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What lies ahead in transfer pricing – Pillar Two and the BEFIT Directive

Marcin Jeliński and Aleksander Świątek

10 April 2024

Changes to the method of determining the tax base of multinational enterprises (MNEs) and large-scale domestic groups in the Union have begun at the EU and international level at the beginning of the year.

The new regulations will cover the European Union and additionally some of them, e.g. Pillar Two, will extend beyond the EU. Changes to the way in which the tax base for MNEs and large-scale domestic groups in the Union is determined will trigger new accounting rules for associated enterprises within the EU and will naturally bring a number of innovations in the area of transfer pricing.

PILLAR TWO

This is a concept developed at the Organisation for Economic Co-operation and Development (OECD) forum under BEPS 2.0. that introduces global minimum tax. Its main objective is to introduce a top-up tax so that the effective tax rate on a group in any country is not lower than 15%.

This tax will apply to MNEs with consolidated revenues of more than 750 million euro. Within the EU, both MNEs and large-scale domestic groups - operating within one country - will be subject to the tax.

The tax will be calculated in three stages:

calculation of the tax base: qualifying income or qualifying loss,
determination of the amount of covered taxes in a jurisdiction,
calculation of the effective tax rate in the jurisdiction.

The directive implementing the principles of Pillar Two – Council Directive (EU) 2022/2523 – entered into force on 1 January 2024. In Poland, the laws transposing Directive 2022/2523 are planned to come into force on 1 January 2025.

BEFIT package

The goal of the BEFIT (Business in Europe: Framework for Income Taxation) package is to harmonise, in correspondence with Pillar Two, at the EU level:

taxation of corporate groups,
transfer pricing regulations and the approach to determining the arm’s length nature of transactions.

The package comprises two directives:

BEFIT Directive (draft published on 12 September 2023 – planned entry into force on 1 July 2028),
TP Directive (draft published on 12 September 2023 – scheduled to enter into force on 1 January 2026).

BEFIT Directive

The directive corresponds to the objectives of Pillar Two and introduces a single mechanism for determining the tax base. The mechanism will apply to three types of groups:

Union groups – a group of entities with a parent based in the EU with consolidated revenues of more than 750 million euro. An associated enterprise belongs to a group if the parent holds at least 75% of shares in it;
multinational groups – a group of entities with a parent based outside the EU, with consolidated revenue of more than 750 million euro – whereby the total revenue of the EU-based companies must exceed 50 million euro and exceed 5% of the total group revenues. An associated enterprise belongs to a group if the parent holds at least 75% of shares in it;
smaller Union groups – a group of entities with a parent based in the EU, with consolidated revenues of less than 750 million euro, if it prepares consolidated financial statements and is willing to join (voluntary, at the request of the entity). An associated enterprise belongs to a group if the parent holds at least 75% of shares in it.

The tax base will be calculated in the above groups according to a single formula. The tax base calculated in this way will then be consolidated at the EU level so that, in the final step, the Member States can tax their respective cut in the tax base, taking into account local adjustments. The effective tax rate in each Member State will be at least 15%.

The above proposals have shaped the appropriate transfer pricing arrangements. As a consequence of accounting for tax within a BEFIT group, transactions within such a group will automatically be considered at arm’s length. This simplified regime is, however, limited in time and applies to transactions made within the first 7 tax years of the implementation of the BEFIT Directive. In addition, it will not cover all transactions, but only low-risk transactions (covering expenses incurred/revenues earned by the taxpayer on intra-BEFIT group transactions if they have increased by less than 10% compared to the average amount of expenses/revenues in the previous three tax years).

However, the arm’s length treatment of prices does not exempt from transfer pricing documentation obligations in this case. Nonetheless, such exemptions are not ruled out in the future.

Other intra-group transactions will still be at risk of being deemed not at arm's length.

For transactions with associated enterprises from outside the BEFIT group, i.e. non-EU group entities or those that do not meet the 75% ownership threshold, a risk assessment tool will be introduced: a ‘traffic light system’.

Traffic light system

The system will apply to activities carried out by low-risk distributors and contract manufacturers (the BEFIT Directive defines a low-risk distributor and contract manufacturer).

The system relies on a database of public benchmarks to be used for risk assessment and documentation preparation. The choice of benchmark will depend on its relevance to the scope of the transaction being compared. Each benchmark will set an arm’s length level range and an appropriate risk zone will be assigned depending on the percentile in which the performance of a given entity falls.

risk zone	profit performance of the tested party relative to the EU profit markers
low	above 60th percentile of the results of the public benchmark
medium	below 60th percentile but above the 40th percentile of the results of the public benchmark
high	below the 40th percentile of the results of the public benchmark

In the case of low-risk zone the Member States should not dedicate additional compliance resources to further review the taxpayer’s results. However, at the same time, the national administrations retain the right to perform transfer pricing adjustments of the profit margins of the taxpayer that falls within the low-risk zone.

In the case of medium-risk zone the competent authorities of the Member States may monitor the results and contact the taxpayer to seek a better understanding of its circumstances before deciding whether to allocate additional resources to carrying out audits.

For transactions classified as high-risk, the competent authorities of the Member States may recommend that the taxpayer reviews its transfer pricing policies and may decide to initiate a tax audit.

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Marcin Jeliński

Tax adviser (Poland), Licensed appraiser

Associate Partner

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