The Tax Treatment of Losses under the Proposed Common Consolidated Corporate Tax Base Directive

Introduction

On March 16 2011 the European Commission published its proposal for a Common Consolidated Corporate Tax Base directive (CCCTB). The CCCTB is a set of rules by which groups of companies that are tax resident in the European Union (EU) or EU-located branches of third-country companies would be able to submit a single consolidated European corporate tax return. 1 This implies that the group operating within the EU would be able to offset the losses of group members against the profits of other group members in order to arrive at the consolidated tax base, even when the group members are residents of different EU Member States. This paper will discuss how losses are treated under the proposed CCCTB directive. The first section will deal with losses on entering the CCCTB regime; the second section will address losses during the CCCTB regime while the third section will deal with losses after exiting the CCCTB regime. In the final section the paper will be concluded with a conclusion.

Losses prior to entering the CCCTB regime

Article 48 of the proposed CCCTB directive provides that losses incurred before opting for the CCCTB regime may be deducted from the tax base ‘to the extent provided under national law’ given that the losses would have been able to be carried forward under the applicable national law. This provision applies for a single taxpayer who opts to be included in the CCCTB regime and not for a group. 2 These pre-CCCTB losses can be utilised by the taxpayer but these would still be governed by the provisions applicable under national law. So, the CCCTB does not ignore the losses, it is just that their use within the system is conditioned by the national law. The foregoing continues to apply if the company then enters a group while it still has unused losses incurred under national rules. 3 By means of this rule it is ensured that there is no major impact with regards to unrelieved losses when a taxpayer opts for the CCCTB regime. If under national law the taxpayer was allowed to carry forward losses for up to 3 years the same will still apply for the pre-CCCTB losses.

Article 64 deals with losses incurred by either:

  1. a company (‘taxpayer’) or permanent establishment (PE) which has already been applying the CCCTB rules as a ‘single taxpayer’ or member of a CCCTB group and now enters a (or another) CCCTB group; or

  2. a company (‘taxpayer’) or PE which enters a CCCTB group (e.g. as a result of an acquisition of shares) directly from its national corporate tax system.

Based on the above distinction, where a company (or PE) enters a CCCTB group, Article 64 needs to be taken into account, which prescribes that the losses shall be offset against the apportioned share of the profits of the new group member according to the rules of the previous regime under which they were incurred, either national rules or in accordance with Article 43 (CCCTB system).

National law can include provisions for a time-expiry for offsetting losses or ceilings as to the maximum amount that may be deducted in a tax year. On the other hand the proposed CCCTB directive under Article 43 provides for unlimited carry forward of losses. 4 A taxpayer whose national law provides for such time-expiry restrictions would be better off in applying for the CCCTB regime in order to benefit from unlimited carry forward of losses if the provisions under Article 48 and Article 64 were not present. Therefore, these articles minimise the possibility of distortions in the internal market in relation to pre-CCCTB losses.

In practice it will follow that if a company which is currently applying the CCCTB regime as a single taxpayer moves into a CCCTB group, it may be carrying both pre-CCCTB losses incurred under national law as well as CCCTB losses generated during the period that it applied the system as a single taxpayer (i.e. without consolidation). In this particular case, Article 64 should be read in conjunction with Article 43 in order to find the order of precedence when offsetting losses. Article 43 (3) provides that the oldest losses shall be used first’. This provision is particularly important when a company is carrying pre-CCCTB losses incurred under national law especially if national law provides for time-expiry rules.

Article 64 provides that the unrelieved losses incurred prior to the taxpayer joining the CCCTB group can only be offset against the apportioned share of the said tax payer. These losses are in fact ring fenced and only deductible in the Member State of residence of the tax payer.

The same would apply under article 71-business reorganisation. Article 71 provides for the following two circumstances of business reorganisation:

  1. “as a result of a business reorganisation, one or more groups, or two or more members of a group, become part of another group”. E.g. as a result of an acquisition of shares;

  2. “where two or more principal taxpayers merge within the meaning of Article 2(a)(i) and (ii) of Council Directive 2009/133/EC.

In both these cases the unrelieved losses prior to the business organisation are ring fenced and deducted from the apportioned part of the tax base of the taxpayer in accordance with Article 102 of the proposed CCCTB directive.

