In short, CFC rules are meant to include undistributed profits of certain qualifying foreign entities (“controlled foreign corporations” or CFCs) in the tax base of Belgian corporate taxpayers.
Although Belgium already had CFC rules after the implementation of ATAD in 2017 (applicable as from 2019), the scope of these provisions was limited. As a result, they were rarely applied. The legislator has now completely changed the system, significantly increasing the impact on international groups.
Importantly, all groups with an international presence will have to analyze whether their Belgian group corporations participate in foreign subsidiaries that qualify as “potential CFCs”, or whether they (or these foreign subsidiaries) have foreign permanent establishments that qualify as such. This will be the case if the following 2 criteria are met:
- For foreign subsidiaries (and their PEs), a participation of at least 50% in the capital, voting rights or profit of the foreign company has to be held by the Belgian group company, either directly or “together with” associated entities or people.
It is not very clear whether the Belgian company has to hold a direct participation in the subsidiary, or whether an indirect 50% share through the group is sufficient (i.e. through associated entities/people without directly holding a participation). If the tax authorities would take the latter approach, the entire group (including sub-sub-sub-…subsidiaries,…) will have to be reviewed. A herculean task for some groups.
- The foreign PE or subsidiary (or a foreign PE of this subsidiary) is not subject to income tax, or subject to an income tax that is less than half the amount of tax that would have been paid if the PE/subsidiary was located in Belgium.
The country of establishment of the potential CFC is not important, because both entities located within the EU as well as outside the EU can be a CFC based on their effective tax burden. For analyzing whether an entity is a CFC based on the taxation criterion (“less than half the Belgian tax”), the tax base of the foreign PEs/subsidiaries will have to be recalculated annually in accordance with Belgian accounting and corporate income tax rules. This is, of course, a very burdensome calculation, especially if indirect holdings also have to be reviewed (see point above). Minor differences between tax regimes could trigger application of the CFC rules (e.g. slightly more favorable participation exemption rules, different amortization schemes, certain tax credits,…).
If these two criteria are met, the foreign PE or subsidiary qualifies as a CFC. The Belgian company then has the obligation to disclose, without exception, the existence of the CFC in the corporate income tax return.
In addition, there could be a tax impact (unless an exception from this tax impact applies): the undistributed passive income of the directly held CFCs could be allocated to the Belgian company and be included in the Belgian tax base. Passive income is defined very broadly. It not only includes dividends, interest, royalties, capital gains on shares and other securities, but also rental and leasing income, income from financial activities and income from procurement companies. The Belgian company could thus be taxed on income it has not received yet (“dry taxation”). Some rules exist to mitigate the risk of double taxation (i.e. a foreign tax credit, and the application of the participation exemption on later redistribution by, or sale of, the CFC).
Certain specific CFCs are, however, excluded from the tax impact: (i) specific financial entities, (ii) CFCs whose passive income is less than 1/3 of their total income, and (iii) CFCs with an economic activity (“substance”). These exceptions have to be expressly claimed in the tax return. The economic substance exclusion must be supported by personnel, equipment, assets and premises. Moreover, only “the offering of services or goods” seems to be considered an economic activity (potentially to be assessed at group level). This might be a too strict interpretation of “economic activity”.
Conclusion: even if there is no tax impact, for instance because it can be claimed that the foreign group entity has sufficient economic substance, reporting in the corporate income tax return is still required if a group entity qualifies as CFC. Hence, it should be checked annually whether a Belgian group company participates in CFCs. This review requires a burdensome recalculation of the tax base of foreign entities and establishments in accordance with Belgian rules. The analysis already has to be made in the tax return for assessment year 2024 (financial years ending on or after December 31, 2023)!
Cayman tax rules
For Belgian resident individual shareholders of a non-listed corporate group, the situation can be even more dire.
The Belgian cayman tax rules entered into force in 2015, with the objective to “look through” low taxed entities or arrangements, and tax the Belgian individuals directly on income of these entities or arrangements (called “legal constructions”). It applies to several kinds of structures and arrangements.
Foreign companies can also fall within the scope of these rules if they are either not subject to income tax, or subject to an income tax lower than 15% (if located outside the E.E.A.) or 1% (if inside the E.E.A.) of the taxable income calculated in accordance with Belgian tax rules. Again, this requires a burdensome annual recalculation of the tax base. Despite the name, these rules do not only hit exotic structures located in tax havens like the Cayman Islands. European (or other) companies subject to (slightly) more favorable corporate tax rules than the Belgian rules can also be in scope! An analysis, similar to the one under the CFC rules, has to be made.
The December 22, 2023 Law significantly impacted the scope of these cayman tax rules, as discussed in a previous Newsletter. Before, the cayman tax rules only applied when a Belgian individual directly held shares of a low taxed entity. As from 2024, any low taxed entity indirectly held by the private individual can trigger cayman tax irrespective of his/her participation percentage, and even if held indirectly through normally taxed (Belgian or foreign) intermediary entities or structures. This means that the cayman tax can apply for instance if a private individual holds a minority participation in a normally taxed (Belgian or foreign) top holding of a private group, and somewhere down the corporate chain the group holds a participation in a low taxed entity.
Cayman tax could also interfere with CFC rules, e.g. if the corporate group also contains Belgian holding companies, and this Belgian company holds shares in a CFC that also qualifies as a low taxed cayman tax entity (“legal construction”). Although a specific provision should avoid too much overlap between these two rules, double use could still occur in multiple situations.
The new rules also mean that a private individual shareholder should recalculate the tax base of all foreign entities of the group annually in order to know whether one of them qualifies as a “low taxed entity” (see 1% or 15% test above). It goes without saying that this will be burdensome and that there can be a large information deficit. Only if the intermediary entity is listed on a stock exchange or is a qualifying fund structure (“blockers”), the underlying entities must not be analyzed.
If a low taxed entity (“legal construction”) can be identified somewhere in the participation chain, this will have the following consequences:
- Its existence has to be disclosed in the personal income tax return of the Belgian investor.
- The assessment (and thus audit) period for the tax return increases to 10 years.
In addition, the income of the low taxed entity could be directly taxable in the hands of the Belgian individual shareholder as if he earned that income directly (“look-through taxation”). A Belgian individual can therefore be taxable on income of a low taxed entity somewhere down the corporate group, even when that income is not actually distributed to that individual and the individual does not directly hold shares in that entity. Some inadequate rules exist to mitigate double taxation when the income is later streamed up. The effect of these rules remains highly uncertain.
The look-through taxation does not apply if the taxpayer can demonstrate that the entity has economic substance. Like for the CFC rules, the Law and its preparatory works seem to interpret this notion quite strictly. This “substance exclusion” should also be claimed in the personal income tax return.
Conclusion: even if there is no immediate tax impact for instance because the “substance exclusion” is claimed, the Belgian individual shareholder still has to report the existence of low taxed cayman tax entities somewhere in the corporate group in his/her tax return. This means that individuals will have to check annually whether they hold shares of corporate groups “containing” low taxed entities.
We can obviously help to verify whether there are any CFCs and/or low taxed cayman tax entities within the group and analyze the effect of these rules.
For more information, do not hesitate to contact the Tiberghien Tax Team.