Bulgaria publishes discussion draft for the implementation of EU Directive on minimum taxation
On 26 September 2023, Bulgaria published its discussion draft proposal aimed at transposing Council Directive (EU) 2022/2523 of 14 December 2022 (“The Directive”). The Directive is a result of the OECD’s BEPS Initiative for the introduction of a global minimum tax rate of 15% for multinational groups (“MNE”) and large-scale domestic groups.
The proposal envisages the introduction of a top-up tax regime, including domestic top-up tax, as well as a primary tax rule (the income inclusion rule – IIR) and a secondary tax rule (based on the Undertaxed Profit Rule – UTPR), aiming to bridge the gap between the current corporate tax rate of 10% in Bulgaria and the 15% effective tax rate agreed upon on the OECD level. Constituent entities (subsidiaries and permanent establishments) part of MNE and large-scale domestic groups whose consolidated revenue is no less than EUR 750 million in at least two of the preceding four years will be in scope of these new rules.
The tax base when determining the new top-up tax due will be determined under new rules relative to those applicable to the national corporate income tax regime, applying on the aggregated net book result for all constituent entities based in Bulgaria with specific add-backs and deductions included. The proposal also includes elections to allow constituent entities to adjust specific elements of the tax base, as well as exclusions for certain activities such as international shipping.
The current proposal does not envision providing a substance-based relief (a reduction in the tax base by a percentage of the carrying value of certain tangible assets and payroll costs), exclusions of enterprises under a certain revenue and profit threshold (the “de minimis” exclusion) or the exclusion for groups in the initial phase of international activities or large-scale domestic groups for the purposes of determining the national top-up tax. These forms of tax relief will however be available when applying the primary and secondary top-up tax rules under the proposal.
In addition to their new top-up tax obligations, the proposal provides for new administrative obligations on constituent entities of MNE groups in Bulgaria. Constituent entities would need to submit declarations to the Bulgarian tax authorities containing information generally around the group and the grounds for determination of the top-up tax due on an annual basis. There are significant penalties attached for incompliance.
The new rules are expected to enter into force as of 1 January 2024, with the secondary top-up tax becoming applicable as of 1 January 2025.
This new regime would have wide-ranging consequences which taxpayers will need to take into account and prepare for. As the new proposal goes through the legislative process and ultimately becomes enacted into law it is important for companies to consider the potential impact on their business structure and internal procedures.
Bulgarian Ministry of Finance proposes amendment to tax regime applicable to banks
The Bulgarian Ministry of Finance published on 26 September 2023 a proposal for an amendment to the tax regime applicable to financing institutions, including banks. If enacted, the new regime would apply from 1 January 2024.
Currently, fair value gains and losses recorded by financing institutions related to financial instruments are recognized for tax purposes on accrual basis, unlike for other taxpayers where the taxable event generally follows the realization principle. It has been announced that the legislative change is supposed to place all taxpayers on equal footing when it comes to bad debt relief and taxing mark-to-market gains.
If enacted, this amendment would have a significant impact to the tax position of all financial institutions in Bulgaria. Furthermore, banks would also need to apply the transitional rules aiming to avoid double taxation or double deductions where a fair value gain or loss has already been recognized for tax purposes during a previous year. The proposed changes add another level of complexity in respect of defer tax accounting and its impact on the related effective tax rate computation under Pillar II.
Bulgaria publishes proposal for implementation of Public CbCR rules
On 19 September 2023, the Bulgarian Ministry of Finance published for public consultation a legislative proposal for the transposition of Directive (EU) 2021/2101, providing for the introduction of the new Public Country-by-Country (CbC) reporting requirements in Bulgaria (“The Public CbCR Directive”). The Public CbCR Directive is aimed at increasing tax transparency obligating MNE groups and large domestic groups to disclose certain information on their corporate income tax status.
The new rules require standalone entities and ultimate parent entities of MNE groups with consolidated revenues exceeding BGN 1,500 million (EUR 750m) in each of the last two consecutive fiscal years to issue an annual report disclosing information on the income taxes accrued and paid by group entities. Where the ultimate parent entity of the group is situated in a third state and upon certain conditions the local subsidiaries or branches may need to adhere to the disclosure obligation.
The annual report would include revenue streams, pre-tax profits, tax accrued and paid, amounts of undistributed profits and other information pertaining to the activity of all related parties included in the group’s consolidated financial statements for the respective period. Part of this information may be temporarily excluded from the report, where its disclosure could cause damage to the commercial position of the respective undertakings. Should a group make use of this exclusion, it must include the list of excluded information and the reasoning for that exclusion as part of its annual report. Information pertaining to jurisdictions which are part of the EU’s list of non-cooperative tax jurisdictions may not be excluded.
Entities in Bulgaria obligated to prepare a Public CbC Report must file the relevant report with the Commercial Register and Register of Non-Profit Legal Persons within 12 months after the end of the respective reporting period. Entities which fail to meet this obligation may be subject to sanctions.
The rules will apply as of 1 January 2025 and the first public CbC report would cover the reporting period related to 2024.
Groups falling within the scope of the rules should assess whether they would have a public reporting obligation in Bulgaria as failing to comply may result in administrative sanctions.
Supreme Court judgment underpins Return on Assets as a profit indicator that needs to be tested in capital intensive industries
The Bulgarian Supreme administrative court (“SAC”) continues to build its practice on transfer pricing disputes. An intriguing case was recently decided by the court in which the revenue authorities had deemed that a Bulgarian manufacturing company did not achieve an arm’s length result in the context of its internal group dealings.
