EU business taxation for the 21st century

The EU Commission published a Communication to the European Parliament and the EU Council on 18 May entitled “Business taxation for the 21st century” with its blueprint for new post-pandemic EU tax agenda to meet the social, financial and tax challenges of the years ahead. The tax agenda announced by the Commission recognises that revenue is needed to finance public investment in order to build, support and sustain an economic recovery. For these purposes, the EU Commission is putting forward proposals for a “robust, efficient and fair tax framework that meets public financing needs, while also supporting the recovery and the green and digital transition”.

The Communication sets out the broad principles for the tax agenda as requiring “a balanced revenue mix, and a tax system guided by the principles of fairness, efficiency and simplicity”. In particular, it should “reduce compliance costs for businesses, facilitate cross-border investment, and provide the right environment for SMEs and larger enterprises alike to thrive”. These aims are, of course, somewhat easier to state than to achieve.

In particular, the Communication picks up the EU’s role in supporting the OECD’s efforts to find an international solution for the taxation of the digital economy, confirming the intention to implement the Pillar 1 and Pillar 2 proposals in the EU by the use of a centralised Directive. Unsurprisingly, there is also a renewal of the broad aim for an EU wide common tax base for businesses, albeit with a change of acronym from CCCTB to BEFIT.

Taxation in general

The agenda recognises that taxation will play a role in supporting other EU initiatives such as those in relation to environmental matters, including the European Green Deal. On the flip side, the Communication stresses that effective collection of taxation is vital, both for public finances and to ensure a level playing field for businesses.

In relation to VAT, the Commission notes that consumption tax rates are already at a historic high, as VAT rates were increased in the years following the financial crisis. As such, priority should be now be given to limiting the inefficient use of reduced VAT rates and exemptions, which (according to the Commission) often fail to deliver on their presumed policy objective, rather than further raising the headline rates.

The Communication sets out the Commission’s intention to launch a broader reflection on the mix of tax within the EU, to conclude in a Tax Symposium on the ‘EU tax mix on the road to 2050’ in 2022.

The Communication also touches on the issue of the EU’s own resources, noting that the Commission will release in July 2021 proposals for a Carbon Border Adjustment Mechanism (CBAM), a digital levy and a revision of the EU Emissions Trading System. However, the Commission also plans to propose additional new own resources, which most notably could include “a Financial Transaction Tax and an own resource linked to the corporate sector”.

As regards the digital levy, this is intended to operate separately to any OECD agreed measures targeted at MNEs. The Communication argues that digital companies “tend to pay less taxes than other companies and the taxes they pay do not always benefit the countries where their activities take place”. The digital levy will be designed in such a way that it is independent of the forthcoming global agreement on international corporate tax reform.
After its establishment, it will coexist with the implementation of an OECD agreement on sharing a fraction of the taxable base of the largest multinational enterprises, once that is ratified and transposed in EU law.

Reform of international taxation

The Communication sets out its broad support for the revised Pillar 1 and Pillar 2 approaches following changes in the US stance on these matters. In particular, on Pillar 1 the Communication notes that discussions initially focused primarily on companies active in the digital sector, but following recent developments the proposed solution could now be simplified with a lower number of MNEs in scope but broadened to cover the largest and most profitable MNEs regardless of their business sector.

The Commission regard both Pillars as consistent with the Commission’s vision for a business taxation framework for the 21st century and would propose that, once agreed, they are implemented in the EU via an EU Directive. The Commission notes that the necessary changes may have implications for existing and proposed EU Directives and initiatives. For example, it will be necessary to align existing ATAD rules concerning CFCs with the Pillar 2 proposals and the Commission sees the minimum global rate as a way to unblock the proposed recasting of the Interest and Royalties Directive to make the benefits of the Directive dependent on the interest being subject to tax at a minimum level in the destination state.

Other business tax proposals

In the meantime, the Communication contains two proposed and more immediate targeted measures. The first is that the Commission will put forward a proposal for the annual publication of the effective corporate tax rate of certain large companies with operations in the EU, using the methodology agreed for the Pillar 2 calculations. The effective corporate tax rate provides information regarding the proportion of corporate tax paid by companies relative to the amount of profits they generate rather than relative to their ‘taxable profits’, which can be reduced through various means such as tax allowances. The proposal is designed to improve public transparency around the real effective tax rate experienced by large EU companies.

Secondly, the Commission will introduce a new legislative initiative in relation to the (mis)use of shell companies. The Commission 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 royalty and interest payments leaving the EU from escaping taxation (so-called ‘double non-taxation’).

More fundamentally, the Communication reveals that the Commission has set its sights on the debt v equity imbalance. The current tax framework allowing for a tax deduction of interest on debt gives rise to a pro-debt bias of tax rules, since a company can deduct interest in relation to debt financing but not the costs related to an equity financing, such as the payment of dividends. This, according to the Commission, can contribute to an excessive accumulation of debt, with possible negative spill-over effects for the EU as a whole, should some countries face high waves of insolvency. The Commission will therefore make a proposal to address the debt-equity bias in corporate taxation, via an allowance system for equity financing, thus contributing to the re-equitisation of financially vulnerable companies.

Finally, and unsurprisingly, the Commission turns its attention back to the issue of the lack of a common corporate tax system in the Single Market, which gives rise to higher compliance costs for businesses active in more than one EU member state (withdrawing the prior proposal for a CCTB or even CCCTB). The Commission will therefore propose a new framework for income taxation for businesses in Europe (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 Member States based on a formula. The intention will be to build on progress in the global discussions, where these concepts are already present, through the use of 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.

BEFIT will involve the consolidation of the profits of the EU members of a multinational group into a single tax base, which will then be allocated to Member States using a formula, to be taxed at national corporate income tax rates. Key considerations will include how to give appropriate weight to sales by destination, to reflect the importance of the market where a multinational group does business, as well as how assets (including intangibles) and labour (personnel and salaries) should be reflected, to ensure a balanced distribution of corporate tax revenue across EU Member States with different economic profiles. The Communication notes that the use of a formula to allocate profits will remove the need for the application of transfer pricing rules within the EU for the companies within scope.

It appears that the Commission’s aim is to introduce BEFIT into EU legislation by 2023.