On May 18, 2021, the European Commission (the Commission) of the European Union (the EU) published a communication on “Business Taxation for the 21st Century” (the Communication), setting out a long-term vision to provide a future-proof EU tax system and a tax agenda for the next two years with targeted measures to ensure effective taxation and promote post-COVID-19 recovery.  These solutions, if implemented, would go far beyond BEPS 2.0.

EU’s role in implementing BEPS 2.0 across EU Member States

The Commission recognises in the Communication the importance of having a global consensus-based solution to reform the international corporate tax framework to tackle issues linked to the increasing globalisation and digitalisation of world economies.  To this end, the discussion led by the OECD Inclusive Framework (BEPS 2.0) focuses on two broad work streams: Pillar 1 (partial re-allocation of taxation rights) and Pillar 2 (minimum effective taxation of multinationals’ profits).  See here for our four-part series on BEPS 2.0.  

Recognising the recent progress on BEPS 2.0 (and expressly acknowledging the positive engagement of the new U.S. administration, on which we reported here), the Communication sets out the Commission’s plan to implement BEPS 2.0 in the EU.  The Commission will propose a Directive for the implementation of Pillar 1 in the EU.  The principal method for implementing Pillar 2 will be a further EU Directive that will reflect the OECD Model Rules with the necessary adjustments.  The Commission will consider the interactions between Pillar 2 and existing EU initiatives, including:

• the interaction between the income inclusion rule under Pillar 2 and the Controlled Foreign Company rules under the Anti-Tax Avoidance Directive;
• Pillar 2’s potential facilitation of EU Member States agreeing on the pending proposal for recasting the EU Interest and Royalties Directive, which will make the benefits of this Directive (i.e., the elimination of withholding tax on interest and royalty payments within a group of companies) conditional on the interest being subject to tax in the destination state; and
• the potential introduction of Pillar 2 as an additional criterion to determine whether a foreign jurisdiction should be included in the EU’s blacklist of non-cooperative jurisdictions. Given the EU’s plan to implement Pillar 2, the number of jurisdictions that could be added to the EU’s blacklist might possibly be significant if this measure is adopted.

EU’s Pillar 1 – wider and further (and with a new befitting name!)

As it is anticipated that Pillar 1 will apply only to an initially limited number of companies, the Commission clearly envisages the EU going further.  The Commission will, accordingly, propose a new framework for income taxation for businesses in Europe, known as “Business in Europe: Framework for Income Taxation” or BEFIT.

BEFIT will be a single corporate tax rulebook for the EU, based on the key features of a common tax base and the allocation of profits between EU Member States based on a formula.  BEFIT will use a formula for the partial reallocation of profits under Pillar 1 and common rules for calculating the tax base for the purposes of applying Pillar 2.  This common rulebook is intended to get rid of the burden of complying with up to 27 different sets of corporate tax rules.  The only discretion left in the hand of each EU Member State is the determination of the national corporate income tax rate, at which the allocated profits to that EU Member State will be taxed.

This formulary apportionment will also get rid of the principles of tax residence and source, which underpin the current international corporate tax system.  It will further depart from the “arm’s length principle” to which members of a group are currently required to adhere to in order to comply with transfer pricing rules.

The Commission will present BEFIT by 2023, replacing the pending proposals for a Common Consolidated Corporate Tax Base (CCCTB).

Targeted anti-tax avoidance solutions

In addition to the long-term vision of implementing BEFIT, the Commission also proposes two targeted solutions on its tax agenda for the next two years to tackle tax avoidance.

The Commission proposes that certain large companies operating in the EU should have to publish their effective tax rates, calculated by using the methodology agreed for the Pillar 2 calculations.

To step up the fight against the abusive use of shell companies, the Commission proposes that a new initiative should be introduced to neutralise the misuse of shell entities for tax purposes.  The proposal would encompass actions such as requiring companies to report to the tax administration the necessary information to assess whether they have substantial presence and real economic activity, denying tax benefits linked to the existence or the use of abusive shell companies, and creating new tax information, monitoring and tax transparency requirements. The Commission also intends to take further steps to prevent double non-taxation of royalty and interest payments leaving the EU.

Some post-COVID-19 supports

To promote post-COVID-19 recovery, the Commission proposes the following supports for businesses to invest and grow.

The Commission acknowledges that there is a persisting pro-debt bias against equity in the EU Member States’ (and other countries’) tax rules.  That bias increases the accumulation of debts, and thereby amplifies the risk of high waves of insolvency in times of economic crisis.  To redress this perceived imbalance, the Commission proposes to address the debt-equity bias in corporate taxation through an allowance system for equity financing.  However, the proposal will also come with anti-abuse measures to ensure those ‘allowances’ are not used for unintended purposes.

To alleviate the cash-flow problem of businesses that would have been healthy but for COVID-19, the Commission proposes adopting a recommendation that prompts EU Member States to allow loss carry back for businesses to at least the previous fiscal year.  However, EU Member States will have to limit the amount of losses to be carried back to €3 million per loss-making fiscal year.

By the way, more EU taxes coming soon...

Although not within the scope of the Communication, the Commission mentions that it will propose other new EU taxing provisions.  These include proposals for a Carbon Border Adjustment Mechanism, a digital levy, a revision of the EU Emissions Trading System, and a revamped set of proposals for the financial transaction tax.  These are expected to be independent of the implementation of BEPS 2.0 and BEFIT.

Conclusion

Businesses operating in the EU should follow closely the Commission’s proposals for tax reforms.  Many of the proposals are close to being revolutionary, especially those related to BEPS 2.0 and BEFIT.  While the CCCTB proposals were controversial when proposed over ten years ago, it is reasonable to envisage even greater concerns regarding the BEFIT proposals of homogenising the base of EU taxation.  At the very least, these proposals will, if implemented in the form announced, significantly affect a business’ tax and/or administrative burden or a group’s tax planning.