BEFIT, the European Union's comprehensive tax reform plan:

beyond the OECD global tax reform

On 1 July 2021, the OECD's BEPS Inclusive Framework adopted the Statement establishing a new framework for global tax reform, which on 8 October 2021 took the form of an agreement finalising the remaining technical elements of tax reform (including the global minimum tax), with 136 signatories. This time, the EU Member States have joined the initiative in its entirety, including Hungary, Ireland and Estonia, which had previously opted out.

However, less coverage in the Hungarian press has been given to the fact that on 18 May 2021, the European Commission announced in its Communication to the European Parliament and the Council entitled "Business in Europe: Framework for Income Taxation" (BEFIT) the plan for a new tax concept that will affect all Member States and will take the OECD's global tax reform as a starting point. This concept is summarised below.

EU tax reform has already started with the reform of the Energy Taxation Directive to support sustainable development. The same package includes proposals for the Carbon Border Adjustment Mechanism (CBAM) and the EU Emissions Trading System (ETS), adopted in July 2021. Also on the table is the concept of a digital levy, independent of (parallel to) the OECD tax reform and compatible with WTO and other international agreements. The Commission had to wait for the OECD agreement to be signed on 8 October 2021 in order to start the detailed elaboration on digital levy. It is expected that this issue will now be given new impetus, while the longer-term plans include the development of the concept of an EU financial transaction levy, which has been blocked for a number of reasons (e.g. the treatment of derivative transactions).

Other objectives of the EU tax reform entail the digitalisation of tax administration, reducing tax compliance costs for businesses, removing tax barriers to cross-border investment and addressing the debt bias in corporate taxation.

In this article, however, we focus on the corporate tax aspects.

The OECD's global tax reform as a starting point

First of all, it is worth briefly touching on the most important elements of the OECD's global tax reform.

Pillar I promotes a fairer distribution of profits and taxing rights between countries. The concept was originally designed only for companies in the digital sector, but its scope now extends to the largest and most profitable multinational enterprises, regardless of industry. In the first seven years of its implementation, Pillar I will affect multinational enterprises (only about a hundred of them) with global turnover above €20 billion and profitability above 10%. A share of the profits of such enterprises (determined from the top slice of certain types of revenues) will be taxed in the countries where the revenues (at least €1 million, but up to €250,000 for smaller countries) are generated. The tax base will be divided between countries according to a formula. After a seven-year monitoring period, it is expected that smaller and smaller multinational enterprises will become involved.

Pillar II („the GloBE rules”) aims to introduce a global minimum corporate tax rate. Multinational enterprises that meet the €750 million consolidated revenue threshold (such enterprises are currently subject to Country-by-Country Reporting requirement) should calculate the effective tax rate on a jurisdictional basis (using a common definition of covered taxes and a tax base determined by reference to financial accounting income with agreed adjustments). (For Hungary, it is important to include the local business tax in the calculation; this aim is expected to be fulfilled). Under the Income Inclusion Rule (IIR), the parent company has to pay top-up tax if the effective tax rate calculated is lower than the minimum tax rate set at 15 percent. However, if a low-taxed member company is not subject to tax under an IIR, then under the Undertaxed Payment rule (UTPR), the parent company is not allowed to deduct the related expenses from its tax base or must make an equivalent adjustment.

As can be seen above, the introduction of a global minimum corporate tax rate does not imply an override of the corporate tax rate in force in the country concerned, but will result in the state of residence of the parent company receiving additional resources through the additional tax paid.

Finally, yet another element of Pillar II is the treaty-based rule (STTR), which allows source countries to impose a limited withholding tax liability on taxable payments between related parties which are subject to a minimum tax rate below the threshold (in this case the threshold is set at 9 percent). This tax will be credtitable in the calculation of the effective tax rate.

Both Pillars of the OECD global tax reform are expected to enter into force from 2023, at which time the signatory countries will recognise the rules as binding on themselves. Under the BEFIT concept, the EU will regulate the implementation details for EU member states in two directives. The directives should reasonably be adopted before the OECD tax reform comes into force in 2023. One directive will ensure a consistent implementation of Pillar I, while the other will set out the required method of transposition of Pillar II (expected to reflect the OECD approach to the common tax base, but will also include the necessary adjustments for the EU).

It is important to point out that although the minimum corporate tax rate of 15 percent has been internationally accepted by the members of the OECD Inclusive Framework, the tax rate remains a national competence and the European Union does not intend to change this. It is up to the Member States to decide on their own tax rates and to determine the content of their measures to improve tax administration and facilitate tax compliance.    

The introduction of the minimum corporate tax rate will affect at least two other existing European directives: the Anti Tax Avoidance Directive (ATAD) and the Interest and Royalties Directive. For the ATAD, the change will affect the concept of Controlled Foreign Company (CFC). The Interest and Royalty Directive currently provides for an exemption from withholding tax on interest and royalty payments between group members. The change (which has been on the table of the European Commission since 2011) will mean that the recipient of the payment will only be entitled to exemption from withholding tax if the payment forms part of its tax base in its own Member State.

