BEFIT could be better for business but road to reform is long
A new proposal to harmonise corporate tax systems across the EU27 could make it easier for European multinationals to scale and compete, but the path to finding agreement on transfer pricing remains complex.
While the OECD struggles to reach for global agreement on its proposed Pillar One and Pillar Two intergovernmental tax agreements, Europe is looking to strike out on its own.
A revised European Commission proposal, out for public consultation until January, would combine elements of the two tax pillars — designed to reduce base erosion and profit shifting by large companies — into a new, cross-single market approach.
CASE STUDY: Preparing for BEPS 2.0 – are you ready?
The proposal could also enable the EU27 to avoid the challenge Hungary has posed to the rest of the bloc by blocking the progress of an European Directive that would have supported the OECD measures.
But while a directive might also be required to advance the BEFIT system — or Business in Europe: Framework for Income Taxation — the package has been pitched to be a business-friendly response to the challenge of increasingly complex tax law.
What is BEFIT?
The BEFIT system sets the ambitious goal of overhauling the tax systems across the countries that are part of the European Union, in order to “address the complexity and high costs that businesses … face as the result of having to comply with 27 different corporate tax systems when doing business across the EU.”
According to the position paper put forward for public consultation, the absence of a common corporate tax system makes the single market less competitive, by distorting investment and financing decisions and increasing the compliance costs faced by businesses active in more than one member state.
The result, it says, is that cross-border businesses in the single market can be worse off than those working across large non-EU markets, such as the US.
But addressing those problems requires a wholesale set of changes that form part of a growing movement to restructure tax across Europe.
In May 2021, the Commission published a report on Business Taxation for the 21st Century which warned that Europe needed “a robust, efficient and fair tax framework that meets public financing needs, while also supporting the recovery and the green and digital transition by creating an environment conducive to fair, sustainable and job rich growth and investment.”
With an ageing society, it was not enough to rely on labour taxes, which make up half the tax take, the report said, or VAT, which comprises another 15 per cent.
Instead, megatrends like the climate and digitalisation of work meant other kinds of taxes needed to inform a greater part of the tax mix.
The BEFIT initiative has four stated aims that are designed to progress this argument.
They include reducing the complexity of tax rules and compliance costs faced by EU businesses operating across borders, removing obstacles to cross-border investment (which would also make the single market more attractive to international investment), creating an environment conducive to fair and sustainable growth and providing sustainable tax revenue.
But will it work?
Iris Burgstaller, Chair of Baker Tilly International’s Global Transfer Pricing Team and a Partner in Austria with member network TPA, says it is not the first time a streamlined tax plan has been floated in the single market.
“Having a common consolidated tax already has a long history in Europe and the EU has tried to implement such a system a couple of times. All previous attempts have failed.”
– Iris Bergstaller
“Having a common consolidated tax already has a long history in Europe and the EU has tried to implement such a system a couple of times,” she says.
“All previous attempts have failed.”
Ms Bergstaller says that if BEFIT were to proceed, the international tax system could have three classes of multinational business.
The first would include the super-large multinationals — most of them digital — with revenues about €20 billion and an EBIT margin above 10 per cent.
These would also fall under OECD Pillar One rules if the multilateral convention is agreed next year.
The second group would feature large multinationals with a turnover above €750 million.
These groups would fall under the BEFIT system but would also be captured under OECD Pillar Two rules, also known as the global minimum tax rules, which require companies to provide aggregate data on a country-by-country basis.
The third group would include all other multinational entities.
Those with revenue below €750 million would not meet the threshold for Pillar Two, but the consultation paper considers the option of broadening the scope of BEFIT.
This would allow smaller entities with cross-border activities to opt in to BEFIT to access common EU rules on the tax base and allocation of profits.
BEFIT a destination but no one roadmap
While the paper out for consultation sets out where the European Commission wants to land, it provides a range of options for how this destination might be reached.
Key questions remain as to how the tax base would be calculated.
One option would be to allow limited tax adjustments, requiring all companies within a group under the BEFIT system to use financial statements prepared to the same accounting standards.
The alternative option — far less simple — would be to develop “a comprehensive corporate tax system with detailed rules for all aspects of profit/tax determination, rather than building a system based on financial accounting,” forcing member states to run two sets of corporate tax rules.
Similar questions remain over the best way to allocate taxable income to member states.
Again, two options are put forward — one option with a formula that takes into account the physical presence of tangible assets, labour and the destination of sales, and an option where intangible assets (such as research and development expenses and costs for marketing and advertising) are also considered.
Ms Bergstaller says the system as described would eliminate transfer pricing issues but only within consolidated groups that all fall under the BEFIT system.
“For group entities outside the consolidated BEFIT group, the arm’s length principle would still apply,” she says.
“In this regard the simplified regime is similar to what is proposed under OECD Pillar One and the highly expected work on Amount B and its publication at the end of 2022.
“Compared to Pillar One, BEFIT has a next-level formulary approach since the idea is not just to rely on transactional data for the allocation of profits to jurisdictions but rather mix KPIs such as tangible assets, labour and sales.
“But as previous attempts have shown, such a system is not only far from simple to implement but it can be questionable whether the outcome is closer to tax fairness than the current system.”
Finding agreement remains difficult
Carsten Hüning is a Partner and Global Leader Transfer Pricing for Baker Tilly Germany.
Despite the work that has taken place over the past few years on the BEPS initiative, he says significant challenges remain before the transfer pricing system can be simplified.
He’s unsure that the latest moves will help resolve fundamental differences in approach that still occur even within the European bloc — let alone across other world markets.
“If I talk with an Italian tax auditor, he might have a totally different understanding of transfer pricing regulations than a German auditor has, for example.”
– Carsten Hüning
“It’s so complex — it’s hard to say that just because you have the data of taxpayers you have a common understanding of principles,” he says.
“If I talk with an Italian tax auditor, he might have a totally different understanding of transfer pricing regulations than a German auditor has, for example.
“That can produce a day-to-day struggle with tax audit defence work and the structure of transfer pricing systems.
“The OECD has said that its plan for reform is based on the principles of coherence, substance and transparency. We have to focus on a global mindset and not have any more loss-making islands or low-tax jurisdictions which do not have fair competition with other countries on tax.”
Mr Hüning’s pricing team works mostly with middle market German clients who often have foreign or related parties and who could be subject to the BEFIT system.
While some of those with predominantly EU operations might benefit from a single-market transfer pricing approach, he says, many would still need to navigate the tax systems in jurisdictions outside the EU, from India and Korea to Africa to the United States.
“There’s definitely been a lot of movement over the last four or five years on transfer pricing but I don’t think we are ready to move to a new system in the next year,” he says.
“Whenever you are talking about international transfer pricing you have to align three countries or five countries or ten. There are so many different standpoints and different needs.
“I believe there’s a lot of work left to do.”