Moving towards harmonized Corporate Income Tax in the European Union: will it be third time lucky?

The establishment of a harmonized corporate income tax system in the European Union (EU) is something to which EU institutions have long aspired. Two previous legislative initiatives, both presented by the European Commission, had pursued this same objective back in 2011 and 2016. Neither of them came to fruition because the consensus among member states required for their final approval was not reached.

Although the precedents are far from encouraging, the Commission has just launched a new legislative proposal with which it hopes to realize this long-standing ambition. Called "BEFIT" (Business in Europe: Framework for  Income Taxation), it is a measure which had already been announced as part of the package included in the Communication on Business Taxation for the 21st Century, of May 2021, which was published in the form of a proposal for a directive last September (as was mentioned in our post in this same blog  dated October 10, 2023). This new proposal supersedes and renders void the 2011 and 2016 initiatives and, if it goes ahead and is approved, would take effect as from July 2028.

According to its explanatory memorandum, the main objective of this proposal is simplification – by replacing 27 different legislative systems with a single "common framework" for corporate income tax – thereby reducing tax uncertainty and compliance costs, which are viewed (by the author of the proposal) as factors which undermine the proper functioning of the internal market, discouraging cross-border investment while creating a fertile ground for abusive tax practices.

The common corporate income tax framework envisaged in BEFIT is based on the following five pillars: (i) the rules which define its scope, (ii) the provisions on quantification of the tax base, (iii) the criteria for aggregation and subsequent allocation of the tax base, (iv) the establishment of a simplified method of compliance in relation to transfer pricing, and (v) certain rules of an administrative and procedural nature. The basic features of each of these pillars are summarized below.

In terms of its scope of application, BEFIT is "hybrid” in nature, since it is mandatory for certain large groups and optional for all other entities. Compliance with its rules will only be mandatory for groups whose consolidated revenues reach a threshold of 750 million euros (in at least two of the four previous fiscal years), with one qualification: groups whose ultimate parent company is located outside the EU will only be obliged to comply if their EU revenues reach 5% of the group's total revenues and a figure of 50 million euros. Smaller groups will be able to opt in to BEFIT if they so wish.

The central component of the BEFIT project is the establishment of a series of common rules for quantifying the corporate income tax base of the entities included in its scope of application. These rules must be complied with by EU resident companies which belong to one of the above-mentioned groups and are either the parent company or subsidiaries in which the parent company has a direct or indirect ownership interest of at least 75%, or permanent establishments in the EU of the group companies.

The tax base of each company is calculated by applying to its accounting result (determined, as a general rule, in accordance with the accounting standards applicable in the preparation of the consolidated financial statements) the positive or negative adjustments envisaged in the provisions of the directive. The proposal regulates in meticulous detail the various income and expense items that may give rise to adjustments to the accounting result.

Once the individual tax bases of each company have been determined in accordance with BEFIT criteria, they must be "aggregated" (a process not to be confused with "consolidation", since it involves simply adding together the individual tax bases with no consolidation adjustments being applied) and the aggregated tax base (where positive) must subsequently be "shared out" among the members of the group. It is precisely in this aggregation process that we see one of the main benefits of BEFIT, i.e. the possibility of cross-border loss relief.

The subsequent allocation of the "aggregated tax base" among the companies of the group is logically one of the critical elements of the new proposal, given that each State will have the power to levy taxes on the portion of the aggregated result that corresponds to it (the group's tax "pie" being shared out among the Member States in which the group is present). The solution for which the BEFIT proposal has opted is a compromise of a transitional nature and, unlike previous initiatives (which proposed allocation formulae based on the weighting of various factors such as the location of property, plant and equipment, wage costs or sales), it envisages an allocation formula based on the relative contribution made by each company to the group's result for tax purposes, using the average figure for the last three fiscal years. The draft directive envisages a review of this method 7 years after the entry into force of BEFIT.

Once the tax result has been "shared out" among the entities of the group, each Member State is free to tax it at the rates it has established at national level and to allow the credits against tax payable and tax incentives provided for in its domestic legislation.

The BEFIT proposal is supplemented by a number of rules aimed at simplifying the management of the tax. These include, on the one hand, the establishment of criteria for relaxing compliance with transfer pricing rules in relation to certain activities deemed to be low risk and, on the other, the establishment of a tax management and administration procedure based on a kind of "one-stop shop". Also envisaged is the creation of a "BEFIT (technical oversight) team" which each group will be assigned and which will be made up of representatives of the different national tax administrations.

And with this we return to the question posed at the start of this article: will it be third time lucky? There are clear differences between the current context and the situation existing in 2011 and 2016: since then, the EU has taken previously unimaginable steps towards the harmonization of corporate income tax (for example, the unanimous adoption of the directive establishing a global minimum level of taxation of multinationals – analyzed in our blog post of January 16, 2024), so in theory, the chances of success with this proposal should be greater than on previous occasions. We will keep a close eye on how the process develops.