Hohenwarter 5 finds this ring fencing to be unsystematic when the consolidated group is regarded as one economic entity. She however, finds it to be a reasonable compromise from a political point of view. The ring fencing of pre-consolidation losses safeguards Member States from having to take into account losses incurred outside their territory which might also have been incurred prior to the group having been established. It safeguards against the transferring of losses cross-border and the erosion of Member State’s tax revenue. Therefore national losses incurred prior to the group opting for the CCCTB regime will not be transferred cross-border once the group starts applying the regime.

Even though the losses remain with the Member State of residence of the taxpayer, cross-border loss offset is in fact being carried out. Without the CCCTB regime the taxpayer would have continued to carry over losses. Under the CCCTB regime the losses carried forward can now be offset against the apportioned tax base which is made up of profits of group members resident in other Member States.

The implication of this provision is significant especially in a time of financial crisis where it is probable that a lot of companies have accumulated losses. If unrelieved losses incurred prior to the taxpayer entering the CCCTB group were not ring fenced, this could imply that losses would be shifted cross-border at the point of entry in the CCCTB as the losses would be included in the CCCTB tax base with the result that the tax base would be significantly reduced.

The CCCTB regime entails full consolidation of the results of the members of the group. The ownership threshold for including a subsidiary in the group does not exclude the presence of minority shareholders. Subsidiaries can be consolidated as long as the parent company holds more than 5 percent of the voting rights and more than 75 percent of the equity, or more than 75 percent of the rights to profits.

Due to the apportionment formula the member’s individual corporate interests can be effected by the rules governing this apportionment, since these rules will serve to the determine the tax liability of each individual group member. Even though pre-consolidation losses are ring fenced and can only be used against the apportioned shares of profits by the individual company, if this share of profits is more than it would have been if there was no CCCTB regime the pre-consolidation losses would be used up quicker. Tax would be paid at an earlier stage in this scenario, which is a determent to the minority shareholders. Also, if the individual company pays more tax it has less distributable profits. This undermines the interests of the company’s minority shareholders. From the text of the Directive it appears that the collective interest prevails over individual interest, a situation that is harmful to the interest of minority shareholders.

The following section will discuss how losses are treated once a group of companies operating in the EU has opted to adopt the CCCTB regime.

Losses during the CCCTB regime

The CCCTB draft proposal provides for an unrestricted loss carry forward system with no loss carry back. 6 However, in the proposed amendments under the Danish Presidency discussed on April 25th, 2012 7 it was proposed that tax loss carry forward not exceeding €1 million could be utilised without restrictions, but any excess loss could only be deducted up to an amount equal to 60% of the remaining tax base. Losses which are not utilised due to this restriction are not lost but carried forward to subsequent years. Companies in the group are made to pay tax in advance on losses which can be utilised in subsequent years if enough profits are available. This limitation is clearly proposed in order to limit the impact of losses on the tax revenue of the Member States. By means of this proposal it is ensured that companies pay some tax in a current year. This creates a disadvantage for groups of companies who are still made to pay tax even though they still have losses that could be offset against the tax base. This is also a determinant to the minority shareholders of the group. These shareholders do not benefit directly from group taxation and would be directly affected by this provision. The Danish Presidency proposed amendments do not provide provisions in case of reorganisation. If this amendment is to be approved, further amendments would need to be made in case of losses upon a reorganisation.

In article 43(3) the proposed Directive also provides that the oldest losses will be utilised first, thus allowing the utilisation of all losses incurred prior the group joining the CCCTB regime and imported in the CCCTB regime.

One might argue that the CCCTB regime also implies a shift in the exercising of taxing powers by Member States. Without the CCCTB regime the Member State of residence of the profit making company would have fully taxed the profits of that company. Since with the CCCTB regime losses of a non-resident member of the group are now included in the tax base, a portion of those losses are indirectly being absorbed by the Member State of the profit making company through the allocation formula. Thus, there is a shift in taxing powers as this Member State is inevitable renouncing taxing part of the profits of the resident company. This shift in taxing powers is in favour of the Member State with the loss making company who will be allocated a portion of the tax base to tax whilst in a non-CCCTB situation this Member State would not have levied any tax.

This shift in the exercising of taxing powers has also a direct impact on the interests of minority shareholders. When an individual company is taxed more as a result of the CCCTB regime, the minority shareholders will be at a disadvantage as more tax would have been paid and fewer profits can be distributed. On the other hand when an individual company is taxed less as a result of the CCCTB regime, the minority shareholders are at an advantage as less tax is paid and more profits can be distributed.

