In a previous publication, the five action points of the ATAD directive were already explained in more detail. [3] This contribution discusses one of these action points, namely the introduction of a CFC rule in Belgian legislation in more detail.
Purpose of a CFC legislation
CFC is the abbreviation used for “Controlled Foreign Company”. Generally speaking, the term CFC rule is used to describe anti-abuse legislation that is aimed at taxing the undistributed profits earned in or through foreign subsidiaries or permanent establishments in the “home country” of the controlling shareholders of the group. Specifically, the CFC legislation thus states that (under certain conditions) non-distributed foreign profits can still be taxed in Belgium with the Belgian parent company. Therefore, it is often argued that a CFC rule can serve as a legitimate instrument to protect the domestic taxable base.
Qualification as a CFC: ATAD provides room for choice
Like Belgium, many other member states do not yet have a version of a CFC rule in their internal legislation. The ATAD expressly stipulates, in accordance with Article 7, that a member state can choose between different implementation possibilities with a regulation limited to artificial arrangements [4] as an absolute minimum:
- Entity approach: Without taking into account the activities of the parent company, certain categories of passive income such as dividends, royalties and interests of the subsidiaries will be taxed under the CFC rule;
- Transactional approach: Only the undistributed profits of a foreign company resulting from artificial arrangements that have been set up with the essential purpose of obtaining a tax advantage are taxed under the CFC rule.
As a basic condition for the application of a CFC rule, the shareholder will have to have more than 50% control over the subsidiary located in another country where a lower corporate tax rate applies. In addition, there must be so-called passive income. Article 8 of the ATAD Directive contains the principles for the calculation of CFC income. If the first approach is taken, the taxable income will be calculated in accordance with the rules of the member state where the controlling company is located. The second approach reflects the transfer pricing rules that are based on the arm's length principle for the allocation of the profits based on the functions performed, the risks taken and the assets used by the controlling company on behalf of the underlying entity which qualifies as artificial.
Application & implementation in Belgium
The Belgian CFC rule will be included in the new article 185/2 of the 1992 Income Tax Code and is fully aligned with the BEPS initiative (action point 3) and the subsequent, largely consistent, European proposal in the form of the ATAD guideline.Based on the proposed legislation [5], it can be concluded that Belgium has chosen to apply the second option, being the transactional approach.
More specifically, the undistributed profits of foreign subsidiaries will only be taxed in Belgium if the 'relevant key functions' related to the profit are also located in Belgium. [6] Specifically this means, among other things, the location of decision makers who are actively involved in making important decisions within the enterprise group.
For example, if a production entity is located in Hungary, but the head of production who, as chief engineer, takes care of the foreign facility’s management, is located in Belgium, this will qualify as a relevant key function exercised in Belgium. The same applies for example in the case where an artificial transfer of an intellectual right to software developed by a Belgian company to a subsidiary established in a tax haven, but where the software is still regularly updated by employees of the domestic company.
The conditions that Belgium implements fourfold and cumulative and can be summarised as follows:
Requirement of control
The parent-subsidiary relationship (or main headquarters-permanent establishment) requires that control is exercised by the parent. More specifically, there must be a direct or indirect presence of the parent in the subsidiary expressed as over 50% of the voting rights, or at least 50% of share ownership, or, finally, rights to the majority of the profits.
A low tax rate is defined as
The entity controlled is established and is located in a country where it subject to a low corporation tax rate or not taxed at all. A low rate country is defined as a country where less than half of the Belgian corporate tax rate would apply if the company were to be established in Belgium.
For example: if the taxable base of the subsidiary amounts to 200, with a rate of 15%, the tax amounts to 30. Suppose that if this company were established in Belgium, the taxable base would be 300. The effectively applied rate is only 10% (the tax is 30 while the taxable base is 300), this is less than half of the Belgian rate, so this CFC condition is met.In the present case, as of tax year 2020, the Belgian CFC rule will therefore only apply if the controlled entity is subject to a corporate tax rate lower than 12.5%.
It involves a foreign entity
This concept is not defined in the new law, but the OECD and action point 3 are based on a very broad interpretation that also includes permanent establishments and transparent entities.
