European Commission publishes proposals for a mandatory EU corporate tax system for MNEs

On October 25, 2016, the European Commission published revised proposals for a Council Directive on a Common Corporate Tax Base (Tax Base Rules) and a Council Directive on a Common Consolidated Corporate Tax Base (Consolidation Rules), re-launching its original proposal of 2011 in two stages. The first part of the proposal sets out the mandatory EU‑wide corporate tax base definition and tax base calculation system. The second part of that proposal focusses on a consolidation system and a tax apportionment mechanism. Both systems would be mandatory for all multinational groups of companies with a total annual turnover in excess of €750 million that conduct business activities in the internal market through a taxable presence in an EU Member State (MNEs). As such, they affect both EU and non-EU head-quartered groups.

The European Commission initially launched its proposal for a Common Consolidated Corporate Tax Base in March 2011. This initial proposal envisaged an optional corporate tax base for multinationals. This included the possibility to consolidate profits and losses realised with activities in any of the EU Member States. Subsequent discussions of this initial proposal between Members States made it clear that there was not sufficient support for unanimous approval; since then the European Commission has been struggling with this proposal. The international efforts on BEPS and the Commissions actions on State Aid apparently brought more consensus amongst the Member States. As such, the European Commission feels comfortable to introduce an EU corporation tax system for multinationals under which the Member States’ autonomy is effectively narrowed down to a mere setting of tax rates.

Mandatory for MNEs

The proposed system will be mandatory for all qualifying group entities of multinationals with an annual consolidated turnover above €750 million that have a taxable presence in any of the EU Member States. Any presence, whether subsidiary or permanent establishment will suffice. Smaller groups could opt-in and, if such election is made, it is for a period of at least five years.

Consolidation

Under the Consolidation Rules, tax consolidation applies between qualifying group entities that are under common control and ownership. Control is expressed by reference to a voting rights test of more than 50 per cent. Ownership is expressed by reference to either an equity holding test or a profit rights test, both of more than seven per cent. The Consolidation Rules prescribe an aggregation of group entities’ tax bases and an elimination of intra-group transactions.

Tax base

The tax base is the on balance amount of all revenues as reduced by all business expenses (the latter to the extent not explicitly listed as non-deductible). Fixed assets are individually depreciable on a straight-line basis over their useful lives. Other eligible assets are categorised per asset class and by reference to depreciation terms of 40, 25, 15 and 8 years respectively.

Participation exemption

A full participation exemption would apply to dividend receipts and capital gains from shareholdings of at least 10 per cent. 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.

Loss carry forward

The Tax Base Rules allow for an indefinite loss carry forward without any restrictions on annually tax-deductible amounts. No loss carry forward is available, where there is a transfer of ownership where the acquiring entity obtains a shareholding that meets the control/ownership test under the group definition (more than 50 per cent voting rights, more than 75 per cent capital or profits) in combination with a major change in the activities of the acquired taxpayer. No loss-carry back mechanism has been put in place.

Super-deduction for R&D costs

The Tax Base Rules include 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 deduct additionally an amount equal to 50 per cent of R&D expenditure, up to €20 million annually. For R&D expenses in excess of that amount the tax-deduction is 25 per cent of the R&D expenditures. An enhanced ‘super-deduction’ applies to start-ups to facilitate innovation. Qualifying start-up companies may deduct an additional amount equal to 100 per cent of R&D expenditure up to €20 million.

Deduction for equity – AGI

In order to stimulating equity rather than debt financing, the Tax Base Rules allow a so-called Allowance for Growth and Investment (AGI). The AGI introduces a tax deduction calculated by reference to a notional yield on equity increases. The notional amount equals the yield of the euro area ten-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.

Anti-tax avoidance

Both proposed directives contain a range of anti-tax avoidance provisions. The proposed provisions constitute refurbished equivalents of the anti-abuse provisions already found in the original CCCTB-proposal. In addition the new provisions also take into account developments with a view to implement the OECD/G20’s BEPS project and the ATAD, including an EBITDA-based interest deduction limitation, an exit taxation provision, a general anti abuse rule (GAAR), controlled foreign company (CFC) legislation, a hybrid mismatches provision, the arm’s length standard and a switch-over clause.
While this is intended to be a single initiative, the Commission proposes that the Member States first secure political agreement on the Tax Base Rules and subsequently proceed with negotiations with regard to the Consolidation Rules. This means that the Tax Base Rules could be adopted also without a later approval of the Consolidation Rules. Interim rules may allow for temporary cross-border loss offset.

If adopted, these measures will fundamentally change the tax treatment of MNEs with activities in the European Union. The principal benefit would be the introduction of a single EU wide corporate tax system for MNEs, replacing the 28 separate EU Member States’ national systems. However, the proposals need unanimous approval of all EU Member States to be adopted. If approved in their current form, Member States would need to implement the Tax Base Rules as from January 1, 2019 and the Consolidation Rules as from January 1, 2021. Given that there is still much uncertainty on the ability of the Commission to have the proposed rules agreed by all the EU Member States, no immediate action is required. However, the Norton Rose Fulbright tax team will keep you up to date on the principal developments going forward as if adopted, they will have a major impact on groups.