‘25 October 2016; the European Commission published proposals for an EU corporation tax system for multinationals under which the Member States’ autonomy would effectively be narrowed down to a mere setting of corporation tax rates.’
Proposals for a CCTB and a CCCTB
On 25 October 2016, as part of a broader package of corporate tax reforms, the European Commission published proposals for a Council Directive on aCommon Corporate Tax Base (CCTB) and a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB), re-launching its original CCCTB-proposal of 2011 in two stages. The CCTB-proposal forwards detailed measures establishing a mandatory harmonized EU wide corporate tax base definition and tax base calculation system. The system would apply for all groups of companies with a total annual turnover in excess of EUR 750 million that conduct business activities in the internal market through a taxable presence in an EU Member State. The CCCTB-proposal forwards detailed measures on top, establishing a harmonized EU wide tax base consolidation and a tax base apportionment mechanism, as well as an accompanying tax administration system for these groups of companies. The European Commission also released proposals for a Council Directive on Double Taxation Dispute Resolution Mechanisms and a proposal to amend Directive (EU) 2016/1164 as regards hybrid mismatches with third countries. These latter developments are set out with in a separate Loyens & Loeff Tax Flash.
Proposals need unanimous approval EU Member States to get adopted
The proposals need to be approved unanimously by all 28 EU Member States. If adopted, the Member States will be required to transpose the directive provisions in their national laws. The CCTB Directive as now proposed would call Member States to effectuate the rules as per 1 January 2019, the CCCTB Directive would call upon an effective application as per 1 January 2021. Unfortunately, at this time we cannot predict the chances of this Commission initiative to become reality any time in future. Although the impact of the proposals – if adopted – will be substantial, there seems to be little need for companies to take immediate action in response. It seems likely however that the increased international attention for corporate taxation matters will continue.
Next steps to further approximation EU corporate tax systems
With these initiatives the Commission takes a next step towards attaining its objectives unveiled in its 17 June 2015 Action Plan of pursuing a further approximation of the EU Member States’ corporate tax systems for the purpose of promoting growth and investment and to secure an effective countering of aggressive tax planning within the internal market. The proposals build on recently adopted tax measures within the EU, including the Anti Tax Avoidance Directive (ATAD) of 12 July 2016, the 2014 and 2015 amendments to the Parent-Subsidiary Directive, and the recast proposal for the Interest and Royalties Directive (2011). The Commission envisages an EU-wide mandatory consolidation and apportionment for large multinationals to constitute a holistic solution for base erosion and profit shifting issues while securing a taxation of corporate profit ‘on the location where value is created’.
The Commission proposes for the Member States to first secure political agreement on the CCTB and subsequently proceed with negotiations with regard to the CCCTB. This means that CCTB could become also without a successive CCCTB. The Commission nevertheless considers both proposals to be part of a single initiative. The original 2011 CCCTB-proposal, still pending before the Council, will be withdrawn if and when these proposals for a CCTB and CCCTB will be adopted.
Modifications to original 2011 CCCTB proposal
The proposals to a great extent match those in the original CCCTB-proposal, save for some important exceptions:
a) Mandatory application;
b) ‘Super-deduction’ for R&D costs;
c) ‘Allowance for Growth and Investment’;
d) Expanding anti-tax avoidance measures by including earlier ATAD proposals;
e) Temporary cross-border loss offset.
ad a) Mandatory application
The CCTB/CCCTB system would apply mandatorily to multinationals with an annual consolidated turnover above EUR 750 million which have a taxable presence in any of the EU Member States for all qualifying group entities. Such a presence would be established either through a permanent establishment situated in a Member State or a through group company that has its tax residency in a Member State. Smaller groups could opt-in for application of the CCTB and/or CCCTB. If such a selection is made, it is for all qualifying entities of that group and for a period of at least 5 years. The mandatory application is contrary to the 2011 proposal, which established an optional CCCTB.
ad b) Super-deduction for R&D costs
The CCTB-proposal includes a ‘super-deduction’ and an ‘enhanced super-deduction’ for research and development (R&D) costs. The deduction would apply on top of the immediate R&D costs expensing feature in the proposal. Under the proposed ‘super deduction’ taxpayers are eligible to additionally tax-deduct an amount equal to 50% of R&D expenditure up to EUR 20 million annually. For R&D expenses in excess of that amount the tax-deduction is 25% of the R&D expenditures. An enhanced ‘super-deduction’ would apply under the proposal for start-ups to facilitate innovation. Qualifying start-up companies may tax-deduct an additional amount equal to 100% of R&D expenditure up to EUR 20 million, provided that these companies do not have any associated enterprises.
