Bulgaria: International tax developments quarterly digest April – June 2024

1. EU progresses with FASTER Directive

On 14 May 2024, the Council of the European Union (“the Council”) reached an agreement (general approach) on the Directive on Faster and Safer Relief of Excess Withholding Taxes (“FASTER”), less than one year after it was proposed by the European Commission (“the Commission”) on 19 June 2023.

FASTER seeks to simplify and harmonize procedures regarding the refunding of withholding tax across the EU, to combat the administrative burden imposed on taxpayers by the differing procedural requirements across Member States. Simultaneously, the Directive seeks to address withholding tax fraud and abuse that can be linked to securities investments, hampering development of the Capital Markets Union.

The new initiative includes three different components, among them a common EU digital tax residence certificate harmonized across Member States, a common reporting approach by financial intermediaries to ensure only certified intermediaries can apply for withholding tax relief and two fast-track procedures.

While the Council reached a political agreement, the text is likely to undergo additional consultation and amendments, with the European Parliament requiring consultation on the agreed text. At present, the deadline set for transposition, should the FASTER proposal move forward, is set at 31 December 2028, with rules expected to enter into force as of 1 January 2030.

Additional topics developed over the course of the Belgian presidency include continued discussion on the Council Directive on the prevention of misuse of shell entities (so-called Unshell Directive), as well as an examination of proposals pertaining to harmonization of transfer pricing rules, the creation of a Head Office Tax system as well as a consolidated corporate tax base under the Business in Europe Framework for Income Taxation. However, at the time of the conclusion of this quarter, these initiatives were not yet principally agreed upon and no consensus on the timeline of their possible implementation has been reached.
 

2. Bulgaria and Malta move forward with renegotiation of the Double Tax Treaty

On 15 May 2024, Bulgaria's Council of Ministers provided its authorization to the Finance Minister to sign a revised Double Tax Treaty (“DTT”) with Malta.

The initial draft was approved by the Bulgarian Council of Ministers on 8 July 2020 as a basis for negotiations but reapproval was necessary following meetings held between both countries in October 2022 and November 2023. The current DTT between the Republic of Bulgaria and the Republic of Malta dates from 1986 and was signed in the context of a significantly different macroeconomic circumstances.

Although the official text of the revised DTT is not available, it is expected that it would be in line with the latest international tax developments, following the OECD/G20 Base Erosion and Profit Shifting (BEPS) recommendations. In particular, the new DTT would likely incorporate the minimum standards envisioned under the Multilateral Instrument (“MLI”), including the principal purpose test, denying treaty benefits to arrangements having as their primary aim to obtain treaty benefits in contravention of the purpose of the treaty.

Additional expected changes as minimum standards of the MLI would likely include an update of the mutual agreement procedure relief mechanism available under the DTT, as well as an updated clause requiring corresponding adjustments related to transfer pricing matters.

As negotiations appear to be ongoing, a timetable for the adoption of the new DTT as well as the final text are still not available.
 

3. OECD issues additional guidance on the application of Pillar One’s Amount B and Pillar Two global minimum taxation rules 

Amount B of Pillar One

On 17 June 2024, the OECD’s Inclusive Framework (“OECD”) released additional guidance on certain outstanding administrative aspects of the Amount B guidance that remained pending in the February 2024 report.

The report on Amount B, comprising part of the OECD’s Pillar One initiative on the allocation of taxable income for large multinational groups, provides a streamlined approach on the application of the arm's length principle to baseline marketing and distribution activities between related parties. Under this new approach, transactions meeting the above description and exhibiting traits that allow them to be reliably priced through a one-sided transfer pricing method will be open to applying a pricing matrix, determining an arm’s length return in view of the characteristics of the distributing entity (i.e., industry, operating expenses and interests). For the rules to apply, the tested party must not have annual operating expenses below 3% of its annual revenue or above a cap of 20% to 30% of this revenue.

In order to clarify the above rules, the OECD has released several lists. The first one includes those jurisdictions which are classified by the World Bank as having low, lower-middle or upper-middle income level and may take advantage of a higher cap on the operating expenses under the pricing matrix. Under the current guidance, 132 jurisdictions, including major markets such as Brazil, China and Türkiye meet these criteria, including Bulgaria as well.

The second list encompasses jurisdictions with a limited amount of data available for the purposes of the application of the pricing matrix and who’s sovereign risk rating indicates that they entail ‘higher risk’. Jurisdictions qualifying under this second list are provided with an upward adjustments to the returns under the Amount B pricing matrix. 135 jurisdictions are currently included in this list, which partially overlap with the first one, however Bulgaria is excluded here.

In addition, the Amount B initiative provides for a political commitment to recognize the results of the application of the pricing matrix by ‘low-capacity’ or ‘covered’ jurisdictions, the definition of which was left open at the time of the issuance of the February report. The new guidance provides a list of covered jurisdictions, comprising both low- and middle-income jurisdictions in Africa, the Middle East and Asia, but also larger developing economies, such as Brazil, Mexico and Argentina. Bulgaria is excluded from this list as well.

The implementation of these new rules remains uncertain, with few states having made major commitments to implement the Amount B guidelines.

