On 28 January 2016 the EC published the proposal for a so-called Anti-Tax Avoidance Directive. It applies to all taxpayers which are subject to corporate tax in an EU Member State, including corporate taxpayers without cross-border activities. The Directive includes six measures. This e-alert discusses the impact of each measure on Belgian corporates.
On 28 January 2016 the European Commission published the proposal for a so-called Anti-Tax Avoidance Directive (Directive)1. This is the next step by the European Union (EU) in the implementation of the outcome of the OECD’s anti-Base Erosion and Profit Shifting project (BEPS) and in its attempts to introduce a common corporate income tax system in the EU (CCCTB). The first action following the BEPS project was the inclusion of a general anti-avoidance rule and a provision against hybrid mismatches in the EU Parent Subsidiary Directive. The use by the European Commission of the “state aid” technique to challenge tax rulings issued by the smaller EU countries, can be viewed as another step to achieve tax harmonisation “through the backdoor” (without needing unanimity of the 28 Member States).
The Directive sets out minimum standards which all EU Member States (Member States) must implement. The preamble explicitly states that the implementation of the Directive should not affect the taxpayer’s obligation to comply with the arm’s length principle or the Member State’s right to adjust a tax liability upwards in accordance with the arm’s length principle. Furthermore, the Directive does not preclude the application of domestic or agreement-based provisions aimed at safeguarding a higher level of protection for domestic corporate tax bases.The Directive applies to all taxpayers which are subject to corporate tax in a Member State, including corporate taxpayers resident outside the EU with a permanent establishment in the EU.
The Directive includes six measures: (1) a general interest limitation rule; (2) a provision on exit taxation; (3) an “exemption to credit system switch-over” clause; (4) a general anti-abuse rule; (5) controlled foreign company rules; and (6) a framework against hybrid mismatches which addresses both hybrid entities and hybrid instruments. These measures are discussed in this alert. We will also give our view on the implications of these measures for corporate taxpayers in Belgium.
The general interest limitation rules will have the most impact in Belgium. These rules are also the most controversial, as they affect purely national situations, regardless of any tax avoidance.
On this point, the Commission cannot be followed where it argues that the Directive complies with the proportionality principle2. In our view, an interest deductibility rule which also affects purely national situations, including interest payments made to financial institutions, does not protect the internal market. This measure will in particular harm Belgian companies, due to the high nominal corporate income tax rates and the absence of tax consolidation.
It is unfortunate that the European Commission wishes to change specific features of the Member State’s domestic corporate tax regime (such as interest deductibility), without taking into account the general context of that corporate tax regime (such as the absence of tax consolidation).
General Interest Limitation Rule
The Directive limits the deduction of “net” interest expenses to an amount of 30% of the taxpayer’s earnings before interest, tax, depreciation and amortisation (EBITDA) or up to an amount of €1,000,000, whichever is higher. “Net” interest refers to borrowing costs that exceed interest income or other taxable revenues from financial assets. This interest limitation rule is similar to the current German interest limitation rule.
The limitation applies without distinction of the origin of the debt. For example, it is not relevant whether the interest is related to intra-group, third party, EU or third country debt, or whether the lender is effectively taxed on such interest. It therefore also applies to interest paid to financial institutions.
Member States may (but are not obliged to) implement the following important exception to the interest limitation rule: taxpayers which are part of a group can fully deduct their net interest if they can demonstrate that the ratio of their equity over their total assets is equal to or higher than the equivalent ratio of the group. A ratio that is 2 percentage points lower than that of the group is still considered to be equal to group ratio. The group consists of all entities which are included in audited consolidated statements drawn up in accordance with the accounting rules that apply in a Member State, IFRS or U.S. GAAP. The EBITDA of a tax year which is not fully absorbed by the net interest incurred by a taxpayer in that or previous tax years may be carried forward indefinitely and will increase the relevant EBITDA of the following year. Similarly, interest which cannot be deducted because of the EBITDA limitation may be carried forward to subsequent years.
The interest limitation rule does not apply to financial institutions and insurance undertakings as the Member States could not come to an agreement on specific rules for these sectors. In the view of the European Commission this exception should only be temporary.
The deductibility rate is set at the top end of the scale of 10-30% recommended by the OECD. Member States are allowed to implement stricter rules.
Implications for Belgium
Belgium currently has favourable interest tax deductibility rules: interest is not tax deductible if a 5/1 debt equity ratio is exceeded, but this ratio only takes into account intra-group financing and financing granted by exempt lenders. These favourable rules are the flipside of the fact that Belgium has no tax consolidation.
