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Industry organisations are concerned about the move away from the ALP and toward formulaic apportionment as part of an EU-wide shared consolidated corporate tax base.
An EU consultation on Business in Europe: Framework for Income Taxation is slated to close today, January 26, at midnight, and so far, business groups and tax consultants have expressed worries over the initiative's transfer pricing consequences.
The Information Technology Industry (ITI) Council, a Washington, DC-based industry group representing US technology corporations, is concerned that the EU may be departing from the arm's-length concept (ALP).
“We encourage the Commission to refrain from taking an approach that incorporates formulary apportionment risks, creating more disputes for companies doing business in the European Union,” ITI said in its consultation document.
BEFIT would imply a unified corporate tax base across the EU, with enterprises subject to formulaic apportionment. Under such a system, EU member states may be able to claim tax revenue based on the location of a company, its employees, and its sales.
For a realistic paradigm, the European Commission is looking to the OECD's two-pillar proposal. This would imply a three-tiered set of profit allocation rules imposing a formula on residual earnings while maintaining the ALP for everything else. However, this is debatable.
Problems with the first pillar
The European Tax Adviser Federation (ETAF), a professional organisation representing over 200,000 tax advisers, claimed that the OECD approach was too restrictive.
“Pillar one only allocates a small part of extra profits based on a formula. This is very different from what the Commission is proposing here, i.e. to allocate all consolidated profits in the EU based on a formula,” noted ETAF in its consultation document.
“We believe that finding an acceptable apportionment formula which accurately reflects the added value creation factors and the contribution of the market jurisdictions for all industries might be difficult,” it added.
As a result, ETAF proposed that the Commission finalise the BEFIT formula after the implementation of pillar one in the EU. Despite the OECD's best efforts, the success of pillar one is not guaranteed.
By moving forward with BEFIT on a comparable concept, the Commission may be able to improve its chances for pillar one. Many questions remain unanswered, and the clock is ticking. The same TP rules might be used to administer an EU-wide corporate tax scheme, but a fresh strategy may be required.
"The ALP has been and continues to be a long-standing and well-understood underlying principle that underlies the global tax system," ITI argued.
“Any departure from the use of ALP increases the risk of mismatches between EU and non-EU jurisdictions and leads to double tax,” it claimed.
If the Commission deviates from the ALP outside the EU, ITI urged that it consider tax treaty commitments as well as the potential of trade conflicts. For some years, the EU has clashed with the US over state aid, but this could worsen.
“Taxpayers are likely to have to apply the ALP within the EU to ensure appropriate profit is recorded in each jurisdiction, despite BEFIT’s intent to simplify paying corporate tax in the EU,” said ITI.
The EU and the OECD are pushing for a transition away from traditional TP regulations, but the globe is unlikely to abandon the ALP entirely. This could imply that a hybrid system is the most likely outcome.
The fourth consideration
The right design of the BEFIT formula is a critical problem for EU policymakers. It has traditionally been predicated on three things - people, sales, and physical assets - however this excludes important elements such as intellectual property.
This is why some tax professionals and business leaders have argued that profit allocation laws should include a fourth factor.
“Any allocation formula must include consideration of intangible assets, which are increasingly key value drivers in many global businesses,” said ITI.
“Allocation factors should not result in an allocation of profits that does not reflect the economic reality of a company’s business model,” the council stressed.
These allocation parameters will determine a company's tax base in a given jurisdiction, therefore taxpayers face major consequences if they get this incorrect. However, it may be costly to EU countries in terms of investment and tax revenue.
“Failure to recognise intangible assets in the allocation formula will decrease the attractiveness of the EU when compared to non-EU locations as a destination for investment,” ITI claimed.
The European Commission will be assessing its choices for the next round of policymaking and negotiation as the BEFIT consultation concludes. The OECD will be waiting to see if its proposals are adopted at the EU level.
By fLEXI tEAM