The EU’s BEFIT Initiative—and Why It Doesn’t Make Sense (Part 1)

On Oct. 17, 2022, the European Commission announced the launch of a public consultation on “Business in Europe: Framework for Income Taxation (BEFIT),” a new framework for EU corporate taxation. BEFIT is one of the initiatives announced by the European Commission in its May 2021 “Communication on Business Taxation for the 21st Century.”

The initiative would, according to the commission, “introduce a common set of rules for EU companies to calculate their taxable base while ensuring a more effective allocation of profits between EU countries, based on a formula.” BEFIT strongly resembles the previous common consolidated corporate tax base proposal, which was withdrawn in the end.

Stakeholders are invited to provide input by Jan. 26 on whether a new EU corporate tax framework is needed, what its objectives would be, and on the most suitable options for implementing such a tax framework.

The BEFIT Initiative

The “Call for evidence for an impact assessment” presents the different options envisaged by the commission—one of these options being not to take any action and maintain the current corporate taxation rules—and the public consultation questionnaire provides further insights on the different options envisaged by the commission.

If EU action is envisaged, the commission considers several policy options to establish the key features of a common tax base. The public consultation questionnaire requests the position of stakeholders on whether the system should be compulsory without threshold, compulsory as from a certain threshold, or compulsory as from a certain threshold but with a possibility for companies below the threshold to opt in. When analyzing the different options, stakeholders should consider the most appropriate/effective option from the point of view of both the taxpayer and the tax authorities.

Status Quo vs. Adoption of an EU Corporate Tax System

First option: Status quo scenario—no action at the EU level

The baseline scenario used as a benchmark assumes that the current national rules on corporate taxation remain unchanged. This would imply maintaining the absence of a common corporate tax system in the single market.

While the commission presents no action as an envisaged option, it is unlikely that it will finally decide not to move forward with this new initiative, as it is stated in the public consultation paper that the commission intends to release a proposal for a Council directive in 2023.

Second option: EU action—Changing the existing domestic tax laws by means of a directive

EU action would provide the key features of a common tax base together with an allocation of profits to member states based on a formula. According to the commission, such a formula should ensure a balanced distribution of corporate tax revenues across member states that better takes into account the realities of today’s economic and global developments when allocating the tax base to member states.

Given the nature of what the commission identifies as a problem (cross-border commercial activities facing tax-related complexities, legislative fragmentation of national corporate tax systems, and reduced competitiveness of the EU single market), the commission is of the view that EU action in the form of a directive, and not a soft law approach, seems most appropriate.

Design Options

Potential scope of the proposal

Regarding the scope of application of BEFIT, the following options are considered:

• Option 1: Only groups with consolidated global revenues exceeding 750 million euros ($806 million); or
• Option 2: A broader scope, with a lower revenue threshold, which, according to the commission, could be of interest to small and medium-sized enterprises with cross-border activities or even to SMEs with plans to operate cross-border in the near future, with an opt-in possibility.

According to the Call for evidence for an impact assessment, sectoral carveouts would, in either case, be limited. In the questionnaire, stakeholders’ views are requested on whether excluding companies active in specific sectors would be a good idea, and on the issue of companies active in a mix of sectors.

Calculation of the taxable basis

• Option 1: Groups in scope would be required to use standardized financial statements and the income reported therein would be subject to a limited list of tax adjustments; or
• Option 2: A comprehensive corporate tax system would be established, with detailed rules for all aspects of profit and tax determination.

On the first option, the commission asks stakeholders to determine what should constitute key adjustments to financial accounts and to assess some suggested adjustments (such as depreciation of fixed assets, exemption of received profit distributions, general anti-abuse rules, controlled foreign companies rules). While the questionnaire is addressed to all “stakeholders,” these highly technical questions can only be answered by people with a strong knowledge of international taxation and not a self-selected group from the public.

On the second option, the commission admits that “Member States would have to run two comprehensive sets of corporate tax rules in parallel, i.e. BEFIT and their national rules (this would not be the case under option 1, where BEFIT rules for tax determination would be simplified).”

In either case, there would be two tax systems applying in parallel, irrespective of how broad the scope of application of BEFIT would be.

Finally, the questionnaire considers the possibility of a cross-border loss relief and asks stakeholders whether it should be part of the system and, if so, what would be the implications. If stakeholders disagree, they should elaborate on ways of disallowing cross-border loss relief in a consolidation system.

Formulary apportionment

Formulary apportionment is a mechanism for allocating the tax base among eligible jurisdictions (EU countries) on the basis of a set of predetermined weighted factors. This formula would replace the arm’s-length principle as the relevant standard for the allocation of profits between associated enterprises.

It is envisaged that the consolidated tax base of the BEFIT Group will be apportioned to the different EU countries in which the group operates, using a formula. An international consensus, reached for the first time, on the use of a profit allocation formula in Pillar One, could help pave the way for the use of a formula in BEFIT. The Pillar One formula only uses one factor, while the more complex BEFIT would use at least three factors.

Stakeholders are requested to take a position on the following options:

• Option 1: A formula excluding intangible assets and considering only tangible assets, labor, and sales by destination; or
• Option 2: A formula incorporating intangible assets as a factor in the formula, in addition to the factors in the alternative option. Here, stakeholders should explain how the value of intangible assets should be taken into account (accounting value, proxy, or some other way) and indicate whether they have any suggestions for the content of the intangible assets factors.

Several options are considered regarding the weight of each factor. In the sample formula below, all four factors mentioned above are included and equally weighted (¼). The share of profit of group member F would be determined as follows (G refers to the whole group):

In this formula, the EU country of destination (market jurisdiction) is less represented than the EU country of origin, as only one quarter of all factors (i.e. sales by destination) allocates profits to the market jurisdiction. To compensate for this, a possibility could be to apply an increased weighting to sales by destination (e.g. a double weighting, giving two fifths of the overall weighting to sales by destination and three fifths to origin).

Allocation of profits to entities outside the EU

Under BEFIT, the arm’s-length principle would continue to apply to price transactions between companies of the BEFIT Group (EU companies and businesses in the scope of BEFIT) and companies of the same group that are tax-resident outside the EU (i.e. outside the BEFIT Group) and/or their associated enterprises in the EU or a country outside the EU.

According to the commission, the planned initiative could simplify the methods for applying transfer pricing rules, to give taxpayers greater legal certainty but without deviating from the arm’s-length principle.

Two options are envisaged:

• Option 1: A simplified approach to the administration of transfer pricing rules, based on macroeconomic industry benchmarks. The aim would not be to replace the arm’s-length principle. In fact, businesses would still need to carry out the necessary transfer pricing analysis. The envisaged rules would only provide guidance on tax authorities’ risk approach to businesses’ transactions with related entities outside the consolidated group; or
• Option 2: Keeping the current approach to the application of transfer pricing rules.

Administrative Considerations

Finally, the administrative aspects of BEFIT are still under careful consideration, as one of the objectives of the initiative is to reduce compliance and administration costs. However, the European Commission admits that “some additional compliance and administrative costs could arise in certain circumstances.” Stakeholders can comment on whether they think that the BEFIT initiative will entail additional costs for taxpayers or tax administrations.

As far as the reduction of administrative burden is concerned, the commission sees filing simplifications regarding tax returns, tax audits and dispute resolution. Stakeholders can indicate which of these simplifications they would consider most useful.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Oliver R. Hoor is a Tax Partner (Head of Transfer Pricing and the German Desk) and Samantha Schmitz is the Chief Knowledge Officer with ATOZ Tax Advisers.

The authors may be contacted at: oliver.hoor@atoz.lu; samantha.schmitz@atoz.lu