Given the high nominal corporate income tax rates in Belgium, Belgian group companies have typically been financed with debt, despite the “notional interest deduction” (a tax deduction calculated on equity).
The introduction of these interest barrier rules in combination with the absence of tax consolidation and high nominal corporate income tax rates, will result in a significant increase of the corporate tax liability.
This development can be a further incentive for the Belgian Government to rethink the Belgian corporate income tax system, including a general reduction of the corporate income tax rates.
The Directive obliges Member States to apply an exit tax when a taxpayer moves assets or its tax residence out of the tax jurisdiction of a Member State. This includes transferring assets from a head office to a permanent establishment in another Member State or a third country as well as transferring assets from a permanent establishment to the head office or a permanent establishment in another Member State. It also includes the transfer of tax residence to another Member State or to a third country except for those assets which remain effectively connected with a permanent establishment in the original Member State; and a transfer of a permanent establishment out of a Member State.
The Member State must tax unrealised capital gains on the assets which are transferred, e.g. the difference between the market value and the book value of the assets which are transferred. If the assets, tax residence or permanent establishment are transferred to another Member State, that Member State must accept the market value established by the Member State of origin as the starting value of the assets for tax purposes. In this regard, ‘market value’ is the amount for which an asset can be exchanged or mutual obligations can be settled between willing unrelated buyers and sellers in a direct transaction.
In the case of a transfer to a Member State or to a third country that is party to the European Economic Area (EEA) Agreement, the taxpayer must have the right to either immediately pay the exit tax or to defer payment of the tax over at least five years and to settle the tax liability through staggered payments.
Belgium will need to amend its exit tax provisions to bring them in line with the Proposal.
Member States must apply a credit system for certain types of foreign income which originate from third countries instead of an exemption (hence the name ‘switch-over’). The foreign income from third countries to which this switch-over clause applies includes profit distributions, proceeds from the disposal of shares and permanent establishment profits. The switch-over clause applies if the entity or permanent establishment from which the income originates is taxed at a corporate tax rate lower than 40% of the statutory corporate tax rate that would have been charged in the Member State of the taxpayer. In that case, the foreign income may not be exempt, but must be taxed with a deduction (credit) of the tax paid in the third country. The deduction may not exceed the amount of tax attributable to the foreign income. The switch-over clause does not apply to losses incurred by a permanent establishment of a resident taxpayer situated in a third country and losses from disposals of shares in an entity which is tax resident in a third country.
The switch-over clause is not limited to group companies; the rule can also apply to an investment in shares of an unrelated listed company.
As Belgium applies a taxation on worldwide profits with an exemption for profits allocated to a PE in a tax treaty jurisdiction, Belgium will need to amend its rules.
The rules regarding the participation exemption, both for dividends (DBI/RDT) and for capital gains on shares, will also need to be amended. However, on balance, the tax position of Belgian companies may in certain cases improve, as the Proposal stipulates that Member States need to grant a tax credit for taxes paid abroad (to avoid double taxation). This is currently not the case under the Belgium participation exemption rules: in case the participation exemption is not available due to the subsidiary not paying a sufficiently high corporate income tax, the participation exemption is denied without tax credit (“all or nothing”).
The Proposal does not include a carve-out for listed companies. If a Belgian company realises a capital gain on shares of a listed company, the gain will not be exempt if it turns out that the listed company is subject to a statutory corporate income tax of less than 13.596%.
General Anti-Abuse Rule
The Directive includes a General Anti-Abuse Rule (GAAR) which is designed to cover gaps that may exist in a country’s specific anti-abuse rules. According to the European Commission, it is designed to reflect the ‘wholly artificial test’ of the CJEU, where ‘wholly artificial’ is being translated as ‘non-genuine’. An arrangement or series of arrangements are regarded to be non-genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality. If the Directive is adopted, non-genuine arrangements or a series thereof carried out for the essential purpose of obtaining a tax advantage that defeats the object or purpose of the otherwise applicable tax provision, must be ignored for the purpose of calculating the corporate tax liability. The tax liability must be calculated by reference to economic substance in accordance with national law.
The GAAR must be applied in the same way in domestic, intra-EU and third country situations.
As the requirements to apply the GAAR are similar to the Belgian GAAR introduced in 2012 (Art. 344§ 1 BITC), this provision will probably not have a big impact on taxpayers in Belgium.
