The Commission publishes its Proposal for a BEFIT Directive
On September 12, 2023, the European Commission unveiled its Proposal for a Directive on Business in Europe: Framework for Income Taxation (the “BEFIT Proposal”). This initiative seeks to establish a comprehensive corporate tax framework applicable to large multinational enterprises (“MNEs”). The primary objective of this proposal is to address the existing complexity and absence of common rules in determining the corporate income taxable base in the European Union (“EU”), with the ultimate goal of promoting a level playing field for businesses across the EU.
This Proposal bears a strong resemblance to the 2011 proposal for a Common Consolidated Corporate Tax Base (“CCCTB”) and the 2016 proposal for a Common Corporate Tax Base (“CCTB”). Although these two prior proposals were never adopted, European Commissioner Mr. Paolo Gentiloni believes that the adoption of the Pillar II Directive in December 2022 has created a unique opportunity that paves the way for the BEFIT Proposal.
2. Scope of application
The BEFIT Proposal provides for a hybrid scope of application, including a mandatory and optional scope of application.
2.1 Mandatory scope of application
The mandatory scope of application encompasses all companies (including their permanent establishments) residing within the EU, as well as permanent establishments of third-country companies, when they are part of a group that prepares consolidated financial statements, achieving combined revenues of EUR 750 million or more in at least two of the last four years.
Companies and permanent establishments with an ultimate parent entity (“UPE”) outside the EU are excluded from the mandatory scope if their combined revenues in the EU do not exceed: (i) 5% of the total group’s sales; or (ii) EUR 50 million, in at least two of the fiscal years.
2.2 Optional scope of application
Domestic or multinational group companies with combined revenues under EUR 750 million can opt to fall under the scope of the BEFIT Proposal (opt-in). This option is also available for permanent establishments of third-country entities.
3. BEFIT Taxable Base
Calculating the BEFIT taxable base is the key provision of the proposal. It involves aggregating the taxable results of each member of the BEFIT Group (the so-called “preliminary tax results”), subject to various adjustments, before allocating this aggregate taxable base to each member of the BEFIT Group.
3.1 BEFIT Group perimeter
The BEFIT Proposal aims to determine the corporate taxable base of the European entities of a group failing within the scope of application of this proposal (the “BEFIT Group”).
The first step is therefore to determine the perimeter of the BEFIT Group.
Such BEFIT Group is formed when at least two companies or permanent establishments either fall within the mandatory scope of application or exercise their option to fall under this scope of application (opt-in).
The perimeter of such BEFIT Group encompasses each company and head office of a permanent establishment that: (i) is the UPE of the group; or (ii) is held by at least 75%, directly or indirectly, by the UPE. This ownership threshold of 75% must be held without interruption throughout the entire fiscal year.
3.2 Preliminary tax results
The second step is to determine the taxable result of each member of the BEFIT Group ( “preliminary tax results”).
As is the case for Pillar II, the starting point for calculating the preliminary tax result of each member of the BEFIT Group is the financial accounting net income or loss for the fiscal year. This net income or loss is determined based on the accounting standards of the UPE (i.e. local GAAP or IFRS). This means that all members of the BEFIT Group will need to reconcile their financial accounts with the same accounting standard as that of their UPE.
This net income or loss shall then be subject to several adjustments and, inter alia, adjustments for:
- costs deductions: costs will be deductible from the preliminary tax result only to the extent that they are incurred as a consequence of direct business interests;
- depreciations: adjustment to allow only for the deduction of depreciations as provided in the proposal. The BEFIT Proposal indeed establishes common rules for tax depreciation to ensure that depreciation is claimed by only one entity per fiscal year. These rules specify the economic owner's right to book depreciation, as well as the depreciation period for certain assets, and exceptions for specific assets;
- dividends distributed: exclusion of 95% of the dividend received or accrued during the financial year if the ownership interest is held by the member of the BEFIT Group for more than one year and entitles the latter to more than 10% of the profits, capital, reserves or voting rights of the owned entity (“Eligible Shareholding”);
- gain/loss from disposition of shares: exclusion of 95% of the gain/loss arising from the disposition of an Eligible Shareholding;
- changes in fair value: exclusion of the gain/loss arising from changes in the fair value of an Eligible Shareholding;
- trading financial assets (i.e. short-term financial assets): inclusion of the fair value change related to trading financial assets;
- permanent establishments: exclusion of the income/loss that is attributable to a permanent establishment;
- interest: inclusion of the amount of exceeding borrowing costs as non-deductible pursuant to domestic law implementing the Anti-Tax Avoidance Directive (so-called “EBITDA rule”), with the exception of exceeding borrowing costs arising from transactions between members of the BEFIT Group;
- fines, penalties and illegal payments: inclusion of the fines and penalties imposed by a public authority for the breach of any legislation; and
- corporate income tax: inclusion of the corporate income tax paid and accrued for the fiscal year, as well as any top-up tax under Pillar II.
