CCCTB or Not To Be?

By James J. Tobin, Esq.

Ernst & Young LLP , New York, NY *

There is exciting news from Europe with the March 16th adoption by the European Commission of formal proposals regarding a Common Consolidated Corporate Tax Base (CCCTB) for the EU. The basic concept of the CCCTB has been around for a while but I suspect many U.S. tax directors and tax advisors haven't paid it too much attention as any prospect for its implementation seemed remote at best. However, the formal issuance of this directive containing 134 articles representing the culmination of 10 years of work on the subject seems to advance the ball down the field and should spur the spectators on this side of the Atlantic to pay a little more attention to figuring out what this CCCTB is all about.

At the outset let me say that I could be a CCCTB fan. One has to admire the ambition of the drafters in terms of the scale of the changes they are proposing and the complexity of the issues they are tackling. As described below, the CCCTB as proposed would redefine the calculation of taxable income for EU purposes, would include a consolidated tax return regime requiring detailed rules like our dauntingly complex U.S. consolidated tax return regulations, would include a new regime of controlled foreign corporation (CFC)/Subpart F type rules which would apply across the EU for CCCTB filers, would significantly modify the current withholding tax rules both for payments within and without the EU, and would adopt a three-factor apportionment method similar to our U.S. state and local tax rules. No wonder it took 10 years to produce the directive.

In addition to being impressed by its sheer ambition, I am intrigued by the opportunities the CCCTB could provide for my clients in three respects. First, there would be an administrative savings from filing fewer corporate tax returns under differing sets of rules. Second, the "one stop shop" audit coordination aspect – that the lead country would coordinate the tax audit for all of the countries covered in the consolidated return – likely would significantly reduce controversy. Third, under the proposal, the CCCTB would be optional for taxpayers, which means that if, based on the apportionment factors, the CCCTB is likely to produce a higher tax cost in the aggregate, a corporate group instead could continue to file individual country returns. Options are always good, right?

Finally, from a self-interested point of view, it seems to me that the CCCTB as proposed is another economic stimulus/tax advisor full employment act. The complexity of the consolidated return concept, the new CFC rules, the apportionment formulas, etc. cannot be overstated. Assistance will be required in aligning existing enterprise resource planning (ERP) systems to produce the necessary information to analyze the potential impact of the rules and to comply with the rules where consolidated filing is elected. Further work will be required in doing what could be a multi-plane analysis of alternative options to determine the optimal approach for a particular company.  This all sounds like lots of fun for international tax guys like me. Until now most of the fun of working with cross-border issues has been limited to us advisors with an international tax specialization focus. Now our U.S. consolidated tax return technicians and state and local experts should be in high demand for European assignments as well.

So the CCCTB is an impressive feat of engineering that could mean big benefits to my clients and big benefits to us tax advisors. But I'm not ready quite yet to deck myself out in Team CCCTB regalia and stand on the sidelines cheering the CCCTB across the finish line. That finish line still seems so far away and there are so many opportunities for mischief between here and there.

Let's start with a quick review of how the new system is meant to work, although given the restrictions on the length of this commentary I will just hit some highlights. For more details I commend the reader both to the directive itself and to the helpful Q&As issued by the Commission.

  The "common" tax base would encompass a single set of rules to be issued for all countries in computing taxable income. The rules for depreciation, capitalization, and timing and measurement of income and expense would all be harmonized. For example, depreciation periods would be specified, 50% of entertainment expenses would be disallowed, 5% of "exempt" dividend or branch income would be presumed to represent related costs and therefore disallowed, and rules would be provided for dealing with a myriad of details such as bad debts, hedging, pensions, etc.  Not novel concepts, but no doubt lots of differences country to country in Europe that would be smoothed out. Interestingly, existing local country taxable income rules would not be required to be aligned for local entities not electing consolidated EU filing.

