The EU’s BEFIT Initiative—and Why it Doesn’t Make Sense (Part 2)

The European Commission’s BEFIT initiative, described in Part 1, raises a number of concerns that are addressed in this article.

National Sovereignty of EU Member States at Stake

The corporate tax laws of EU member states vary from one state to another against the backdrop of the structure and focus of the respective economy. Notably, EU member states have the freedom to adopt different tax policy choices with a view to setting the right incentives for their economies.

Member states’ national sovereignty over tax matters is a fundamental principle of the EU. Therefore, when it comes to important decisions in the field of taxation, unanimous agreement by all countries is required.

While there have been several attempts by the European Commission to move to qualified majority voting, where measures can be approved by a minimum number of EU countries, representing a minimum share of the EU population, such attempts have so far failed.

In our view, moving to qualified majority voting in taxation would undermine the competitiveness of the EU, as it would diminish the pressure on national authorities to pursue efficient and competitive tax policies, and would result in higher taxation across the EU bloc.

The BEFIT initiative would undermine national sovereignty over tax matters through the backdoor, as it would largely replace domestic tax laws with an EU corporate tax system over which individual member states would have only very limited control.

Absence of a Need for BEFIT

Since the time of the common consolidated corporate tax base proposal, the European and international tax landscape has undergone a dramatic transformation. Following the OECD’s base erosion and profit shifting project, the European Commission adopted several EU directives that aimed to tackle perceived tax evasion and tax avoidance.

The two Anti-Tax Avoidance Directives (ATAD and ATAD II) provided for a number of strict anti-abuse provisions that had to be transposed into the domestic tax laws of EU member states. Tax transparency has been elevated to a new level through the various amendments to the Directive on Administrative Cooperation (DAC 1–7). The commission further released a draft directive regarding the misuse of EU shell entities (entities lacking a minimum level of substance for tax purposes), ATAD III, also referred to as the “Unshell Directive,” and a draft directive on laying down rules on a debt-equity bias reduction, DEBRA.

Other important changes to the international tax landscape have been advanced by the Organization for Economic Cooperation and Development. The multilateral instrument resulted in the implementation of various anti-abuse provisions, such as the principal purpose test, in covered bilateral tax treaties. In 2017 and 2020, the OECD transfer pricing guidelines were revised in accordance with the guidance developed as part of the OECD’s follow-up work on BEPS Actions 8–10 and 13.

The corporate tax laws of EU member states are therefore already largely harmonized, and tax authorities of EU member states have a comprehensive arsenal of anti-abuse rules that allows them to tackle any kind of abusive situation, as well as reporting requirements that should allow them to be aware of any residual abuse.

Absence of a Legal Basis for BEFIT

The purported legal basis of the BEFIT initiative is Article 115 of the Treaty on the Functioning of the EU, which stipulates that legal measures under that article shall be vested with the legal form of a directive. However, the EU’s competences are governed and limited by the principles of subsidiarity and proportionality, if the directive is imperative for the functioning of the internal market.

The principle of subsidiarity

The general aim of the principle of subsidiarity is to guarantee a degree of independence for a lower authority in relation to a higher body or for a local authority in relation to central government. It therefore involves the sharing of powers between several levels of authority, a principle which forms the institutional basis for federal states.

When applied in the context of the EU, the principle of subsidiarity serves to regulate the exercise of the Union’s non-exclusive powers. It rules out Union intervention when an issue can be dealt with effectively by member states themselves at central, regional or local level. The Union is justified in exercising its powers only when member states are unable to achieve the objectives of a proposed action satisfactorily and added value can be provided if the action is carried out at Union level.

Here, the European Commission claims that:

“BEFIT aims to simplify the rules for corporate taxation in the single market, mainly resulting from the fragmentation of the EU into 27 disparate tax systems. This is a serious impediment to businesses that are active in more than one Member State. The current framework of uncoordinated action planned and implemented by each Member State individually, results in persisting fragmentation and complexity, as companies need to deal with 27 different tax systems and the same number of tax administrations. … This problem is of primarily cross-border nature, so it can only be tackled by laying down legislation at the EU level.” (page three of the explanatory memorandum)

The principle of proportionality

The envisaged measure further must comply with the principle of proportionality. Accordingly, a measure must not go beyond what is required to ensure the minimum necessary level of protection for the internal market.

