European Commission Adopts Communication on Business Taxation

The European Commission has adopted a Communication to the European Parliament and the Council on Business Taxation for the 21st Century (“the Communication”). The Communication outlines a long-term plan to provide a fair and sustainable business environment and EU tax system, as well as a short-term tax agenda for the next two years, with targeted measures to promote investment and ensure effective taxation. The Communication also aims to support Europe's recovery from the COVID-19 pandemic and to ensure adequate public revenues over the coming years, as well as promote sustainable and job-rich growth in the EU. 

According to the Communication, the Commission seeks to tackle the following issues: (i) outdated taxation principles; (ii) a patchwork of tax systems within the EU and (iii) increasing complexity of systems. 

• Outdated taxation principles: The current international corporate tax system, which was designed more than a hundred years ago and is based on principles of tax residence and source, is no longer felt to be up to date. Globalisation and digitalisation have made tax rules increasingly difficult to apply to the modern economy. 

• Patchwork of tax systems within the EU: 27 different national tax systems complicate cross-border operations within the EU. This is perceived as creating challenges for EU SMEs, start-ups and other businesses looking to grow and expand, and to hurt investment and the EU's competitiveness. 

• Increasing complexity: Modern business models continue to become increasingly international, complex and digital. On the one hand, this creates high compliance costs for businesses as well as risks of double taxation, while on the other hand, it creates loopholes between tax systems which companies may exploit. Furthermore, the complexity contributes to a lack of transparency, which might undermine trust of the general public in the tax system as a whole. 

The Commission is proposing a short term and a long term strategy to address the abovementioned issues. In the long term, the Commission aims to present by 2023 a new framework called Business in Europe: Framework for Income Taxation (“BEFIT”). According to the Communication, BEFIT will aim to provide a single corporate tax rulebook for the EU, based on apportionment and a common tax base. It is meant to reduce administrative burdens and compliance costs, remove tax obstacles and reduce tax avoidance opportunities in the EU Single Market. BEFIT will replace the pending proposal of a Common Consolidated Corporate Tax Base (“CCCTB”), which will be withdrawn. 

In the short term, the Communication defines a tax agenda for the next two years, with measures that aim to promote productive investment and entrepreneurship, safeguard national revenues, and support the green and digital transitions. The agenda is built on the roadmap set out in the Tax Action Plan, presented by the Commission last summer. Measures under the plan will include (i) improving transparency; (ii) addressing the debt-equity bias in financing and (iii) tax treatment of losses. 

• Improving transparency: The Commission proposes that large companies operating in the EU publish their effective tax rates in order to create greater public transparency. Furthermore, the Commission aims to address the abusive use of shell companies through new anti-tax avoidance measures. 

• Addressing the debt-equity bias in financing:The Commission plans to support the economic recovery by addressing the debt-equity bias in current corporate taxation, which treats debt financing of companies more favourably than equity financing. Under the current system, businesses can deduct interest attached to debt financing, but not the costs related to equity financing. It is feared that accumulated debt could lead to waves of insolvency, with a negative effect for the EU as a whole. The Commission aims to redress the debt-equity bias and contribute to the re-equitization of companies that are financially vulnerable due to the COVID-19 crisis. 

• Tax treatment of losses: The Commission also recommends that Member States allow loss carry-back for businesses to at least the previous fiscal year. This is angled at businesses which were profitable in the years before the pandemic, allowing them to offset their 2020 and 2021 losses against taxes paid before 2020. The amount of losses carried back is to be limited to €3 million per loss-making fiscal year. This measure is designed to particularly benefit SMEs. 

As Hong Kong traders may already be aware, the Communication is part of a wider EU tax reform agenda for the coming years. In addition to the corporate tax reforms set out in the Communication, the Commission is expected to present measures to ensure fair taxation in the digital economy by proposing a digital levy, which will serve as an EU own-resource, review the Energy Taxation Directive, and propose a carbon border adjustment mechanism (“CBAM”). 

The expected timelines of the expected reforms are as follows: 

• Legislative proposal to address aggressive tax-planning opportunities linked to the use of shell companies - by Q4 2021; 

• Legislative proposal creating a Debt Equity Bias Reduction Allowance (“DEBRA”) - by Q1 2022; 

• Legislative proposal for the publication of effective tax rates paid by large companies - by 2022; 

• Proposal for BEFIT, moving towards a common tax rulebook and providing for fairer allocation of taxing rights between Member States – by 2023. 

Please click on the following to access the Communication to the European Parliament and the Council on Business Taxation for the 21st Century.