Pillar Two

In parallel to the issuance of its new Amount B clarifications, the OECD also released new administrative guidance to clarify and simplify the application of the global minimum tax on multinational enterprises (“MNE”s) and an overview of the process for recognizing qualified status for the legislation of jurisdictions implementing the global anti-base erosion (“GloBE”) rules.

The new administrative guidance provides clarity on some of the key technical areas along with suggested simplified procedures for application of the GloBE rules, including an additional optional election available to taxpayers, allowing MNE Groups to aggregate various categories of deferred tax liabilities for determining whether they have reversed within five years and therefore do not need to be recaptured.

Other topics include clarifications on the methodology used to determine deferred tax assets and liabilities for GloBE purposes, guidance on allocation of cross-border current and deferred taxes, as well as clarifications on the treatment of securitization vehicles under a jurisdiction's domestic minimum top-up tax that will prevent these vehicles giving rise to volatile outcomes under the GloBE rules.
 

4. European Court of Justice Rules on Bulgarian Withholding Tax Case

On May 16, 2024, the European Court of Justice (“ECJ”) has delivered its Order on Entain Services (Bulgaria) EOOD (Case C-287/23). The case revolves around the application of Bulgarian withholding tax on dividends distributed by a Bulgarian company to its parent entity based in Gibraltar, in light of the freedoms outlined in the Treaty on the Functioning of the EU (“TFEU”).

The current case is a second referral as under the first one (C‑458/18), the ECJ ruled that Gibraltar parent entities did not have access to relief under Directive 2011/96/EU (“Parent-subsidiary Directive”).

The ECJ examined the case with a focus on the freedom of establishment and concluded that denying withholding tax relief to Gibraltar entities constitutes a restriction under the TFEU. Notably, Bulgarian parent entities are not subject to this withholding tax and generally enjoy an effective exemption from corporate tax on their dividend income.

Furthermore, the ECJ dismissed the Bulgarian government's argument that the restriction was justifiable as a measure to prevent tax abuse. The Court held that providing the withholding tax relief solely to parent entities tax resident in another EU/EEA Member State does not appear to meet the tax abuse justification for the rule in question.

The ruling confirms that the denial of withholding tax exemption for dividends received by a Gibraltar parent company is in conflict with the principle of freedom of establishment enshrined under the TFEU.

While the ECJ's decision was based on the freedom of establishment, it leaves open the question of whether the same outcome would have been reached under the free movement of capital principle, which also applies to third countries, as Bulgaria’s current withholding tax exemption regime on dividends applies solely to EU/EEA tax resident parent entities.

5. Supreme administrative court rejects the tax administration’s assessment on inter-group financing

In May 2024, the Supreme administrative court delivered a landmark ruling which dealt with both transfer pricing and international tax aspects of an intra-group financing transaction. The case involved a profitable Bulgarian taxpayer who had refinanced its long-term debt with an intra-group loan from its foreign tax resident parent. The tax authorities considered this did not adhere to the arm’s length principle and allowed only partial deductibility of the interest expenses of the Bulgarian taxpayer. Additionally, the revenue authorities disputed the beneficial ownership status of the foreign interest income recipient under the intra-group financing, thus revoking access to the withholding tax exemption.

Although the tax administration’s position was upheld by the first instance court, the Supreme administrative court revoked the tax assessment act in its entirety. Namely, the court ruled that the tax auditors did not prove the taxpayer’s actions deviated from the  arm’s length conditions as the refinancing did not deviate from regular market practice. Furthermore, the court dismissed the beneficial ownership arguments of the revenue authorities and revoked the assessed withholding tax, relying on the fact that the income recipient under the intra-group financing economically benefited from those proceeds and has the power to freely to determine the use to which it is put.

This case highlights the Bulgarian tax administration’s practice of performing in-depth analysis from a transfer pricing perspective which extends not only to a review of benchmark studies, but an overall assessment of the taxpayer’s options realistically available. Companies should periodically assess their position on intra-group dealings in order to valuate any potential risks in light of the changing economic environment, which could provide for new and better alternatives compared to the moment when the transaction was entered into.     
 

6. Supreme administrative court rules on the tax auditors’ approach to apply a different TP method   

In June 2024, the Supreme administrative court revoked an assessment act where the tax administration had challenged a Bulgarian taxpayer’s transfer pricing policy. Namely, the tax auditors did not agree with the applied transfer pricing analysis of each related party transaction on a separate basis, but rather considered that all of the intra-group transactions are so closely connected to one another that they should all be reviewed together. Thus, a single transfer pricing method (namely, TNMM with return on assets as a profit level indicator) was used by the revenue authorities and as a result the company’s tax result was significantly increased.

The Supreme administrative court revoked the assessment act, as the tax auditors had not provided sufficient evidence the taxpayer’s approach did not result in an arm’s length result. Furthermore, the court outlined that aggregating several related party dealings and analyzing them under a single TP method was permissible where they cannot be evaluated adequately on a separate basis. Considering the tax auditors did not provide strong arguments why the transactions cannot be reliably analyzed on a transaction-by-transaction basis, the aggregation approach was not allowed and further motivated the revoking of the assessment act.

The described case further showcases the revenue authorities’ detailed review of the taxpayers’ transfer pricing documentation during tax audits. Furthermore, it appears for manufacturing companies employing significant non-current tangible assets, the tax administration tends to perform a separate transfer pricing analysis based on the return on assets as a preferred profit level indicator.