Passive profits are required
Passive profits are regarded as being profits that do not arise from operational activities, whereby legislators had the possibility to choose between different options on how to construct this passive income. For Belgium we have reverted to the transactional approach.
The increased importance of a substantiated transfer pricing policy
At first sight, the Belgian approach leads to a lower risk of double taxation as the passive income of a foreign subsidiary or permanent establishment can only give rise to a Belgian taxation if there is a connection with key functions performed in Belgium. In addition, the approach itself also closely matches the internationally accepted arm's length principle, which applies as a general principle to the transfer pricing rules and certain sections of double taxation treaties.
In order to achieve the lowest risk for the application of the CFC rule in general and to avoid double taxation (see below), it is of the utmost importance that your company applies a well-founded transfer pricing policy that ensures that key functions are already compensated in conformity with the market. If the transfer pricing policy is not properly substantiated in accordance with the effective value chain of the group of companies and the proper functions and risks are not adequately compensated, there is a risk that a part of the profit of the foreign entities or permanent establishments will be added to the taxable base of the parent entity.
If your Belgian company is either a parent entity or part of a larger group, it is very important to be well prepared for the new CFC rule before 1 January 2019. The starting point is to analyse the general value chain of the corporate group and to verify whether a properly substantiated remuneration has been allocated to each key function exercised. The legal obligation to consider how you implement transfer pricing has thus become even more important and goes even further than the mandatory documentation required under current Belgian rules and the notification obligation for companies that exceed certain limits on an individual or group basis. [7]
No more double taxation risk? Or not quite?
Choosing to implement the transactional approach seems to be the most obvious for Belgium. However, even if Belgium decides to apply the transactional approach, in practice there will still be a certain risk of double taxation. This is due to the fact that different countries can also choose fundamentally different approaches on how they wish to implement a CFC rule in their internal rulebook. As a result, there is a risk that the qualification of certain profits under the CFC rule of country A are also qualify under a CFC rule applicable in country B.
Furthermore, while the ATAD directive also proposes, in order to avoid double taxation, to allow the offsetting of the tax already paid in the country where the subsidiary is established, no mention is made of this aspect in the Belgian legislative proposal. Although the risk of double taxation is mentioned in the explanatory memorandum, the government has not included a provision in Article 185/2 WIB92 based on which it would be possible to deduct foreign taxes paid. This is allegedly due to the fact that Belgium has decided to apply the transactional approach and the fact that the measure is intended to counteract the artificial movement of assets and profits to countries where taxes are low. Hence, the intention could not be to compensate the costs associated with this artificial shift with the tax that arises precisely due to the application of the CFC rule. How Belgium would like to avoid double taxation if the member state involved does not use the same method of calculation for establishing passive income is not discussed and this remains unclear for the time being.
Conclusion
Take a close look at your transfer pricing policy to check whether the correct profit allocations are being made for the Belgian taxpayers in light of the broader transfer pricing principles such as the value chain and the outcome of a functional and risk analysis. In practice, this is the only way to limit the impact of the new Belgian CFC rule for your (group of) companies.
[1] Anti Tax Avoidance Directive - Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market, OJ EU L 193, 19 July 2016).
[2] Base Erosion and Profit Shifting: The BEPS plan contains 15 action points against international tax avoidance and profit shifting. These action points are mainly built around three pillars: coherence, substance and transparency.
[3]'The impact of the ATAD directives on the summer agreement', Anne-Sophie Van Den Bosch, 28/10/2017, https://www.moorestephens.be/nl/diensten/tax-legal-services/751-de-invl…
[4] An artificial arrangement applies in cases where assets are identified that the foreign company owns and whereby strategic decisions are taken by the taxpayer or persons employed by this taxpayer.
[5] Parl. Doc. Chamber 2017-2018, no. 2846/1, 46ff.
[6] Relevant key functions, or the so-called 'significant people functions' (SPF), is an internationally accepted OECD concept that is used, among other things, in terms of profit allocation for a permanent establishment and when making the functional and risk analysis framework within a transfer pricing study.
[7] Article 321/1 to 321/7 of the 1992 Income Tax Code on additional reporting requirements regarding transfer prices. These determine the limits to determine when a Belgian company must submit a country report, comply with a notification requirement, submit a group file and/or local file.
