On May 18, 2021, the European Commission (Commission) announced its Communication on Business Taxation for the 21st Century (the Communication). The 2021 Communication was initially introduced on July 15, 2020, but it was repeatedly postponed, with a public consultation seeking stakeholder comment earlier this year.
Background
In 2011, the Commission launched a Council directive on a Common Consolidated Corporate Tax Base (CCCTB). However, the initial draft was opposed by many member states, with tax consolidation being one of the more intractable debates.
In October 2016, the Commission revised its CCCTB proposal from 2011, resulting in a re-launch of the CCCTB with an adopted Action Plan to reform the corporate tax framework in the EU. The re-launch of CCCTB, in response to the fines imposed on Apple, Amazon and other multinational companies for their tax avoidance schemes, aimed to combat tax avoidance while simplifying cross-border taxation for companies. However, despite making significant progress on many critical components of the previous CCCTB proposal, Member States were unable to reach a final agreement.
Overview of the Communication
On May 18, 2021, the Commission outlined its tax policy agenda, including targeted solutions exceeding the scope of the Organization for Economic Co-operation and Development (OECD) BEPS 2.0 project. The Commission also declared its intention to replace CCCTB with a new approach contained in the Business in Europe: Framework for Income Taxation (the BEFIT). This new proposal will provide a single corporate tax rulebook for the EU, based on apportionment and a common tax base.
The proposed agendas emphasize the significance of a stable, effective and equitable tax structure that satisfies the EU's public finance obligations and impending tax proposals. The Commission's tax agenda complements the ongoing work on international corporate tax reform and aims to support the EU's post-COVID-19 economic recovery, digital and green deal transitions, including a 55% reduction in emissions 2030 and carbon neutrality by 2050.
The Communication includes plans to revise the EU Emissions Trading System (EU ETS) and the Energy Taxation Directive, creating a Carbon Border Adjustment Mechanism (CBAM). These recommendations would contribute to the EU's new structure of internal resources to finance the EU budget. In addition, the Commission reaffirms its intention to propose additional internal resources, notably a Financial Transaction Tax and a corporate sector-specific internal resource. The Communication notes CBAM, the digital levy and a change of the EU ETS, all expected in July 2021, and are among the preliminary recommendations outlined in the Communication.
For the proposed EU digital levy, the Communication states that the levy will be independent of the expected global BEPS 2.0 agreement on international corporate tax reform and will be designed in accordance with WTO and other international obligations. The goal of the digital levy is to provide a new source of revenue to maintain the EU budget's long-term viability and enable investments supporting the digital transition. Once implemented, the digital levy will coexist with the Pillar One agreement as written into EU legislation. This plan will be distinct from the 2018 plans for a Digital Services Tax and a Significant Digital Presence, both of which will be withdrawn.
Road map
The Communication also highlights targeted measures for implementing the global BEPS 2.0 agreement to achieve a comprehensive EU corporate tax structure, including short-term corporate taxation efforts and action items for the Commission's agenda for the next two years.
Short-term initiatives – BEPS 2.0
The Communication summarizes how the EU will implement BEPS 2.0, which is expected to be adopted at the OECD's Inclusive Framework (IF) level. The Commission recommends incorporating Pillar One and Pillar Two into proposed EU Directives, which, if adopted unanimously, will be binding on the Member States.
The Commission's proposal intends to simplify Pillar One by making it relevant to all types of companies, not just companies that sell automated digital services or enterprises that deal with consumers. In addition, existing and pending EU initiatives will need to be amended to account for Pillar Two, Anti-tax Avoidance Directives (ATAD), the Interest and Royalty Directive and the EU list of non-cooperative jurisdictions
Short term initiatives – Beyond BEPS 2.0
The Commission outlined short-term initiatives for the next two years, with targeted measures that address specific immediate challenges in the EU post-COVID-19. The short-term initiatives proposed by the Commission include:
- Action 1: Recommendation on the tax treatment of losses to support Small and mid-size enterprises (SMEs) recovering from the COVID-19 pandemic. The guidance prompts Member States to allow loss carry-back for businesses to at least the previous fiscal year. Loss carry-back has the advantage of benefitting companies that were profitable in the years before the pandemic. Companies that were making a profit and paying taxes in the years prior to 2020 would offset their 2020 and 2021 losses against these taxes. To ensure that the measure is targeted at those businesses suffering as a direct result of the pandemic, Member States must limit the amount of losses carried back to €3 million (approximately $3.66 million) per loss-making fiscal year.