  •   Anti-abuse rules would be provided. Base-eroding payments of interest and interest equivalents to third-country affiliates could be disallowed if the recipient is low-taxed and is resident in a country that does not have exchange of information with the EU. A CFC regime is also included under the anti-abuse provision which would attribute income of a low-taxed (lower than 40% of the average EU corporate tax rate) controlled subsidiary more than 30% of the income of which falls into a category of tainted income (basically passive income including royalties and rents).
  •   All commonly controlled companies resident in participating EU countries would be included in the consolidated filing. Control would be defined as over 50% of vote and over 75% of value (rights to capital or profits).  There would be full offset of profits and losses. All intra-group transactions between affiliated companies would be ignored. And ignored seems to mean fully ignored rather than a deferred intercompany transaction concept like we have in the United States. Consequently, this also means that no withholding tax would be imposed on any cross-border payments of interest, royalties, etc., between consolidated entities.  This represents a much more expanded withholding exemption than under the existing parent-subsidiary directive. SRLY-type rules are provided for pre-consolidation losses and other attributes. Likewise, rules are provided for allocating attributes when leaving or dissolving a group. However, the consolidation rules in the directive are only five pages long. The U.S. consolidated return regulations are over 400 pages long. So no doubt more detail would have to emerge.
  •   The taxable income of the consolidated group would be apportioned under a three-factor formula, consisting of sales, labor, and assets. The sales factor would be based on the country of destination of goods sold or the location of performance of services.  The labor factor would be based half on total payroll costs and half on number of employees. The asset factor would be based on net taxable book value of tangible assets but also would include, apparently as a transitional adjustment, capitalization of R&D and marketing expenses for the six-year period prior to an entity's entering the consolidated group. This interesting rule would seem to potentially allocate a whole lot of "asset" value to any contract R&D subsidiaries and to distribution subsidiaries and to ignore the value of other intangible assets, which seems quite questionable to me. Special apportionment rules are provided for certain industries, such as financial services, insurance, shipping, and oil and gas.
  •   The rules would apply to groups with a common parent in the EU and also to groups with a common parent outside the EU, so EU subsidiaries of U.S. multinationals would be eligible. In such case, the U.S. parent apparently would need to designate a "principal taxpayer" from among its EU subsidiaries and that company would be the equivalent of the common parent of the group. Therefore, the consolidated tax return would be filed in that country and "one stop shop" audit coordination and administration would take place in that country. Given the varying degrees of tax authority "aggression" we see around Europe, this could be a very significant — if not the most significant — advantage to the new system for non-EU headquarter groups. Note though that there is a provision that would allow the Competent Authorities of the Member States to re-designate another subsidiary as the principal taxpayer in exceptional circumstances. 

So what are the chances of CCCBT being implemented any time soon? Well, the odds of all 27 Member States agreeing to it in the foreseeable future seem pretty long. Several countries, including Ireland and the United Kingdom, have gone on record as not in favor. However, other countries, including Germany and France, are pushing hard for it although they may not like all the details that were included in the Commission's proposals. So as I understand it, a more likely route than full implementation could be a procedure referred to as enhanced cooperation (which ironically is the same mechanism as was used to agree on EU rules on divorce), under which the system could commence with a minimum of nine Member States adopting it and a qualified majority vote. In that case, the CCCTB would apply only to affiliates in the adopting countries. This appears to have a chance of actually happening sometime over the next several years.

What does this all mean to U.S. multinationals? First of all, it means that they need to start understanding what the CCCTB is all about and taking it seriously. They should evaluate the impact on their EU subs, both from the standpoint of full implementation and more realistically from the standpoint initially of partial implementation by just those EU countries that are advocating the system. Obviously, a very interesting aspect will be the impact on U.S. foreign tax credit calculations. The common tax base, the offset of gains and losses within Europe, and the apportionment approach would no doubt result in individual subsidiary tax liabilities that would be widely disproportionate to the subsidiaries' U.S. E&P, which would create widely varying and unpredictable effective tax rates for §902 foreign tax credit purposes. Query the potential application of the §909 foreign tax credit splitter rules — although one would not think that that particular anti-abuse provision should be extended to sweep in the effects of a foreign consolidation regime where the tax is apportioned based on foreign law. Still, one wouldn't have thought it should sweep in group relief regimes either.

Overall the CCCTB could be quite a good thing.  Potentially very good from an administrative and controversy standpoint.  From a tax planning standpoint, taking into account the combination of the important European countries that are not EU members (e.g., Switzerland), the likely opt out by several key EU countries (e.g., Ireland), and the optionality of the rules, there may well be interesting planning opportunities and it would seem most U.S. groups would be able to avoid a material adverse impact. So for many U.S. multinationals, it all seems pretty good. However, one has to be a bit more worried about the proposal as a first step. If the CCCTB is adopted under enhanced cooperation, will pressure be brought to bear on non-participating EU countries, more than has been the case with respect to the adoption of the Euro? Will there be a push for mandating adoption when fiscal leakage from optionality becomes apparent? Will a regime that is designed for the few countries that participate in a first wave be appropriate for others that might join later? Will it be easy to reform, which could allow for lots of mischief following the initial implementation?

So while, as I said at the outset, I could be a CCCTB fan, I'm cautious and a bit suspicious and I feel the need to restrain my natural enthusiasm for now. I'd recommend that the consolidated return and state and local tax black belts not pack their bags for Europe quite yet. But we in the United States should be watching developments on the other side of the Atlantic more closely than we typically do. And I will be poised to jump on the CCCTB bandwagon.

This commentary also will appear in the May 2011 issue of BNA's Tax Management International Journal.  For more information, in the Tax Management Portfolios, see Liebman, 999 T.M., Business Operations in the European Union.

 Copyright©2011 by The Bureau of National Affairs, Inc.

 The views expressed herein are those of the author and do not necessarily reflect those of Ernst & Young LLP.