BEFIT: Harmonising taxable income for large corporate groups in the European Union
The European Commission has published a proposal for a directive to implement the BEFIT concept (short for “Business in Europe: Framework for Income Taxation”). The new law would allow the creation of standardised rules for calculating taxable income for purposes of corporate income tax. Taxpayers belonging to a BEFIT group will be taxed in the country of their residence, but only with respect to a portion of the tax result determined for the entire group.
The proposal is intended to complement the European Union’s tax policy and further implementation of the BEPS (Base Erosion and Profit Shifting) project, in particular Pillar Two, which aims to tighten tax systems and effectively combat aggressive tax planning. It establishes a minimum level of taxation for the largest taxpayers (15% of income) and introduces complementary mechanisms for additional taxation of under-taxed income.
Who is affected by the new provisions?
Pursuant to the proposed directive, a BEFIT group will include:
- Companies resident for tax purposes in a member state
- Their foreign tax establishments located in other member states, and
- Tax establishments located in the member state of entities resident for tax purposes in a third country meeting certain criteria.
A BEFIT group will be formed when the annual revenue of the group (domestic or international) as reported in the consolidated financial statement was EUR 750 million or more in at least two of the last four fiscal years. A BEFIT group can be formed if at least two companies show ties. In particular, the ultimate parent company will have to hold directly or indirectly at least 75% of the ownership or profit rights in companies belonging to the group. In turn, an establishment will have to belong to a company that belongs to the BEFIT group based on the foregoing criteria.
Thus, the directive is aimed at the same group of taxpayers as Pillar Two of BEPS.
For groups where the ultimate parent company is located outside the EU, the units located in the EU will form a BEFIT group if, additionally, their consolidated revenues were at least EUR 50 million in at least two of the last four fiscal years and accounted for at least 5% of the entire group’s revenues.
For whom will they be voluntary?
The proposal provides that smaller corporate groups preparing consolidated financial statements will be able to voluntarily form a BEFIT group.
How will the tax base be divided?
The BEFIT group’s tax result will be determined for each fiscal year based on the net profit or loss determined for financial accounting purposes based on accounting standards accepted in the EU. This result will be subject to a number of adjustments, with the basis of calculation being the result before consolidation adjustments for intra-BEFIT group transactions. One of the many adjustments, for example, is exclusion from the BEFIT group’s tax result of transportation activity subject to tonnage tax.
The draft directive provides that income and losses from mining activities will not be subject to aggregation, as in principle they are taxable at the place where such activity is carried out. Also, revenues and expenses from international transport activities not covered by the tonnage tax are not subject to allocation, as in principle they are taxable only in the state where the ship or aircraft management company is located.
During the transition period from 2028 to 2035, the share of the BEFIT group’s tax base in a given state will be proportional to the ratio of the BEFIT group member’s averaged tax result from the three preceding fiscal years to the BEFIT group’s averaged total result determined based on the group members’ performance during that period.
These determinations may constitute the basis for a later permanent method of allocating taxation rights.
What about withholding tax?
Withholding tax will not be levied on transactions between members of a given BEFIT group if the actual beneficiary of the receivable is a member of the BEFIT group. Individual transactions are not to be taxed because all transactions will be taxed on the aggregate tax base calculated for the BEFIT group. To prevent profits from being diverted outside the BEFIT group, member states will retain the power to verify that the recipient of the payment is the actual beneficiary.
And transfer prices?
The Commission has also proposed amendments in the area of transfer pricing.
Ultimately, the new regulation may obviate the need to value transactions, due to the possible introduction of a system of permanent allocation of tax income to specific countries.
During the transition period, the arm’s-length principle will be maintained, as transactions within the BEFIT group will affect current tax settlements and thus shape the rules for the permanent allocation of tax income for the future. The proposed provisions also introduce a presumption of compliance of the terms of transactions with the arm’s-length principle if the value of the transactions remains within 10% of the values realised in the preceding three years.
For transactions with related entities not belonging to the BEFIT group, the directive proposes a simpler “traffic light” system.
This system will apply to low-risk activities—distributors with a limited functional profile and contract manufacturers. If transactions with such taxpayers are examined using the unilateral transfer pricing methods recommended by the OECD, it will be possible to rely on publicly available benchmark studies setting the market level of transfer pricing in the European Union. The greater the difference between the taxpayer’s result and the standardised level of market prices, the higher the risk category to which the taxpayer will be assigned, which in the future may translate into a higher probability of triggering a tax audit.
What are the aims of the proposal?
According to the proponents, the introduction of these amendments at the EU level will make it easier to determine the tax base and tax liabilities and reduce administrative effort. This is expected to translate into lower compliance costs for taxpayers and oversight costs for the tax authorities.
Under the proposal, the member states would start applying the provisions in mid-2028.
Jan Skowroński, Tax practice, Wardyński & Partners