Ad c) Allowance for Growth and Investment (AGI)
The CCTB-proposal includes a so-called ‘Allowance for Growth and Investment’ (AGI) with a purpose amongst others of stimulating growth. The AGI under the proposal allows for a tax-deduction calculated by reference to a notional yield on equity increases, whereby that notional amount equals the yield of the euro area 10-year government benchmark bond as published by the European Central Bank. Equity decreases are taxable to an amount equal to the notional yield on the decrease.
Ad d) Anti-tax avoidance measures (including ATAD incorporation)
The CCTB/CCCTB-system would contain a range of anti-tax avoidance provisions. The proposed provisions basically constitute refurbished equivalents of the anti-abuse provisions already found in the original CCCTB-proposal, however taking into account developments with a view to the OECD/G20’s BEPS project and the ATAD.
Permanent establishment. The directive proposals define the permanent establishment closely to the post-BEPS definition in the OECD Model Tax Convention. Contrary to the original CCCTB-proposal, the revised definition only covers intra-EU cases, i.e., permanent establishments situated within the EU which belong to a taxpayer that resides for tax purposes within the EU. Definitions of permanent establishments in third-countries are left to be dealt with via the Member States’ double tax convention networks and domestic tax laws.
Arm’s length standard. The CCTB-proposal incorporates the arm’s length standard, in similar terms as the OECD Model Tax Convention, – as the recital states – ‘to avoid the base erosion of higher tax jurisdictions through shifting profits via inflated transfer prices towards lower tax countries’. The proposed EU arm’s length standard is not limited to intra-EU scenarios only. The draft text establishes that ‘where conditions are made or imposed in relations between associated enterprises that differ from those that would have been made between independent enterprises, any income that would have accrued to the taxpayer but because of those conditions has not so accrued, shall be included in the income of that taxpayer and taxed accordingly.’ Downward adjustments do not seem to be provided for, at least not explicitly. Under a CCCTB the arm’s length standard would remain applicable to allocate company results in third country situations. Within the CCCTB-group no such a standard would apply as the common consolidated corporate tax base would be divided amongst Member States by reference to a predetermined fixed formula.
Expanding anti-tax avoidance measures by including earlier ATAD proposals. The proposals further include a number of anti-avoidance provisions incorporating earlier ATAD proposals. In the re-launched CCCTB these provisions function as absolute rules rather than as minimum standards. This would tighten room for manoeuvre for EU Member States. The proposals forward an EBITDA-based interest deduction limitation, an exit taxation provision, a general anti abuse rule (GAAR), controlled foreign company (CFC) legislation, and a hybrid mismatches provision. The rule on interest deductibility limits the annual deduction of net borrowing costs to the higher of (i) 30% of the earnings before interest, taxes, depreciation and amortisation (EBITDA) and (ii) an amount of EUR 3 million. The CFC provision provides for an inclusion of non-repatriated income of low-taxed controlled EU/EEA and non-EU/EEA subsidiaries and permanent establishment abroad with passive income. In intra-EU/EEA cases the CFC provision would not apply if the CFC ‘has been set up for valid commercial reasons that reflect economic reality’.
Third country mismatch rules and switch-over provision. The proposals further include measures to address mismatches involving third countries, hybrid permanent establishments, tax residency mismatches and mismatch issues in the area of double tax relief tax eligibility. Since no mismatches are expected to arise within the operation of the common system, anti-mismatch provisions in the proposals only target mismatches as regards the operation of the common system in relation to national Member State tax systems and third country tax systems. The proposals further include a switch-over provision similar to that in the original Commission’s ATAD proposal of 28 January 2016. Under the switch-over the participation exemption would not apply to profit distributions and capital gains on disposals of shares in low-taxed third country entities.
ad e) Temporary cross-border loss offset
The CCTB-proposal includes an intra-EU cross-border loss offset provision, accompanied by a subsequent recapture mechanism. The loss-import/recapture system is envisaged to apply in the transitory period in which only the CCTB Directive applies (2019-2021). The mechanism has been developed to make up for temporarily depriving taxpayers from the benefits of tax consolidation under the envisaged CCCTB. The proposal is silent on the offset provision’s faith would the CCCTB not see the light of day.
Under the proposed CCTB rules losses incurred by an immediate subsidiary or a permanent establishment situated in another Member State may be offset against the taxpayer’s home state’s taxable profits. Loss-import eligibility concerning immediate subsidiaries would be available in proportion to the respective taxpayer’s shareholding. The proposal does not provide for loss-import eligibility concerning loss-making indirect subsidiaries. The deducted amounts are added back to the taxpayer’s taxable base if and to the extent its subsidiary or permanent establishment subsequently becomes profitable. An automatic add-back applies after 5 years, or in case the subsidiary or permanent establishment is sold, wound up or transformed into a permanent establishment or subsidiary respectively, irrespective of the fair market value of the subsidiary or permanent establishment at that time.
