Corporate Tax Reform: Business Taxation for the 21st Century
On 18 May 2021, the European Commission adopted a new Communication on Business Taxation for the 21st century with the aim of promoting a robust, efficient and fair business tax system in the EU.
The Communication notes EU business taxation policy has changed radically over the past year in response to the COVID-19 pandemic and sets out a long-term vision to provide a fair and sustainable business environment and EU tax system. It also sets out a tax agenda for the next two years which includes targeted measures aimed at promoting productive investment and entrepreneurship and supporting the green and digital transitions. This builds on the Tax Package for Fair and Simple Taxation announced in July 2020. The Communication also takes account of the progress made in the G20/OECD discussions on global tax reform.
What is in the Communication?
The Communication confirms that the Commission will act swiftly to implement any agreement reached by members of the OECD Inclusive Framework on BEPS to reform the international corporate tax framework. The Commission will propose a Directive for the implementation of Pillar 1 in the EU to ensure its consistent implementation across Member States. Similarly, the principal method for implementing Pillar 2 will be a Directive which will reflect the agreement reached, with necessary adjustments to ensure consistent application within the EU and compatibility with EU law.
The Communication notes the implementation of a global agreement on minimum effective taxation will have implications for existing and pending EU Directives and initiatives. For example, the interaction of the proposed Income Inclusion Rule under Pillar 2 with Controlled Foreign Company (CFC) rules introduced EU-wide by the Anti-Tax Avoidance Directive (ATAD). It also notes that the transposition of Pillar 2 should pave the way for agreeing the pending proposal for recasting the Interest and Royalties Directive.
The Communication also sets out five actions for corporate tax reform which would go beyond any potential agreement at OECD level, with the stated priorities of enabling fair and sustainable growth and ensuring effective taxation.
On 22 December 2021, the European Commission proposed a Directive to implement into EU law the Pillar Two Global Anti-Base Erosion (GloBE) Model Rules (the Model Rules) published by the OECD on 20 December. The proposed Directive closely follows the Model Rules. However, it extends the scope of the Model Rules to large-scale purely domestic groups to ensure compliance with EU fundamental freedoms.
Five Actions for Corporate Tax Reform
The first four of these actions focus on the dual priorities of ensuring fair and effective taxation and promoting productive investment and entrepreneurship. The fifth action sets out a plan for a new EU business tax framework for the decades to come.
Actions to ensure fair and effective taxation:
Action 1: The Commission will, by 2022, put forward a new legislative proposal for the annual publication of the effective corporate tax rate of certain large companies with operations in the EU, based on the methodology under discussion in Pillar 2 of the OECD negotiations. 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 stated aim of the proposal is to improve public transparency around the real effective tax rate of large EU companies.
Action 2: By Q4 2021, the Commission would make a legislative proposal to tackle the misuse of shell entities for tax purposes through new anti-tax avoidance measures (“ATAD 3”). It was envisaged that the proposal would include actions, such as, requiring companies to report information to assess whether they have substantial presence and real economic activity, denying tax benefits linked to abusive shell companies, and creating new tax information, monitoring and tax transparency requirements. The Commission also intends to take further steps to prevent the double non-taxation of royalty and interest payments leaving the EU.
On 22 December 2021, the European Commission adopted the proposal – ATAD 3. The proposed Directive sets out certain criteria (referred to as ‘gateway’ criteria and substance requirements) which will allow tax administrations to designate an entity as a shell.
Under the proposals, an entity that is presumed to be a ‘shell’ will not be able to access tax relief and the benefits of the tax treaty network of a Member State and/or qualify for the treatment under the Parent-Subsidiary and Interest and Royalties Directives.
To facilitate the implementation of these consequences, the Member State of residence of the company will either deny the shell company a tax residence certificate or the certificate will specify that the company is a shell. Entities that do not meet all substance indicators will have the opportunity to rebut the presumption of being a shell.
The Commission called for feedback on the proposed Directive in January 2022. The Institute responded to the call for feedback on 6 April 2022. Feedback received will be summarised and presented to the European Parliament and EU Council to input into the legislative debate.
Actions to enable productive investment and entrepreneurship:
Action 3: Adopting a Recommendation to Member States on the domestic treatment of losses to ensure fair competition between companies and better support businesses during the recovery. The Recommendation prompts Member States to allow loss carry-back for businesses to at least the previous fiscal year. This will benefit businesses, in particular SMEs, that were profitable in the years before the pandemic, allowing them to offset their 2020 and 2021 losses against the taxes they paid before 2020. This Recommendation is being adopted alongside the Communication.
Action 4: By Q1 2022, the Commission will make a legislative proposal creating a Debt Equity Bias Reduction Allowance (DEBRA). This proposal aims to address the “pro-debt bias” in the current tax framework where businesses can deduct interest attached to debt financing, but not the costs related to equity financing. The proposal is intended to contribute to the re-equitisation of companies that are financially vulnerable by encouraging companies to finance their activities through equity rather than debt.
Action for a longer-term business taxation framework:
Action 5: By 2023, the Commission will present a new framework for business taxation in the EU, named the Business in Europe: Framework for Income Taxation (BEFIT). This new proposal would replace the existing proposal for a Common Consolidated Corporate Tax Base (CCCTB). The BEFIT proposal would provide for a single corporate tax rulebook for the EU. If implemented, it would consolidate the profits of EU members of a multinational group into a single tax base which would be allocated to Member States using a formula, to be taxed at national corporate tax rates.
Other Future Reforms on the EU Tax Policy Agenda
This Communication is part of a wider EU tax reform agenda for the coming years. The multi-faceted approach to reforming taxation in the EU aims to make taxation fairer, greener and fitter for the modern economy, and contribute to Europe’s long-term, sustainable growth.
In addition to the corporate tax reforms set out in the Communication, the Commission noted it would proceed with the proposal for a digital levy within the EU, which would serve as an EU own resource. However, following political agreement reached at a meeting of the G20 in July 2021, where they endorsed an overhaul of the rules for taxing international companies, the EU announced that it was putting “on hold” work on the proposed EU digital levy.
In the context of the “Fit For 55” package and European Green Deal, the Commission confirmed it would also make proposals, such as the review of the Energy Taxation Directive and the Carbon Border Adjustment Mechanism (CBAM), to ensure that taxation and other pricing instruments support the EU’s objective of reducing emissions by 55% by 2030 and becoming climate neutral by 2050. A review of tobacco taxation is also planned. In July 2021, the Commission adopted a proposal for a revision of the Energy Taxation Directive and a proposal for a regulation establishing a CBAM.
Finally, in 2022 the Commission plans to launch a broader reflection on the future of taxation in the EU, which will culminate in a Tax Symposium on the EU tax mix on the road to 2050, taking into account how trends, such as, climate change, an aging population and the digital transformation of the labour market, are likely to have an impact on the future tax mix in EU Member States.
European Commission Documents and Links
May 2021 – Communication on Business Taxation for the 21st Century
May 2021 – Press release
May 2021 – Questions and Answers on the Commission proposal for new business tax agenda
May 2021 – Factsheet for EU’s new business tax agenda
July 2020 – Package for fair and simple taxation