What is the future of taxation in Europe: state of play for ongoing initiatives

The international tax landscape has undergone major changes over the past few years which is set to have a significant impact on the overall tax architecture. At both international and European Union (EU) levels, several initiatives have been pursued aimed at aligning tax collection with the location of economic activity and achieve a minimum level of tax collection.

So what are the current main initiatives and what impacts will such regimes be expected to have on multinational groups? Moreover, given forthcoming Directives, can we question the usefulness of maintaining existing anti-avoidance rules, which may no longer be needed?

State of play for ongoing initiatives

The first and more impactful initiative for large multinational companies is BEPS 2.0. This project is composed of two pillars:

• Pillar 1 on new nexus and profit allocation rules where multinational companies may have significant business but few or no local operations in the jurisdiction where sales are made.  Increasingly, this is a common occurrence where sales are made through digital channels; and,

• Pillar 2 on a new global minimum effective tax rate of 15% with the aim of ensuring that all business income worldwide is subject to this agreed minimum rate. This is enforced through a set of top-up-tax and undertaxed payment rules.

Following the work done on the Pillar  2 standards by the Organisation for Economic Co-operation and Development (OECD) at the end of 2022, the EU Commission then issued a Directive whose purpose is to ensure that large groups operating in the EU are taxed at a minimum global effective tax rate of 15%.

Simultaneously and in addition to the above, the Commission launched a public consultation on Business in Europe: Framework for Income Taxation (BEFIT), with the aim to propose a Directive by the third quarter of 2023. The proposed Directive would provide a standard set of rules for European companies to calculate their taxable base by allocating profits between EU Member States based on a formula.

While approval and the provisions of BEFIT are still uncertain, we anticipate that its application will follow through the same cluster of companies as for the Pillar 2 regime but be limited to the EU zone. If BEFIT is implemented,  for those entities within scope the formula-based apportionment may replace existing transfer pricing on allocating profits among group companies according to the functions performed, assets used and risks assumed, namely the application of the arm’s length principle in the EU zone.

In addition, on 11 May 2022, the Commission published a draft Directive on the Debt-equity bias reduction allowance (DEBRA). This proposal sets out rules to address the tax-related asymmetry in the treatment of debt and equity to encourage a higher proportion of equity compared to debt finance.

This measure would apply to all taxpayers subject to corporate income tax in one or more EU Member States, except for companies in the financial sector. It includes two distinct provisions that apply independently: (i) a notional interest allowance on the variations of the amounts of equity instruments; and (ii) a cap on interest deduction to 85% of net borrowing costs, which is interest paid minus interest received.

Given that interest limitation rules already apply in the EU under Article 4 of the Anti-Tax Avoidance Directive (ATAD), DEBRA provides that the rule under this proposal applies as a first step. Then the taxpayer calculates other limitations applicable, including the one in accordance with Article 4 of ATAD. If this results in a lower deductible amount, the taxpayer will be entitled to carry forward or carry back the difference under Article 4 of ATAD. A final Directive on this matter would need to be adopted unanimously by all 27 Member States to come into effect on 1 January 2024.

On 11 November 2021, the European Parliament formally adopted the public EU country-by-country reporting (CbCR) Directive aimed at multinational groups with a presence in the EU and who might need to publish their CbCR under these rules. The disclosure is intended for fiscal years starting on or after 22 June 2024. Multinational groups falling within scope will be required to 1) file a CbC report on tax and related information concerning the whole group in the relevant EU Member State; 2) publish the CbC report on their corporate website and publicly accessible commercial register.

Data reported under CbCR is also a matter for applying the safe harbour rules in the Pillar 2 regime. In this respect, CbCR data must be prepared based on qualified financial statements to be considered as qualified CbCR for Pillar 2 purposes. In practice, it is possible to use statutory local, generally accepted accounting principles (GAAP) for the purposes of safe harbour rules. However, as some local standards, such as those in France, do recognise deferred tax effects, the use of a local GAAP-based CbCR may trigger some volatility in the Effective Tax Rate (ETR).