0n 12 September 2023, the European Commission published a proposed directive on establishing a head office tax (HOT) system for micro, small and medium-sized enterprises (SMEs) that would allow standalone SMEs with permanent establishments (PEs) in other EU member states to elect to compute their tax liability based on the tax rules of the head office member state. The directive aims to alleviate the administrative, regulatory and compliance cost burdens on SMEs and the tax authorities and encourages SMEs to expand across borders.
It should be noted that, along with the HOT directive, the European Commission also published the proposed BEFIT or “Business in Europe Framework for Income Taxation” directive that contains a common set of rules for calculating the tax base of large EU groups (for prior coverage, see the tax alert dated 15 September 2023) and proposals for harmonised transfer pricing rules within the EU (for prior coverage, see the article in the September 2023 issue of Transfer Pricing News).
If the proposed HOT directive is approved as drafted, member states would be required to transpose the measures into their domestic law by 31 December 2025, so the directive would apply as from 1 January 2026.
The HOT proposal is a sensible step towards corporate income tax simplification for internationally active SMEs, but it could have greater effect with a more expansive scope and with a simplified method for profit attribution to PEs.
Frederik Boulogne
BDO in Netherlands
Susan Lyons
BDO Global
It should be noted that, along with the HOT directive, the European Commission also published the proposed BEFIT or “Business in Europe Framework for Income Taxation” directive that contains a common set of rules for calculating the tax base of large EU groups (for prior coverage, see the tax alert dated 15 September 2023) and proposals for harmonised transfer pricing rules within the EU (for prior coverage, see the article in the September 2023 issue of Transfer Pricing News).
Highlights of the proposed HOT directive
- The eligibility and termination measures in the directive aim to discourage abuse and potential tax planning practices (e.g., transferring a head office to another member state that has more beneficial features in its tax system).
- As noted above, the directive would apply to EU-based standalone SMEs that operate exclusively through PEs (but not subsidiaries) in one or more member states. However, certain SMEs would fall outside the scope of the HOT directive, e.g., SMEs that are part of a consolidated group for financial accounting purposes, SMEs that derive income from shipping activities subject to a tonnage tax regime, etc.
- An affirmative election would be needed to apply the directive. The head office would be required to notify the competent tax authorities in its member state that an election is being made at least three months before the applicable fiscal year starts.
- Once an election has been made, the head office taxation rules would apply to the PE(s) in one or more member states for five fiscal years unless the SME transfers its tax residence out of the head office member state or the joint turnover of the PE(s) exceeds an amount equal to triple the head office turnover for the last two fiscal years. The election could be renewed at the end of the five-year period provided the eligibility requirements continue to be met.
- The taxable results of PE(s) of qualifying SMEs could be computed based only on the tax rules in the member state where their head office is resident, with the applicable tax rate being the rate applicable in the PE(s) member state.
- A one-stop shop would be set up under so that only one tax authority would deal with the tax filings, assessments and collection of tax due by the PE(s) (i.e., the authority in the head office’s member state).
- The head office would file a single tax return with its tax authorities that would include the tax liability of the SME with respect to its taxable result in the head office member state and with respect to each PE in other member states. If separate financial accounts are not prepared for a PE, the tax return would also need to include details of the assets, liabilities and profits attributable to the PE. The head office would settle the income tax liabilities with respect to its taxable result and the taxable result of its PE(s) in the host member state(s).
- After collecting the amount due from the head office, the tax authorities would transfer the resulting tax revenue to each member state where the SME has a PE(s) and information would be exchanged between the relevant tax authorities.
If the proposed HOT directive is approved as drafted, member states would be required to transpose the measures into their domestic law by 31 December 2025, so the directive would apply as from 1 January 2026.
BDO insights
The HOT directive proposal complements the BEFIT proposal aimed at large groups, as it will help SMEs choose the best option throughout their lifecycle.The HOT proposal is a sensible step towards corporate income tax simplification for internationally active SMEs, but it could have greater effect with a more expansive scope and with a simplified method for profit attribution to PEs.
Frederik Boulogne
BDO in Netherlands
Susan Lyons
BDO Global