A proposal for the taxation of cross-border branches known as “the head office tax” or “HOT” system is currently making its way through the EU legislative process. The HOT proposal is aimed at simplifying corporate tax rules for micro, small and medium enterprises (SMEs) during their early stages of expansion. It appears to be generally supported by the European Parliament and is seen by the EU as complementary to the more controversial BEFIT proposal aimed at large companies.
Both proposals require unanimous approval at the European Council and therefore their adoption remains uncertain.
What types of life sciences companies is this proposal relevant to?
The HOT proposal is relevant to SMEs who are expanding across EU Member States through branches, referred to as permanent establishments, rather than subsidiaries. SMEs are defined under EU rules as including companies which have fewer than 250 employees and either have an annual turnover not exceeding €50 million or an annual balance sheet total not exceeding €43 million. The vast majority of domestic Irish businesses fall within this definition.
As currently drafted, the HOT system does not apply to companies that are or have subsidiaries. Concerns have been raised that this will exclude a significant number of companies so it is possible that there will be some relaxation of this restriction.
There are additional conditions to qualify for the regime including that for the previous two fiscal years:
- The combined turnover of the branches must not exceed double the turnover generated by the head office, and
- The head office must be resident for tax purposes in the head office Member State during that period
What is the current system for the taxation of permanent establishments?
Under the current rules, companies with permanent establishments in several Member States must comply with a different set of tax rules for calculating, filing and paying corporate tax in every Member State in which they have a taxable presence.
For example, an Irish SME company with branches in France, Spain and Germany must file corporate tax returns and pay corporate tax liabilities in each of those Member States. To calculate the taxable profits in each Member State, the Irish company needs to apply the different national rules on matters such as depreciation, amortisation, tax deductibility of expenses and losses, treatment of interest, bad debts, fines, etc.
How would the HOT system operate?
Under the proposed system, an Irish company with branches in one or more EU Member States would be able to file a single tax return with the Irish tax authorities. Using the above example, this would cover both its own activities in Ireland and the activities of each permanent establishment in other Member States, i.e. France, Spain and Germany. In a significant simplification, the taxable profits of the permanent establishments would be computed in accordance with the tax rules of Ireland. However, the tax rate applicable to the taxable profit of each permanent establishment would be the rate applicable in France, Spain and Germany, respectively.
The company would pay the tax liabilities arising from its own activities and those of its permanent establishments to the Irish tax authorities who would then transfer the tax arising from the profits of each permanent establishment to their respective tax authorities in France, Spain and Germany.
Therefore, the company would only deal with the Irish tax authorities for both the corporate tax return filing and payment of tax.
Will the HOT system be optional?
It is proposed that the HOT system will be optional for SMEs. However, once adopted by a company, the HOT rules will generally apply to all of its permanent establishments for a period of five fiscal years.
Current status of this proposal?
Members of the European Parliament adopted a resolution which is generally supportive of the HOT proposal on 10 April 2024. They have proposed some amendments including extending the scope of the Directive to cover situations where SMEs operate in other Member States with up to two subsidiaries. They also recommend that transposition of the proposed Directive should be required by 1 January 2025.
Concerns
Specific concerns have been raised with the EU Commission by a number of Member States. These include that permanent establishments operating in the same Member State could be taxed differently, depending on where their respective head offices are located. This might lead to tax planning opportunities, with deliberate relocations of head offices towards countries with the most favourable corporate tax regimes. In addition, the exclusion of SMEs who are part of a corporate group has also raised concerns that the proposal would benefit only a small number of SMEs.
Conclusion
We recommend that life sciences SMEs with permanent establishments in other EU Member States monitor developments in relation to this proposal over the coming months. If implemented, the HOT proposal may be an attractive option for SMEs that are within the scope of this new system. This is because it will reduce complexity for them in dealing with corporate tax compliance for their EU branches. However, the key to the success of the system is likely to be dependent on the possible widening of the scope to include companies that have subsidiaries, so that a greater number of companies can benefit from the system.
Due to the requirement for unanimity at the European Council, it will be necessary to resolve the concerns of all Member States to achieve the required support and pave the way for the adoption of the proposal as an EU Directive. Significant work will be required if this is to be achieved in advance of the transposition date proposed by the European Parliament of 1 January 2025.
For more information and expert advice on all relevant taxation matters impacting your business, contact a member of our Tax team.
People also ask
What is the HOT proposal of the European Commission? |
The European Commission’s Head Office Taxation System (HOT Proposal) is a proposal aiming to create a simplified tax system for micro, small and medium enterprises (SMEs) based in the EU and with one or several permanent establishments in other EU Member States. |
How would the HOT system apply to Irish SMEs? |
SMEs with a head office in Ireland and with permanent establishments in other Member States would be permitted to submit the tax return relating to the tax liabilities of its head office and all of its permanent establishments to the Irish tax authority. The tax liabilities would be calculated using the Irish rules but the rates applied to the permanent establishments would differ depending on the Member State where the permanent establishment is present. |
The content of this article is provided for information purposes only and does not constitute legal or other advice.
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