Belgium adopts model A CFC rules

Belgium's federal government has adopted new rules governing the taxation of the non-distributed profits of a Controlled Foreign Company (CFC). The reform represents a shift from model B (Transactional approach) to model A (Entity approach) of the EU Anti-Tax Avoidance Directive (ATAD). The new rules are applicable as from assessment year 2024, applying to financial years ending on or after December 31, 2023.

The previous CFC regime, which has been in effect since assessment year 2020, aimed to tax undistributed profits from controlled low taxed subsidiaries or branches resulting from an artificial arrangement or a series of arrangements set up with the essential purpose to obtain a tax benefit. This approach required the significant people functions generating income for the CFC to be based in Belgium. The new rules mainly focus on the taxation of passive profit of a CFC that is directly owned by the Belgian controlling company and that is subject to low-taxation abroad, unless the CFC has sufficient economic substance.

In order to assess whether a portion of the profit of a foreign company should be included in the taxable basis of the Belgian controlling company, it must first be determined whether the foreign company qualifies as a CFC. Subsequently, it must be assessed whether the CFC is eligible for one of the safe harbours (cf. below). If that is the case, its profits are not to be included in the taxable basis of the Belgian controlling company. If no safe harbour is applicable, the amount of the CFC’s undistributed profit to be included in the taxable basis of the Belgian controlling company should be computed.
 

Identification of a CFC

A foreign company qualifies as a CFC if both the participation and taxation condition are met.

• The participation condition is met when a Belgian company, either on a standalone basis or together with its associated companies, (i) has the majority of voting rights on all shares, (ii) holds at least 50% of the capital, or (iii) is entitled to at least 50% of the profits of a foreign company. A foreign Permanent Establishment (PE) automatically satisfies this condition. As the test is to be done at group level, considering the rights of “associated companies” as well, it can imply that a company that is held by a Belgian company for only 10% qualifies as a CFC because at least 40% is held by other associated companies. This is an important change and broader compared to the previous legislation.
• The taxation condition is met for a foreign company or PE that is either (i) not subject to income tax or (ii) is subject to income tax which is less than half of the Belgian corporate income tax that would have been due be if the foreign company or PE would have been established in Belgium. This condition is presumed to be met by entities established in jurisdictions listed as tax havens by the EU or Belgium, although this is rebuttable
   

Safe harbours

Despite qualifying as a CFC, the new legislation includes 3 safe harbours at the level of the Belgian controlling company for certain foreign profits. More specifically, the CFC income inclusion should not be applied if:

• The Belgian controlling company provides evidence that the CFC is carrying out a substantial economic activity, supported by personnel, equipment, assets and buildings defined as “the offering of goods or services on a particular market”. In this regard, the Memorandum of Understanding clarifies that the offering of intercompany services does not meet this definition, unless respective transactions are carried out at arm’s length;

• Less than 1/3 of the total income of the CFC originates from so called “passive income”;

• The CFC is a regulated financial institution to which the EBITDA interest deduction limitation does not apply and for which the total income is derived, for 1/3 or less, from transactions with the Belgian controlling company or entities associated with the latter.
  
  

Taxation of undistributed passive profits

Unless one of the safe harbours applies, certain passive non-distributed profits of the CFC shall be included in the taxable basis of the Belgian controlling company in relation to its direct participation in the CFC.

There are four steps to be considered in order to determine the profits of the CFC that will be included in the Belgian taxable basis:

1. Calculation of the profit of the CFC based on Belgian accounting and tax rules as if the CFC were located in Belgium.
2. Limitation of the profits in proportion to the part of profits that is not distributed.
3. Limitation of the profits in proportion to the CFC's passive income.
4. Allocation of the CFC's profits in proportion to the highest of the Belgian company’s direct voting right, direct ownership rights in the share capital and rights to the profits of the CFC.
   
   

The methodical calculation of the profits that may need to be included as CFC income according to Belgian accounting and tax rules is likely to be quite complicated and may lead to income inclusion of income that is not recorded as income in the financial statements of the CFC following the “Belgian” calculation. A detailed calculation, understanding and assessment of the rules and definitions is advised to properly understand the potential impact.

An important change compared to the previous CFC rules is thus that only direct participations and direct branches (as well as branches from a direct participation) are envisaged whereas the previous CFC rules also targeted indirect participations and branches where the Belgian controlling company did not hold any direct stake. The application only to “direct participations” is less stringent than the provisions of ATAD. The Belgian legislator opted to apply the CFC income inclusion to direct participation only in order to avoid an inclusion at different levels. 

Passive income is broadly defined and includes, amongst others, income from interests, royalties, dividends, income from disposal of shares, but also income from rental and leasing, certain financial activities, and even income from the purchase and sale of goods and services, to which little or no economic value is added by the CFC.

Note for instance that intermediate passive holding companies may therefore trigger CFC inclusion in the hands of the Belgian controlling shareholding when they receive dividends from companies that would not qualify for the Belgian participation regime.
 

Avoidance of double taxation

The new rules foresee three ways in which double taxation can be avoided:

1. Different to the previous rules, the new rules provide a carry forward non-refundable foreign tax credit (‘FTC”). This FTC, determined by certain foreign income tax paid by the CFC (on its profits) can be proportionally set off against the Belgian corporate income tax due on the CFC's profits.
   
   
2. Upon a profit distribution of the CFC, the old rule is maintained, i.e. the Dividend Received Deduction regime (“DRD-regime”, being the Belgian implementation of the participation exemption), can be applied to the extent that the Belgian controlling company demonstrates that these profits have already been included in the taxable basis under the CFC rules in a prior tax year in the hands of the Belgian company.
   
   
3. As for capital gains realized on a disposal of a participation in a CFC, double taxation can be avoided through a specific exemption of such capital gain provided that:

• the profits have already been included in the taxable basis under the CFC rules in a prior tax year in the hands of the Belgian controlling company;

• these profits have not yet been distributed;

• at the time of the disposal, these profits still existed on a separate liability account of the balance sheet;

• the taxable amount of the capital gain exceeds the total impairments previously assumed on the disposed shares, minus the already taxed portion of those impairments;

• a specific anti-abuse rule with respect to the change in ownership is not triggered.
  
  

Reporting obligation

Belgian companies are required to disclose the existence of a CFC in their corporate income tax return. This requirement for disclosure becomes effective as soon as both the participation and taxation condition have been met, even if no CFC profit is actually included in the Belgian taxable basis.

Implications to businesses

The new CFC rules shift the focus from income generated as a result of artificial arrangements to passive income generated by a CFC without sufficient economic substance, resulting in a broader scope of application. Note that the assessment on sufficient economic substance will be essential for the new rules and the expectation is that the Belgian tax authorities will scrutinize the economic substance.

Direct minority shareholdings in a CFC may lead to a proportionate CFC income inclusion if the CFC is controlled together with other associated entities for more than 50%. On the other hand, the CFC income inclusion can now only apply to direct participations. The newly created FTC possibility also lowers the double taxation risk. Considering the complexity of the rules, the broad reporting obligation and the specific “Belgian" calculation requirements, a proactive approach is highly recommended as the rules apply as from assessment year 2024. The interaction with the Pillar 2 rules should also be closely monitored for the in-scope Multinational Enterprises.

In case of any further questions with regard to these developments, please do not hesitate to reach out to your trusted EY person of contact.