Namely, after reviewing in detail the provided benchmark study from the company which relied on the Transactional Net Margin Method (TNMM) with a profit level indicator of return on assets (RoA), the tax inspectors discovered that one of the identified comparable parties was part of a group and had in fact dealings with related parties. Furthermore, it was deemed that the discussed comparable observation had unique conditions such as access to maritime port which also made it non-comparable to the taxpayer. Based on the above, the revenue authorities eliminated this party from the benchmark study altering the arm’s length range and as a result the taxpayer’s taxable profit on the controlled transaction was adjusted in order to fall within the adjusted range.
The taxpayer prepared an additional transfer pricing analysis again based on TNMM, however using as a profit level indicator the return on costs. The SAC dismissed this additional analysis deeming that RoA is a more appropriate indicator in determining an arm’s length price range of the manufacturing activities of the taxpayer as these involved significant investments and the reviewed manufacturing was capital intensive.
Ultimately, the SAC agreed with the tax administration’s approach and confirmed the assessment notе. Ultimately, no additional tax was assessed on the taxpayer, however his tax losses for the audited years were significantly decreased which could have an effect for following tax years.
The revenue authorities continue to scrutinize in depth the transfer pricing documentation of Bulgarian taxpayers, as well as reviewing the RoA for taxpayers in certain capital intensive industries, even where the respective company has initially relied on a different profit level indicator for the respective transaction. It would be advisable for companies to monitor their local files, as well as the prepared benchmark studies in order to identify any potential tax risks, including to verify whether they fall within an arm’s length range when applying a RoA profit level indicator where significant investments have been made.
European Commission releases new proposal on computing a consolidated corporate tax base for large enterprise groups
On 12 September 2023, the European Commission issued a package of proposals for the implementation of the program of the Business in Europe: Framework for Income taxation (BEFIT) initiative. The first of these proposals (“The BEFIT Proposal”) is aimed at establishing a comprehensive corporate tax framework for groups of MNE and large domestic groups and to set out rules relating to the calculation and allocation of a consolidated tax base.
Constituent entities, including companies and permanent establishments, of MNE Groups and large-scale domestic groups with annual combined revenue of at least EUR 750 million will fall into the mandatory scope of the new rules. The BEFIT Proposal will also allow for voluntary application of its provisions for smaller groups that do not meet the turnover threshold.
Under the BEFIT Proposal, the results of each member of a group subject to the rules will be consolidated into a common corporate tax base. Using the financial statements of each group member as a baseline, the new rules introduce a set of specific adjustments to the results to determine the preliminary tax result for each group member. The total preliminary results are then aggregated to determine the BEFIT tax base. A positive tax base is allocated across group members base subject to specific allocation rules, whereas group-wide losses may be carried forward and set off against a future positive BEFIT tax result.
If adopted, the provisions of the BEFIT Proposal would need to be transposed by Member states by 1 January and applicable as of July 2028. If enacted, it would mark a significant step towards harmonization in direct taxation at the EU level.
European Commission proposes Directive aimed at harmonizing Transfer Pricing rules
As part of its package implementing the BEFIT program, the European Commission has published on 12 September 2023 a proposal for a Council Directive on Transfer Pricing (“The TP Proposal”). The aim of the Directive is to harmonize certain transfer pricing (“TP”) rules across the EU Member States by introducing simplified provisions aligned across jurisdictions, including formalizing the meaning of the arm’s length principle and clarifying the role and status of the OECD Transfer Pricing Guidelines.
The TP Proposal reiterates the requirement that dealings between associated enterprises must be made at arm’s length, reflecting the outcome that would have been achieved if the parties were independent and determined by market forces. To that end, the new rules introduce a harmonized definition of associated enterprises, previously left to the discretion of the Member States. In addition, permanent establishments will also be treated as associated enterprises and their dealings should also adhere to the arm’s length principle.
To determine arm’s length conditions, the TP Proposal allows both the use of the five primary transfer pricing methods of assessing uncontrolled comparables outlined in the OECD guidelines but also any other method or technique that is consistent with the arm’s length principle and would provide a more reliable estimate. Along with that, the TP Proposal would introduce special rules for corresponding and compensating adjustments.
If adopted, the provisions of the TP Proposal are planned to come into force as of 1 January 2026. The TP Proposal could bring harmonization across the EU Member states in a consistent application of the arm’s length principle. This may require certain amendments to the internal group TP procedures and methodologies in the relevant jurisdiction in order to assess whether they adhere to the new rules.
European Commission proposes Head Office Tax System for SMEs operating across borders through permanent establishments
In addition to the above, the European Commission issued a new proposal that would implement a single head office tax system for small and medium enterprises (SMEs) operating cross-border through permanent establishments. This would constitute a major simplification of rules for such SMEs who otherwise face high compliance costs for corporate income tax owing to the interaction of multiple different tax systems.
Companies in scope of the rules would have the option to calculate their tax base only on the tax rules of the Member State of their head office and file a single tax return with the tax administration of that Member state.
If adopted, the provisions of the proposal are planned to come into force as of 1 January 2026. Although the scope of the proposal seems narrow, it may provide for significant alleviation of the administrative burden of taxpayers who would be entitled to apply this regime.