3.3 Allocation of Taxable Base
The third step is then to aggregate these preliminary tax results before allocating the aggregate tax result to each member of the BEFIT Group.
Indeed, the group consolidated taxable base (the “BEFIT Taxable Base”) is simply equal to the aggregated preliminary tax results of each member of the BEFIT Group, after the abovementioned adjustments.
This BEFIT Taxable Base is then allocated to the members of the BEFIT Group based on an allocation key. This key considers the three-year average of each member of the BEFIT Group’s preliminary tax results and is based on the following formula:
- numerator: the 3-year average of the preliminary tax result of any member of the BEFIT group; divided by,
- denominator: the aggregated preliminary tax results of the entire BEFIT Group, calculated similarly to the numerator.
This allocation key ensures that the BEFIT Taxable Base is distributed among members of the BEFIT Group based on their relative weight in the BEFIT Taxable Base.
4. Withholding Tax and Tax Credits
The BEFIT Proposal also provides for a withholding tax exemption for transactions carried out among members of the BEFIT Group, unless the beneficial owner is not a member of the BEFIT Group.
Additionally, the proposal outlines rules for the granting of tax credits to members of the BEFIT Group, in case they are taxed on some of their income in other Member States or third countries.
5. Transfer Pricing: Traffic Light System
The BEFIT Proposal also introduces a transfer pricing risk monitoring system (so-called “traffic light system”) which assesses and manages transfer pricing risks for certain activities within BEFIT Groups.
Qualifying Activities – This system applies to low-risk distribution and manufacturing activities performed by low-risk distributors and manufacturers within a BEFIT Group.
Benchmarking – In order for the risk to be monitored, the Commission will establish and publish public benchmarks using five-year average profit performance (EBIT margin) of similarallow-risk distributors and manufacturers. These public benchmarks will be updated by the Commission.
Risk Assessment – The system defines three risk levels: “low”, “medium”, or “high” based on EBIT margins compared with benchmarks. The risk zones are determined by the profitability percentile of any member of the BEFIT Group, with “low-risk” entities above the 60th percentile, “medium-risk” entities between the 40th and 60th percentile, and "high-risk" entities below the 40th percentile. In essence, the traffic light system balances risk assessment and compliance management, categorizing activities by risk and using benchmarks to ensure arm’s-length transfer pricing while reducing administrative and compliance burdens for low-risk entities.
The BEFIT Proposal outlines a comprehensive procedure for filing BEFIT information returns and individual tax returns, auditing members of the BEFIT Group, appealing against return assessments, addressing judicial appeals and imposing penalties.
7. Entry into Force
The BEFIT Proposal is scheduled to be implemented into domestic law by January 1, 2028, and to enter into force as from July 1, 2028.
8. Final considerations
While the BEFIT Proposal is still surrounded by uncertainty, it is certainly a monumental move towards simplifying and harmonizing corporate taxation across the EU.
However, it is essential to note that this proposal focuses solely on rules for determining a consolidated taxable base, leaving other aspects of the corporate income tax regime within the jurisdiction of Member States. Member States retain the freedom to set their corporate tax rates and provide tax deductions on the BEFIT Taxable Base allocated to members of the BEFIT Group, provided they comply with the Pillar II Directive, and ensure a minimum effective taxation rate of 15%.
The adoption of this proposal requires unanimous approval by the European Council– a challenging task in the legislative process. Nevertheless, the Spanish Presidency of the Council has expressed its commitment to advancing this proposal during its tenure. As the proposal continues to progress, it is imperative for businesses to remain vigilant and adapt to the evolving tax landscape, while ensuring compliance and seizing new opportunities in this transformed tax regime.