Components that have remained substantially identical to original 2011 CCCTB-proposal
The components in the directive proposals that have remained substantially identical include the following:
a) Group definition;
b) Tax base and participation exemption;
d) Loss carry forward;
e) Formulary apportionment;
f) Administrative procedures;
g) Selected issues
Ad a) Group definition
Under the CCCTB-proposal the tax consolidation applies provided a two-part continuous test is met based on control and ownership. Control is expressed by reference to a voting rights test of more than 50%. Ownership is expressed by reference to either an equity holding test or a profit rights test, both of more than 75%. The tax consolidation encompasses a pooling of group members’ tax bases and an elimination of all intra-group transactions.
Ad b) Tax base and participation exemption
Under the CCTB-proposal the tax base is defined and calculated basically as the on balance amount of all revenues as reduced with all business expenses (the latter to the extent not explicitly listed as non-deductible).
A full participation exemption would apply to dividend receipts and capital gains from shareholdings of at least 10%. A 12-months minimum holding period requirement has been put into place. Profits derived through business operations carried on through permanent establishments in other Member States and third countries would be exempt as well.
Ad c) Depreciation
Under the CCTB-proposal fixed assets would be individually depreciable to nil on a straight-line basis over their useful lives. Eligible assets are categorized per asset class and by reference to depreciation terms of 40, 25, 15 and 8 years respectively. A rollover relief mechanism applies for replacement assets, provided that the asset replacement involved incurs within 2 years. A pool system has been put into place for other assets allowing for a depreciation in 4 years. The pool system comes with automatic roll over relief for replacement assets.
Ad d) Loss carry forward
The CCTB-proposal allows for an indefinite loss carry forward without any restrictions on annually tax-deductible amounts. No loss carry forward is available in cases of shareholding ownership transfers whereby the acquiring entity obtains a shareholding that meets the control/ownership test under above group definition (more than 50% voting rights, more than 75% capital or profits) in combination with a major change of activity of the acquired taxpayer. No loss-carry back mechanism has been put in place for administrative convenience reasons, amongst others.
Ad e) Formulary apportionment
The common tax base will be divided by using a predetermined fixed formula apportioning the tax base by reference to an equally weighted payroll-assets-sales formula. The labour factor has been divided into a payroll and employee headcount component. The asset factor consists of fixed tangible assets only, excluding financial assets and intangibles. The labour and assets factors seek to apportion at origin. The sales factor seeks to apportion sales at destination. Special rules apply to cater for the needs of certain industries and their specificities, such as financial services and insurance, oil and gas as well as shipping and air transport.
Ad f) Administrative procedures
The proposals provide for a ‘one-stop-shop’ system. The common administrative rules would apply to the consolidated group. Single taxpayers that would opt to apply the CCTB would remain subject to national administrative provisions. Groups would deal with the tax administration (i.e., the ‘principal tax authority’) of the Member State in which the group parent is tax resident (i.e., ‘the principal taxpayer’). Administrative rules and procedures are proposed to address any arising disputes between either Member States tax authorities mutually, or taxpayers and Member State tax authorities.
Ad g) Selected issues
In addition to this, the CCTB-proposal establishes detailed rules to define and calculate tax base amongst others involving stocks, work-in progress, long-term contracts, provisions, pensions, bad debt deductions, hedging, insurance undertakings, rollover relief for replacement assets, and impairments. The proposal also foresees in transitory provisions, and provisions on dealing with transparent entities. The CCCTB-proposal includes special rules to address business reorganisations and the taxation of losses and unrealised capital gains (e.g., specific rules on entering/leaving the group), a sharing of withholding tax proceeds between Member States, and some specific provisions to address misuse of exemption eligibility. The proposals further establish rules securing a reciprocal alignment of directive provisions and also establish powers for the Commission to adopt delegated acts in a range of areas.
If adopted, the measures will fundamentally change tax positions for all groups of companies with a total annual turnover in excess of EUR 750 million that conduct business activities in the internal market through a taxable presence in an EU Member State. The directives would effectually introduce a single EU wide corporation tax system for these multinationals, replacing the 28 separate EU Member States’ national systems. EU Member States autonomy in this area would be narrowed down to a mere setting of tax rates. Only time will tell whether the EU Member States will be prepared to allow for such an autonomy transfer to the Union. If so, multinationals would perhaps need to alter the legal organisations of their intra-EU operations in future to adapt to a new EU tax landscape. However, as any effective entry into force is not foreseen before 2019 and 2021 respectively and the fact that these proposals are draft proposals and that the EU Member States would need to unanimously consent on final proposals, it seems to be too early for immediate action. It may however be expected that current increased international attention for corporate taxation is unlikely to decrease in coming years.