Assessment

The commission only has a legal basis in Article 115 of the TFEU to the extent that the draft directive is imperative for the functioning of the internal market and adheres to the principles of subsidiarity and proportionality.

As regards the need for BEFIT for the functioning of the internal market, the commission claims that the complexity of 27 tax systems creates a serious impediment to businesses that undermines the competitiveness of the internal market and can only be tackled by laying down legislation at EU level.

However, it is questionable whether this initiative, which would result in extreme complexity and legal uncertainty for years, is required for the functioning of the internal market. All the more since the tax laws of EU member states have been largely harmonized over the last decades. Moreover, differences in tax systems are consistent with member states’ sovereignty in tax matters, which cannot be undermined through invoking Article 115 of the TFEU.

Even if it could be established that some tax law changes are imperative for the functioning of the internal market, the BEFIT initiative aiming at the implementation of a European corporate tax system would be inconsistent with both the principle of subsidiarity and the principle of proportionality. On this basis, the commission should, in our view, have no authority to intervene.

Tax Treaty Override

Bilateral tax treaties concluded between EU member states allocate an unlimited primary taxing right over business profits to the residence state of a company. Other EU member states may only tax (part of) the business profits of the company to the extent it has a permanent establishment in their territory and business profits are attributable to such permanent establishment.

Prices charged for the transfer of goods and services between associated enterprises (that are transfer prices) must comply with the arm’s-length principle. Otherwise, the tax authorities of the contracting states may perform tax adjustments with a view to restate arm’s-length conditions.

Formulary apportionment as proposed under BEFIT would be inconsistent with the tax treaty obligations of EU member states, undermine the arm’s-length principle, and represent tax treaty override.

While legitimate EU law prevails over domestic tax laws and tax treaties in an EU context, one should keep in mind that the tax treaties concluded by EU member states are generally based on the OECD Model. The concepts and principles included in the OECD Model have been developed over time and agreed upon at global level by OECD countries (all EU member states belong to the OECD).

Overwriting these concepts and fundamental tax principles with regard to transactions between EU companies by BEFIT would represent a step backwards, and not an improvement as suggested by the EU Commission.

Chronic Legal Uncertainty

The implementation of BEFIT has the potential to result in years (likely more than a decade) of chronic legal uncertainty. While the numerous tax law changes over past years already have resulted in significant legal uncertainty, a large part of existing domestic tax law has a long history, including extensive guidance and established case law.

Replacing these domestic tax systems with a new set of rules that might be interpreted differently in EU member states would be an adventure for taxpayers and member states. Considering that it may take up to 10 years before the Court of Justice of the European Union takes a decision—a case must go through the courts of the relevant member state before it can be referred to the CJEU—it would be a very long time before the new rules are settled.

This would mean that taxpayers and tax authorities would need to dedicate increased resources to ensuring compliance and settling disputes resulting from the legal uncertainty.

Unpredictable Impact on Public Finances

Under BEFIT, the arm’s-length principle would be replaced by formulary apportionment (even though transactions would still need to adhere to the arm’s-length standard). The arm’s-length principle would only be relevant for transactions with non-EU members of the group.

Such drastic change to the corporate tax system obviously would raise concerns with respect to public finances, as it seems impossible to predict the exact impact on member states’ budgets. Corporate tax revenues would likely change significantly, whether on the upside or the downside.

In addition, such a fundamental change of the corporate tax system may create unintended incentives for multinational groups to reduce their economic activity in a member state. For example, multinational groups might consider shifting shared service centers and production to jurisdictions with low salary costs.

Conclusion and Outlook

The BEFIT initiative aims at the adoption of a common set of rules for EU companies to calculate their taxable basis and the allocation of profits between EU countries based on formulary apportionment. Stakeholders have until Jan. 26 to provide their input on whether a new EU corporate tax framework is needed and, if so, on the most suitable options for implementing such framework.

While the baseline scenario is that the current national rules on corporate taxation remain unchanged, the adoption of the BEFIT proposal by the commission is already planned for the third quarter of 2023. As such, one may wonder why the commission is organizing a public consultation, when the outcome seems to be clear from the outset.

Maybe the commission intends to give this initiative the impression of democratic legitimacy through a public consultation process. However, it remains unclear how a self-selecting group of respondents can give credibility to this disruptive and extremely complex tax initiative.

Ultimately, it remains to be seen whether the governments of EU member states will unanimously give up their sovereignty in tax matters, including their control over public finance.

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