The CCCTB regime has to be applied initially for a term of 5 years and then for consecutive terms of 3 years. However, if a new member joins the group the 5 year period of the group is not altered. Thus and individual taxpayer can join the group in year 4. If this taxpayer had accumulated losses now these losses can be deducted against the individual’s taxpayer apportioned share. If the group exits the CCCTB regime after the 5 years it might be the case that most of the accumulated losses of the taxpayer have been utilised. This is again a disadvantage to the minority interest shareholders of the particular taxpayer also given that this individual taxpayer has formed part of the CCCTB group for a very short period of time.

Minority interest shareholders are an important part of the equation and the CCCTB regime does not cater for them contrary to some national legislation. For example the UK and France provide for compensation to be provided to the company whose losses are being utilised in order to safeguard the interests of minority shareholders. This compensation is aimed at quantifying the disadvantages caused by the surrender of losses and sets out the terms of an indemnity payment. This indemnity, paid by the consolidating parent/company utilising the losses to the surrendering company, tends to compensate the additional tax liability carried forward, against the surrendering company’s own profits.

Article 43(2) states that ‘a reduction of the tax base on account of losses from previous tax years shall not result in a negative amount.’ This implies that losses can only be included in the tax base as long as these do not exceed profits included in the tax base. 8 This article applies to both groups and a single taxpayer opting for the CCCTB regime. If a taxpayer has carried forward losses in a profitable tax year, the taxpayer may only use such losses up to the amount of its taxable profits in that same tax year and carry forward the loss balance for future years.

Article 86 9 which portrays the general principles of the apportionment of the consolidated tax base provides in point 2 that ‘the consolidated tax base of a group shall be shared only when it is positive.’ If a CCCTB group is loss-making in a tax year, the negative consolidated tax base will not be shared that year, irrespective of whether some group members may be profit-making. This is because the proposal’s rules on consolidation prescribe that the (positive or negative) individual tax results of group members are added up together to form the consolidated tax base which may be positive or negative. In the first case, the formula is used to distribute taxable shares of income to all group members (regardless of whether they have been profit-or loss-making that year). By contrast, if the consolidated tax base is negative, it is kept undistributed and the losses are carried forward to be offset in future years. 10

For example a CCCTB group has the following companies situated in different EU Member States with the following financial results for the year end.

Company X (situated in Member State A) 600 Profit
Company Y (situated in Member State B) (600) Loss
Company Z (situated in Member State C) (300) Loss

The overall result in this case is a loss of €300. No tax will be paid by the group in year 0 but €300 will be carried forward as a consolidated group loss for future years.

The provision under article 57(2) of the proposed CCCTB directive is aimed at avoiding stranded losses. 11 However, this approach implies that profits are in fact shared by all tax payers whereas losses are just attributed to the group and not shared. This results in an asymmetrical treatment of profits and losses in the CCCTB regime. Also, as the structure of a group remains constant and the sharing mechanism remains stable as well, there will be no stranded losses. Problems only arise when the sharing mechanism changes. 12

Taking the previous example if Companies X, Y and Z had equal apportionment rights than if the overall loss of €300 was to be apportioned to each Member State, all companies would have €100 of losses carried forward. In year 2 Company Z generates a profit of €300 while Companies X and Y have a result of €0. The €300 is the consolidated tax base which is shared among the 3 companies (€100) each. The losses carried forward would be deducted against the apportioned tax base and the group would pay no tax in year 2.

If the €300 loss was carried forward at the level of the group (as per the CCCTB proposed directive), in year 2 the consolidated tax base would be 0 (€300 profit for year – €300 loss carried forward). The group will again pay no tax.

Therefore it makes no difference whether the losses are carried forward at group level or whether they are apportioned to the individual taxpayer. Taking the same example but in the year 2 changing the apportionment base to Company X ½, Companies Y and Z ¼ each. The following would be the results.

  • Where losses are attributed to the taxpayer the consolidated tax base in year 2 is €300 which is apportioned to Company X €150 and Companies Y & Z €75 each. In this case Company X will have to pay tax on €50 (€150-€100), while Companies Y & Z will have €25 of losses carried forward each.

  • When losses remain at the level of the group, the consolidated tax base in year 2 is €0 and the group would not pay any tax.

