n 12 September 2023, the European Commission (“Commission”) published a proposal for a directive establishing a head office tax (HOT) system for micro, small, and medium-sized enterprises (SMEs). The proposed directive would allow SMEs that are growing and expanding across the border through permanent establishments (PEs) to opt in for applying the tax rules of the EU member state of the head office to calculate the taxable result of their PEs in other member states. Consequently, the local sets of tax rules in the member state in which the PE is located would not need to be applied.
While the optional application of these rules may create occasional competition distortions due to varying tax rules for comparable businesses, the proposed directive seeks to outweigh these risks. The benefits would, according to the Commission, include significant reductions in tax compliance costs for SMEs with PEs, making the system advantageous overall.
If the proposed directive is adopted in its proposed form, it would need to be transposed into domestic legislation by 31 December 2025 and to apply as from 1 January 2026.
Scope
The scope of the proposed directive is limited to standalone SMEs that operate exclusively through PEs in one or more member states. For the definition of SMEs, the proposed directive refers to Directive 2013/34/EU on the annual financial statements, consolidated financial statements, and related reports of certain types of undertakings. Following the definitions of SMEs in that directive, a company would only be in scope if on the date of its balance sheet it does not exceed the limits of at least two of the three following criteria:
Balance sheet total: EUR 20 million;
Net turnover: EUR 40 million; and/or
Average number of employees during the financial year: 250.
However, head offices carrying out shipping activities subject to a tonnage tax regime would be excluded from applying the HOT rules in respect of their PEs in other member states to the extent that these derive income from shipping activities.
Proposed directive features
The proposed directive would offer eligible SMEs the option to calculate the taxable results of their PEs solely based on the tax rules of their head office's member state. However, the tax rates applicable to the PEs would remain in accordance with the member states where the PEs are located.
This option is subject to strict eligibility criteria to prevent the circumvention of the rules. The head office would be eligible to utilize the HOT rules for its PEs in other member states, but only if, over the past two fiscal years, the combined turnover of its PEs has not exceeded twice the turnover generated by the head office and it has maintained tax residency in the head office's member state during the same period.
The option would be initially valid for five years, unless the head office changes residence or the joint turnover of the PEs becomes at least triple of the head office’s turnover, in which case the HOT rules would cease to apply.
The option would be able to be renewed at the end of the five-year period, provided the eligibility requirements are met. Renewal would be permitted without limit, as long as eligibility conditions are satisfied. If a standalone SME opts to establish a subsidiary, the combined turnover of its PEs exceeds twice that of the head office, or it no longer qualifies as an SME, it would be ineligible to renew the application of the HOT rules when the five-year term ends.
One-stop shop with centralized procedures
The proposed directive foresees a one-stop shop approach for tax compliance purposes. In-scope SMEs would interact exclusively with the tax administration of their head office's member state for opting in, filing obligations, and tax payments.
The head office would act as the "filing entity" for all PEs, filing a single tax return with the tax administration of the head office’s member state, separating the taxable income of the head office from that of its PEs. Such member state then would apply the rates applicable in the member states where the SME has PEs on the profits allocated to those PEs. Subsequently, after having collected the overall amount from the head office, the tax administrations would transfer the resulting tax revenues to each member state where the SME has PEs. This approach is meant to simplify tax compliance for SMEs and eliminate the complexities associated with the involvement of multiple tax systems and administrations.
The proposed directive also includes rules on the exchange of information. Efficient exchange of information between relevant tax authorities would be facilitated, adhering to the EU directive on administrative cooperation in the field of taxation. This would ensure that the exchange of information aligns with the simplification goals of the proposed directive.
In relation to audits, appeals, and dispute resolution, each member state would retain the authority to audit PEs within their jurisdiction. Member states also would be able to request joint audits that obligate the addressed member state to participate, which would maintain the integrity of the tax audit process.
What’s next?
As the proposed directive relates to direct taxation, unanimity within the European Council is required, given that taxation remains an element of the sovereignty of the member states, i.e., each member state has veto power and can block agreement of the proposal. Experience from previous proposals in the field of direct taxation indicates that proposals can stall at the level of the European Council for many years in the absence of unanimous agreement and lack of political momentum, given that taxation is a sensitive political matter influenced by a myriad of factors. In this respect, various political and economic factors could possibly influence the adoption of the proposed directive, including the upcoming European elections.
Comments