Proposed European “Head Office Tax” System

3 July 2024

Simplification through a head office-based tax system?

The “Head Office Tax (HOT)” system is a complementary EU tax simplification measure to the “Business in Europe: Framework for Income Taxation (BEFIT)”. While the “BEFIT” draft directive is primarily aimed at large corporate groups, the “HOT” proposal aims to simplify the tax rules for small and medium-sized enterprises (SMEs) in their initial expansion phases into other Member States.

The EU Commission's HOT proposal provides an option for SMEs that operate cross border in the EU via permanent establishments (branches) to calculate the taxes to be paid exclusively on the basis of the tax regulations of the Member State in which the company has its headquarters. As present, the proposed HOT system does not apply to SMEs operating in other countries via subsidiaries but this may be widened to include enterprises with up to two subsidiaries. It has been proposed that the simplification measure will be applicable from 1st January 2026.

Background: Relief package?

Complying with cross border corporate tax rules can be complex and challenging for smaller enterprises seeking to expand into new markets. SMEs that want to operate in other countries must be aware of various tax systems and regulations. The Commission President von der Leyen had already announced in the “State of the Union” of 2022 that the Commission would launch a relief package for SMEs to promote their economic development. The newly published draft HOT Directive establishes special rules for permanent establishments of SMEs in other Member States for the purpose of simplification and cost reduction.

Proposal’s key features - What can SMEs expect from HOT?

The regulatory mechanism of the draft HOT Directive provides, that the taxes to be paid are calculated solely based on the tax regulations of the Member State in which the company has its Head Office. Therefore, the SME only has to submit one tax return to the tax administration of its Head Office.

In order to qualify, the enterprise must meet the thresholds of a micro, small and medium-sized (SMEs) business, as defined in Directive 2013/34/EU, thereby having:

Fewer than 250 employees, on average, during the financial year and either:
Annual turnover not exceeding €50 million, or
Gross balance sheet assets not exceeding €43 million

Additionally, SMEs wishing to avail of the HOT measure must meet the following conditions in the previous two fiscal years:

the aggregated turnover of its branches is less than double the turnover of the head office;
the tax residence in the last two tax years is in the Member State of the head office;
the SME is not part of a consolidated group for accounting purposes.

Optionality?

The provisions of the draft HOT guidelines are not mandatory. Rather, the SME has the option of whether to apply the regulations. Once a SME opts into the HOT Regime, the provisions must be applied uniformly to all branches in other Member States. It is not possible to limit the application of the regulations to individual permanent establishments and remains effective for a period of up to five fiscal years.

Tax procedural rules?

The main objective of HOT, which consists of simplification and the reduction of compliance costs, becomes clear in the context of the procedural provisions. The competent tax authority of the Head Office Member State acts as the central office (One-Stop-Shop). The tax authority of the Head Office Member State is also responsible for checking the tax return, including tax collection based on the tax rate of the country within which the branch is situated. Subsequently, the responsible tax authority in the home country will distribute the amount collected to the competent tax authority of the Member State in which the branch is located.

Initial assessment and next steps

In the European internal market, the importance of SMEs should not be underestimated. For this reason, it is fundamentally welcome that the Commission is providing simplification regulations for this type of enterprise. The EU has already determined in a 2018 study that SMEs are unduly burdened with considerable economic and compliance costs in contrast to larger multinational enterprises.

One positive aspect is that the regulations are purely optional, as they give companies maximum flexibility. However, the HOT draft directive could create unequal competitive conditions for competing companies. Although the HOT Rules ultimately apply the tax rate of the Member State where the branch is located, the calculation basis for the applicable tax rate may differ significantly when applying the HOT Rules.

Overall, the HOT draft directive reduces the complexity of tax law, compliance costs and, last but not least, existing language barriers with tax authorities and providers of tax advisory services in other countries. Tax advisors in Ireland, such as Moore Ireland, can provide their clients with more comprehensive advice “from a single source” by exercising such an option for the HOT regime if the client has its Head Office in Ireland.

Experts are sceptical as to whether the proposal will be accepted in view of the unanimity principle of the 27 Member States in the EU Council. Implementation would pose major challenges for national tax authorities. Ultimately, it remains to be seen how the negotiations will proceed and whether they will result in the adoption of the draft directives.

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