On 12 September 2023, the European Commission published a proposal for a new directive “Head Offices Tax System” (“HOT Proposal”) aiming at creating a simplified tax system for small to medium-sized enterprises (“SMEs”) based in a EU Member State and carrying out their activity through one or several permanent establishment(s) (“PE”) established in other EU Member States.
What is it?
The HOT Proposal would introduce two levels of simplification (which will be optional for all eligible SMEs):
- First, for the purposes of the computation of the PE(s) tax base: eligible SMEs could calculate the taxable result(s) of their PE(s) based only on the taxation rules of the Member State of their head office, while the applicable tax rate(s) would remain that/those of the Member State(s) where the PE(s) is/are located;
- Second, from a compliance perspective: the filing, assessment and tax collection of eligible SMEs could be centralised in the head office Member State (one-stop-shop system). SMEs would thus file one single tax return with the tax administration of their head office (which would in turn transfer the resulting tax revenues to each Member State where the SME maintains a PE). The tax authority of the Member State of the PE would remain competent to audit the PE established in its jurisdiction.
Such option should last for five years, unless the head office changes residence in the meantime 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.
Which entities are eligible?
The scope of the rules is limited to standalone SMEs that operate exclusively through PEs in one or more Member States (therefore excluding SMEs having subsidiaries in other Member States). The HOT Proposal lays down strict eligibility conditions to benefit from the rules. In particular, SMEs resident for tax purposes in an EU Member State that do not exceed the limits of at least two of the three following criteria, are in the scope:
- Balance sheet total: EUR 20,000,000;
- Net turnover: EUR 40,000,000;
- Average number of employees during the financial year: 250.
Furthermore, SMEs that are part of consolidated group for financial accounting purposes are excluded from the scope of the HOT Proposal, as well as the portion of an SME’s income derived from shipping activities carried out by PEs subject to a tonnage tax regime.
In addition to the eligibility criteria pertaining to the SMEs, SMEs and their PEs must comply with the following conditions in order to benefit from the rules:
- The joint turnover of all PEs must not be higher than the double of the head office’s turnover;
- The head office must have been tax resident in the same EU Member State for the past two fiscal years; and
- The head office qualified as an SME according to Directive 2013/34/EU during the past two fiscal years.
It should also be noted that the HOT Proposal does not provide a definition for “Permanent Establishment” and instead refers to the definition set forth in the relevant double tax treaty concluded between the EU Member State of the head office and that of the PE.
Interaction with BEFIT proposal
The BEFIT proposal is primarily aimed at large groups operating across the EU. The HOT Proposal simplifies rules for SMEs during their early stages of expansion. If SMEs successfully expand and grow, they may outgrow the scope of the HOT rules, but then they would be able to opt into BEFIT. In this way, the two proposals are complementary. Smaller businesses would be able to choose the best option for their own needs throughout their lifecycle.