On September 12, 2023, the European Commission presented three directive proposals aimed at introducing a common regulatory framework for corporate income taxation within the EU:
- COM (2023) 532 – BEFIT Directive: Common system for calculating the tax base of corporate groups in the EU;
- COM (2023) 529 – Transfer Pricing Directive: Common approach to transfer pricing within the EU;
- COM (2023) 528 – Head Office Tax System: Simplified procedures for micro, small, and medium-sized enterprises.
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These proposals aim to “harmonize” the process, stimulate growth and investment and reduce tax compliance costs for large international players engaged in cross-border operations. The development of a common direct taxation system within the EU would simplify the tax environment in the internal market, strengthening the level playing field and legal certainty.
Currently, both the “Head Office Tax System” and the “Transfer Pricing Directive” have been expressed to the European Parliament. The BEFIT Directive, the subject of this contribution, is further behind in the process, having been postponed multiple times. Its complete adoption is pending the full implementation of Pillar II and Pillar I at the European level.
COM (2023) 532 – BEFIT Directive
COM (2023) 532 – BEFIT Directive represents the regulatory framework for corporate tax in the EU, aiming to consolidate the profits of a multinational group into a single tax base, which will be allocated to Member States through a so-called formulary apportionment. This consolidated tax base will then be taxed at national corporate income tax rates as per the laws of each Member State.
BEFIT Scope
This regulation would apply to the following entities:
- National or multinational groups headquartered in the EU, preparing consolidated financial statements with annual revenues of €750 million or more in at least two of the four preceding tax periods, limited to entities where the parent company holds (directly or indirectly) at least 75% of the ownership or profit distribution rights;
- For groups headquartered outside the EU, their EU-located entities must have at least €50 million in consolidated annual revenues in at least two of the four preceding tax periods, representing at least 5% of the group’s total revenues.
Application Methods
The determination of the taxable income will be based on the consolidated European income, calculated as the average of the results produced by the group over the last three tax periods, allocated as a percentage based on the income generated in the involved States. Profits/losses of related parties that are not BEFIT Group members will not be considered.
Under the One Stop Shop approach, a group member may file group information returns, while tax audits and disputes will remain at the level of each Member State. The starting point will be the aggregation of results for the BEFIT tax base. The second step involves assigning this base to BEFIT group members based on a transitional allocation rule (applicable from 2028 to 2035), which uses each member’s percentage of an aggregated tax base calculated as the average of the taxable results of the three preceding fiscal years.
Role of Transfer Pricing in BEFIT
In particular, it is necessary to distinguish two scenarios:
- Intra-BEFIT Group operations, both during the “transitional” period and the “steady state” period;
- Operations external to the BEFIT Group.
Intra-BEFIT Group Operations – “Transitional Period”
For determining the BEFIT tax base, the outcome of intra-BEFIT Group operations will be a crucial factor for the allocation of the tax base to individual BEFIT group members. During this phase, the requirement to adhere to the so-called arm’s length principle, as prescribed by the OECD, will be considered. A risk assessment will be conducted for intra-group operations, comparing the expenses incurred or income earned (analyzed per group member) from intra-group operations in the current year with the average expenses/income of the three preceding tax periods.
Based on the findings, one could fall into:
- Low Risk Zone: If these expenses or income increase in a tax period by less than 10% compared to the average expenses/income of the previous three periods, there will be a presumption of alignment with the arm’s length principle.
- High Risk Zone: If these expenses incurred or income earned increase by more than 10% compared to the average expenses/income of the previous three periods, there will be a presumption of non-alignment with the arm’s length principle. The excess over 10% will not be recognized for calculating the tax base allocation to that individual member, unless proven otherwise.
Intra-BEFIT Group Operations – “Steady State Period”
In this case, there will be a neutralization of transfer pricing, as the determination of taxable income will be based on a European consolidated income, calculated as the average of the results produced by the group over the last three tax periods, allocated according to a specific formula.
External Operations to the BEFIT Group – “Transitional Period
The profits and losses of related parties that are not BEFIT group members will not be aggregated into the BEFIT group’s tax base. In the event of profits from transactions between BEFIT group members and non-members, the allocation of such profits will occur through a system based on specific benchmarking analyses prepared by macro sector and activity, using the so-called Traffic Light System.
This system will apply exclusively to two low-profile risks:
- Low-risk distributor;
- Contract manufacturer.
These are entities that do not have any economic ownership and do not bear risks (e.g., market, inventory, credit) other than in a limited manner. These analyses will be published on the European Commission’s website and will identify for each sector the ranges of values based on specific profit indicators.
Conclusions
Despite the provisions described in this contribution, national legislators remain free to apply deductions, tax incentives, or additional benefits to the portions of the aggregated tax base assigned to them, with the only limitation being the minimum global effective tax rate set by the Pillar 2 directive. This possibility might still leave room for the risk of arbitrage and aggressive tax planning.