effective and fair allocation of profits between EU countries. The BEFIT proposal will replace the pending proposal of a Common Consolidated Corporate Tax Base (CCCTB). This article is aiming to touch upon on a high-level basis on some of the most important pillars of the BEFIT proposal. At the same time, the article aims to address possible issues, uncertainties, and challenges stemming from the proposal.

The Need For Befit

The EU Commission (Commission) is of the view that BEFIT will boost the competitiveness of the single market by removing tax barriers and thus supporting investment in the EU. Moreover, it will reduce tax compliance costs, especially for small and medium-sized enterprises (SMEs) and will result to a more effective and fair taxation in terms of allocation of tax revenues to MS. However, despite the Commission’s positive view on BEFIT, a lot of stakeholders are challenging whether there is a real need for it.

If one of the objectives of the BEFIT proposal is to simplify and reduce the tax compliance burden, BEFIT may be a step towards the right direction. However, this may not be the case for all taxpayers and may have the exact opposite effect.

Moreover, it is evident that the main objective of the BEFIT proposal is to tackle tax avoidance and increase tax revenues to address increased public debt levels resulting from Covid-19 and the effect of macroeconomic trends such as the growing aging population. This is supported by the report adopted by the Committee on Budgets of the European Parliament (BUDG Committee) on 17 April 2023. The report proposes to source EU Budget with new taxes and is aiming to achieve a diversification of the EU financing sources. The report proposes, inter alia, the BEFIT initiative as a starting point for a new own resource.

However, it is questionable if a common corporate tax base and allocation of profits to MS based on a formula is the right tool to achieve this as there are various other tools to combat tax avoidance (e.g., Base Erosion and Profit Shifting (BEPS)- Pillar 2, Anti-Tax Avoidance Directive 3-Unshell Directive, tax transparency & exchange of information mechanisms and changes to the Interest & Royalty Directive).

Entities Within The Scope Of The Befit Proposal

In terms of the design and entities within scope of the BEFIT proposal, the Commission provides for two options:

• Option 1: BEFIT to apply only to multinationals with consolidated global revenues exceeding EUR 750 million or

• Option 2: BEFIT to have a broader scope with a lower revenue threshold and with an opt-in possibility

Given the overlap of the BEFIT proposal with other new legislative initiatives which are yet to come into force, such as BEPS Pillars 1 & 2, if the BEFIT proposal is implemented, it will likely introduce great uncertainty and complexity in the short-term. As such, a lot of stakeholders are of the view that BEFIT should be optional to taxpayers. Such optionality would be advantageous for a number of reasons, for example, the size and sector of businesses that will opt in for BEFIT may vary and this would provide a good indication of what works and what does not.

Determination Of The Tax Base

The EU Commission is suggesting two options as to the determination of the tax base for the purposes of BEFIT:

• Option 1: use standardized financial statements subject to limited adjustments and

• Option 2: introduce a new comprehensive corporate tax system, with detailed rules for determination of the tax base.

It is widely recognised that via BEFIT, the Commission is relaunching CCCTB. However, there is now one important difference; that is, by giving their approval to the Pillar 2 Directive, MS have effectively agreed to a tax base on financial income with certain limited adjustments, which is Option 1 under BEFIT. To the contrary, Option 2 will introduce a new comprehensive corporate tax system which will lead to undesired outcome as tax compliance will become overly complex. Given the above, the expectation is that Option 1 may be the option to be favoured by both the Commission and MS.

CROSS-BORDER LOSS COMPENSATION

Currently, it is quite a challenge for EU businesses to claim loss relief for final losses despite jurisprudence of the Court of Justice of the EU as there are several conditions and limitations. If BEFIT were to include a satisfactory loss offset mechanism, this could make the regime attractive, and businesses may be incentivised to opt into the regime. For BEFIT to become even more appealing, the loss offset should also capture third countries outside the EU. This will be in line with one of the main objectives of BEFIT which is the removal of barriers to cross-border activities and bolstering the competitiveness of the EU economy.

Transfer Pricing Considerations

Under BEFIT, the Arm’s Length Principle (ALP) and the Transfer Pricing (TP) rules will not apply on transactions between companies of the BEFIT group as profits would be apportioned based on a formula which would be based on a pre-determined set of weighted factors. However, the ALP will apply on transactions with companies that are outside the BEFIT group and associated enterprises in the EU that will not be part of the BEFIT group. It is debatable whether replacing the ALP and the OECD TP Guidelines, which have been in existence for decades, with a formula for apportionment would result in a fairer allocation of tax revenues. This will be a drastic change with an unpredictable impact on the tax revenues of MS.

Impact On Bilateral Tax Treaties

Currently, there is uncertainty as to how Double Tax Treaties and BEFIT will co-exit. For the time being, the implementation of BEFIT seems to distort the allocation of taxing rights. Under BEFIT, it remains to be seen whether third countries will apply and respect treaties with EU countries or whether BEFIT would be a source of new challenges, for example, in terms of beneficial ownership of income in case the underlying income is apportioned to more than one EU MS. Another challenge that would arise for BEFIT when it comes to administration is how to design the dispute resolution procedures with third countries i.e., Which treaty should apply? Is it the one in the EU MS in which the transaction was conducted or would it be the responsibility of the MS in which the BEFIT return is filed? While it is expected that adequate answers and solutions will be given in the future, it will take substantial time until this happens.

Timeline

Even though as per the Commission, the baseline scenario is that current national rules in the EU will remain unchanged, it is evident that the Commission is favouring an action in the form of a directive as it believes this will lead to a more balanced allocation of corporate tax revenues to MS.

The Commission aims in releasing a draft directive in the third quarter of 2023 with implementation deadline by the end of 2024. The draft directive will be subject to another public consultation and will require unanimous approval by all MS before it can be adopted. It remains to be seen whether this is a realistic timeline. Given the recent examples of Pillar 2 and ATAD 3 Unshell Directive, it is likely that BEFIT would take longer than initially anticipated.

On the legislative front, 2023 is a very interesting year with a lot of activity both in terms of consultation, legislation, and implementation of already approved tax policy changes. All these changes and initiatives are connected and will have a medium and longterm impact to businesses and MS alike. BEFIT may have considerable adverse effect on countries like Cyprus with negative impact on tax revenues. It is suggested that the Cyprus government undertakes its own impact assessment exercise to understand what BEFIT means for Cyprus. One possible course of action is for Cyprus to take the position that BEFIT should be optional as this will be beneficial in terms of understanding how the new BEFIT framework “plays out” across the EU and how this affects the ability of Cyprus to attract business.