- Action 2: Measures to foster innovation through an allowance system to alleviate the debt-equity bias in corporate taxation. The economic crisis following the COVID-19 pandemic resulted in a significant increase in the stock of debts held by businesses. Existing pro-debt tax regulations, which allow corporations to deduct interest associated with debt financing but not expenditures associated with equity financing, might encourage debt accumulation leading to increased insolvency in some countries, with possible spillover effects for the EU. In essence, the Debt-Equity Bias Reduction Allowance (DEBRA) proposal will try to redress the debt-equity bias and contribute to the re-equitization of financially vulnerable companies because of the COVID-19 crisis.
- Action 3: Greater public transparency and fairness on the taxes paid by MNEs. The proposal will require certain MNEs operating in the EU to publish their effective tax rates. The proposal will allow public scrutiny where aggressive tax planning strategies are used and provide policy-makers with a better overview of the tax contribution made by MNEs operating in the EU.
- Action 4: New anti-tax avoidance measures to tackle the abusive use of shell companies. Shell companies are legal entities and arrangements that have little or no substantial presence and real economic activity, and in some cases, may be used purely for aggressive tax planning. The Commission will propose new monitoring and reporting requirements improving oversight and response by tax authorities to aggressive tax planning through shell companies. The Commission also intends to take further steps to prevent double non-taxation on royalty and interest payments leaving the EU.
Long term initiatives - BEFIT
In the long-term, the Communication outlined a strategy for a new EU framework for corporate taxation that will reduce administrative cost, remove tax barriers and foster a more business-friendly environment in the Single Market.
- Action 5: The Commission declared its intention to replace the CCCTB with BEFIT. BEFIT is a significant single market initiative that seeks to expand on the OECD's Pillar One approach regarding the formula for partial reallocation of profits and the rules for calculating the tax base under Pillar Two. This new proposal will provide a single corporate tax rulebook for the EU, based on apportionment and a common tax base. BEFIT will combine the profit of MNEs operating in the EU into a single tax base, which will subsequently be allocated to Member States through formulary apportionment. The formula for allocating the consolidated tax base will take into account three parameters (sales, labor and assets) to approach a presumably equitable distribution of corporation tax revenue among Member States with diverse economic profiles. The adoption of a formula to apportion earnings would eliminate the need for complex transfer pricing procedures to be applied within the EU for the companies within the scope of BEFIT.
While BEFIT appears to be based on the same principles as the previous CCCTB proposal, it aims to account for developments that have occurred since then by building on Pillar Two's tax base agreements and improving the allocation process by better accounting for digitalization. Existing procedures for allocating tax bases for MNEs operating in the EU's single market would be replaced by BEFIT's formulary apportionment. Furthermore, the initiative would upend the EU's current structure, which permits multinational corporations to move earnings to low-tax countries.
If the proposal is adopted by the Member States, MNEs would have to reassess their EU tax strategy. This would require a proactive approach as well as a potential shift in their EU tax policy.
Timeline for upcoming EU proposals
- Adopt the recommendation on the domestic treatment of losses for SMEs, published alongside the Communication.
- The legislative proposal sets out rules to neutralize the misuse of shell entities for tax purposes (referred to as ATAD 3 in the Commission Q&A) by Q4 2021.
- Legislative proposal creating a Debt Equity Bias Reduction Allowance by Q1 2022.
- Legislative proposal for the publication of effective tax rates paid by MNEs, based on the methodology under discussion in Pillar Two by 2022.
- Proposal for BEFIT, moving towards a common tax rulebook and providing a fairer allocation of taxing rights between the Member States by 2023.
In addition to the timelines mentioned above, the Commission plans to launch a broader reflection on the future of taxation in the EU. This process will culminate in a tax symposium on the EU tax mix on the road to 2050 in 2022.