It makes a difference whether losses are attributed to the taxpayer or left at group level when the sharing ratio changes. However, one might argue that the losses were incurred by the group at the point where there was a different sharing ratio and it may thus be fairer if the losses are attributed to the taxpayers. This argument must also be considered given the varying degree of tax rates in the different EU Member States.

If Member States B & C for example have higher tax rates, the losses would be more beneficial for the group if utilised in those Member States against future taxable profits there. When the consolidated tax base results in a profit this is shared according to the allocation formula and tax is paid according to the individual Member States tax rate. By keeping losses at the level of the group there may be an effect in the total taxation paid by the group over a number of years due to the varying tax rates.

The proposed CCCTB directive also addresses non-EU subsidiary losses under Controlled Foreign Companies (CFC) rules. Article 82 provides for specific anti-abuse rules for CFC resident in third countries. The following conditions need to be met:

  • an EU company as group member (directly/indirectly) holds > 50 % in voting rights, share capital or profit entitlement in entity resident in third country; and

  • third country CFC is subject to low tax regime with certain amount and type of passive income.

In the case of losses article 83(1) provides that “losses of the foreign entity shall not be included in the tax base but shall be carried forward and taken into account when applying Article 82 in subsequent years.” There is therefore no import of losses through the application of the CFC rules.

The income from a third country PE is exempt under article 11(e) of the proposed directive. The proposed directive does not provide a definition of what is ‘income’. When one reads through article 11 it gives the impression that it deals with positive results and therefore one can deduce that positive results of a third country PE are exempt. The proposed directive makes no specific mention to losses of a third country PE. Would the interaction between the proposed CCCTB regime and existing double taxation conventions imply that when the credit method is applied losses can be taken into account and profits exempt? Since the proposed directive does not provide a definition of ‘income’ would the neutral interpretation of ‘income’ under the double taxation conventions apply? If this is the case than it would imply that losses are also exempt? The proposed directive should provide further clarification with regards to the results of third country PEs.

This article has been published in Intertax Volume 41, issue 11 pages 581-587, 2013 Kluwer Law International BV, The Netherlands.

The author wishes to thank Profs. Pasquale Pistone and Mr. Lluís Fargas for their valuable comments to this article.

The views expressed in this article are the author’s views and do not necessarily reflect the views of Deloitte Malta.

Part 2 of this article will feature in the Summer issue of The Accountant.

Footnotes

  • 1 “‘Common Tax Base – European commission’, available online http://ec.europa.eu/taxation_customs/taxation/company_tax/common_tax_base/index_en.htm Accessed on 3 December 2012″

  • 2 “A single taxpayer is a taxpayer who does not fullfill the requirements of consolidation and still opts to apply the system under the CCCTB directive.”

  • 3 “‘Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB) {SEC(2011) 315 SEC(2011) 316} COM (2011 121/4’, 2011 Article 64”

  • 4 “It should be brought to attention that in the proposed amendments under the Danish Presidency discussed on the 25 April 2012 it was proposed that tax loss carry forwards not exceeding €1 million could be utilized without restrictions. However, any excess loss could only be deducted up to an amount equal to 60% of the remaining tax base.”

  • 5 “Daniela Hohenwarter-Mayr, ‘Moving In and Out of a Group’ in Common Consolidated Corporate Tax Base edited by Michael Lang, Pasquale Pistone, Josef Schuch and Claus Staringer, vol. 53 (Linde 2008), Series on International Tax Law Univ.-Prof. Dr. Michael Lang (Editor), 179”

  • 6 “Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB) {SEC(2011) 315 SEC(2011) 316} COM (2011 121/4′ Article 43(1)”

  • 7 “Council of the European Union , Bruseels, ‘Proposal for a Council Directive on a Common Consolidated Corporate Tax Base – Presidency comments on the compromise proposal.’, April 25, 2012”

  • 8 “This provision will not apply in situations where losses exceed €1,000,000 if the Danish Presidency proposed amendments are applied.”

  • 9 “Applies to CCCTB groups.”

  • 10 “Article 101 ‘Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB) {SEC(2011) 315 SEC(2011) 316} COM (2011 121/4′ ; Article 57(2)’Common Corporate Consolidated Tax Base Working Group (CCCTB WG). CCCTB: Possible elements of a Technical Outline. CCCTB/WP057’, July 26, 2007”

  • 11 “Partial attribution of losses to group members which afterwards are unable to generate profits.”

  • 12 “Hohenwarter-Mayr, ‘Moving In and Out of a Group’ 181”

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