Controlled Foreign Company Legislation
The Directive obliges Member States to apply controlled foreign company (CFC) rules to taxpayers with controlled subsidiaries in low-tax jurisdictions with a certain amount of mobile passive income. The CFC rules attribute non-distributed income of the low-taxed controlled foreign subsidiary to its parent company by including it in the tax base of the parent. A subsidiary is ‘controlled’ if the taxpayer, together with its associated enterprises as defined under the applicable corporate tax system, holds a direct or indirect participation of at least 50% of the voting rights or owns more than 50% of capital or is entitled to receive more than 50% of the profits of that entity. The subsidiary is located in a low-tax jurisdiction if under the general regime profits are subject to an effective corporate tax rate lower than 40% of the effective tax rate that would have been charged under the applicable corporate tax system in the Member State of the taxpayer. Furthermore, the CFC rules only apply if more than 50% of the income accruing to the entity falls within any of the following categories: (1) interest; (2) royalties; (3) dividends and income from disposal of shares; (4) income from financial leasing; (5) income from immovable property unless the Member State of the parent would not be entitled to tax the income because of a tax treaty; (6) income from insurance, banking and other financial activities; or (7) income from services rendered to the taxpayer or its associated enterprises. This provision only applies to financial undertakings if more than 50% of the income in these categories comes from transactions with the taxpayer or its associated enterprises. The CFC rules do not apply if the subsidiary’s principal class of shares is regularly traded on one or more recognised stock exchanges.
The foreign income to be included in the tax base must be calculated in accordance with the rules of the corporate tax law of the resident state of the taxpayer and in proportion to the entitlement of the taxpayer to receive profits of the subsidiary. The income must be included in the tax year in which the tax year of the subsidiary ends. Losses of the subsidiary are not included in the tax base, but are carried forward. To avoid double taxation, the amount which was previously taxed under the CFC rules must be deducted from the tax base when calculating tax due on distributed profits or upon the disposal of the participation.
The CFC rules apply to both third country and EU CFCs. However, for CFCs in the EU and EEA countries these rules only apply if the establishment of the entity is wholly artificial or to the extent that the entity engages, in the course of its activity, in non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage. The attribution of controlled company income must be calculated in accordance with the arm’s length principle.
Financial undertakings which are tax resident in the EU or the EEA and EU and EEA permanent establishments of financial undertakings are excluded from the scope of the CFC rules.
Belgium currently does not have CFC legislation, except that the anti-abuse provision set out in Art. 344, §2 BITC can be viewed as a sort of CFC. However, that provision does not apply in case the taxpayer can demonstrate that the arrangement meets legitimate business needs or that a normal tax has been paid in Belgium. The Proposal results in the low-taxed income generated outside of the EU or EEA being taxable in Belgium, even if the arrangement meets legitimate business needs.
As the proposed CFC provision is stricter than Art. 344, 2 BITC, it can be expected that Art. 344, §2 BITC will be abolished once the CFC provision is introduced.
Framework against hybrid mismatches in EU situations
The final measure provides that when two Member States give a different legal characterisation to the same taxpayer (hybrid entity) or payment (hybrid instrument) and this leads to either a situation where a deduction of the same payment, expenses or losses occurs in both Member States or to a deduction in one Member State but not an inclusion in the tax base of the other Member State, the legal characterisation given to the hybrid entity or to the hybrid instrument by the source state in which the payment is made or the expenses are incurred or losses are suffered, must be followed by the other Member State.
It is important to note that this measure only applies in intra-EU situations and not in third country situations. This means that, for example, U.S. check-the-box situations are not affected. The preamble of the Directive states that hybrid mismatches between Member States and third countries need to be examined further.
Belgium will have to design new legislation to implement this provision.
The measures which are included in the Directive have been discussed over the past few years in the framework of the proposed CCCTB Directive. Furthermore, these measures were part of the discussions in the OECD BEPS project. Member States have committed themselves to implementing the outcomes of the 15 BEPS Action Items. We have the impression that the European Commission expects that these measures will be acceptable to all Member States. An indication of this expectation is that supposedly more controversial elements, such as an interest limitation rule for financial and insurance companies and extension of the framework for hybrid mismatches to third countries, have been left out. It seems, therefore, that the European Commission expects that the Directive can be adopted within a relatively short timeframe.
1Proposal for a Council Directive laying down rules against tax avoidance practices that directly affect the functioning of the internal market - 2016/0011.
2The Commission argues that the envisaged measures do not go beyond ensuring the minimum necessary level of protection for the internal market…; the proposal does not go beyond what is necessary to achieve its objectives and is therefore compliant with the principle of proportionality.