The European Commission will also propose that compliance with Pillar II should be an additional criterion for inclusion in the EU list of non-cooperative jurisdictions for tax purposes, thus ensuring that non-EU non-cooperative countries are encouraged to join the international agreement.

The Action points of the EU tax reform

The European Union’s business tax agenda for the for the next two years entails the following action points.

Action Point 1: legislative proposal for the publication of effective tax rates paid by large companies

Taxes paid by large economic operators will be given even greater visibility by the EU Commission's proposal later this year to publish the actual (effective) tax rate calculations under Pillar II on an annual basis under a new EU directive. On 1 June 2021, the Council of the European Union already agreed that Country-by-Country reports should also be made public from 2023 (with an 18-month implementation deadline), but the single effective tax rate calculations will provide even deeper insight into the effective tax burden borne by large multinational groups. (Update: the amended directive entered into force on 1 December 2021 and will become applicable from the first financial year starting on or after 22 June 2024 - Directive (EU) 2021/2101 of the European Parliament and of the Council of 24 November 2021 amending Directive 2013/34/EU as regards disclosure of income tax information by certain undertakings and branches).

Action Point 2: legislative proposal setting out EU rules to neutralise the misuse of shell entities for tax purposes

EU proposal for directive to combat abuse through shell entities is also expected later in 2021. The proposal includes measures to discourage the use of such entities, such as mandatory reporting to help establish a significant economic presence and actual economic activity, denial of tax benefits, and new tax reporting, tax audit and transparency requirements. The Commission also intends to take steps to prevent royalty and interest payments from the EU from avoiding taxation (so-called "double non-taxation"). (Update: the proposal for a Directive laying down rules to prevent the misuse of shell entities for tax purposes and amending Directive 2011/16/EU was published on 22 December 2022 with proposed date of coming into force as on 1 January 2024).

Action Point 3: recommendation on the domestic treatment of losses

On 18 May 2021, the Commission adopted a Recommendation on the tax treatment of losses during the COVID-19 crisis. This measure will ensure a level playing field for small and medium-sized enterprises, which are generally less able to use their carry-forward losses than large companies.

The Recommendation requires Member States to allow companies to carry-back losses at least to the financial year preceding the pandemic COVID-19, i.e. at least to 2019. At the discretion of Member States, this minimum period may be extended so that losses incurred in the financial years 2020 and 2021 can be deducted from the tax already paid on profits for the financial years 2019, 2018 and 2017. However, they should allow for an immediate tax refund of any anticipated retroactive carry-forward losses in fiscal year 2021 before the end of fiscal year 2021.

The Commission proposes certain restrictions to protect national budgets: the maximum amount of losses that can be carried back in one year is €3 million and, if Member States allow carry-back up to 2017, only companies that have not made losses in the period 2017 to 2019 can be eligible.

Hungarian corporate taxation has so far allowed only the use of tax loss carry-forwards, while tax loss carry-backs were not allowed. We expect to receive a response shortly on what measures Hungary will take in response to the Commission's recommendation. (Update: the 2022 Hungarian corporate income tax amendments did not include the possibility of tax loss carry-backs and are not foreseen for the nearest future).

Action Point 4: a legislative proposal creating a Debt Equity Bias Reduction Allowance (DEBRA)

In early 2022, the Commission will propose a directive to tackle the debt-equity bias in corporate tax, which will take the form of a Debt Equity Bias Reduction Allowance (DEBRA). Tax regimes around the world allow for the deduction of interest on debt capital from the tax base, however, the costs associated with equity financing (e.g. dividends paid) are not deductible from the tax base under any tax regime. As a result, debt financing is considered to be the cheapest form of equity financing and is preferred by companies over equity financing. This has led to an accumulation of corporate debt, which has reached dangerously high levels as a result of the COVID-19 pandemic.

Action Point 5: a proposal for BEFIT (Business in Europe: Framework for Income Taxation), moving towards a common tax rulebook

By 2023, the Commission will propose a new framework for corporate income taxation (Business in Europe: Framework for Income Taxation, BEFIT). The BEFIT is a single corporate tax rulebook, the key features of which are a common tax base and allocation of profits between Member States based on a formula (formulary apportionment). The proposed formula will take into account the Pillar I and Pillar II formulas for the partial redistribution of profits and the determination of the tax base, but will cover the whole of the income.

With the BEFIT proposal, the legislative proposals on the Common Consolidated Corporate Tax Base (CCCTB) are withdrawn.

Under the BEFIT, the pre-tax profits of the EU member companies of multinational enterprises are consolidated into a single tax base, which is then apportioned between Member States according to a formula and taxed at national corporate tax rates. Issues to be decided include how to weight the revenues from each market, how to assess the importance of each market for the business of the multinational group, and how to take into account the value of assets (in particular intangible assets) and labour costs in order to ensure that corporate tax revenues are reasonably distributed between EU Member States with different economic profiles.

The formula also eliminates the need to apply complex transfer pricing rules to transactions between EU companies covered by the BEFIT.

By introducing a single corporate tax rulebook and a tax base allocation based on a formula, the BEFIT will be an important step towards building a more robust corporate tax system in the Single Market.

The author of this article is Marina Lisznyanszkaja, senior tax advisor of VGD Hungary.

12 January, 2022