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Reading the EU’s Public CbC Reporting Tea Leaves

Posted on Mar. 11, 2021
[Editor's Note:

This article originally appeared in the February 15, 2021, issue of Tax Notes International.

]

It’s a new year, and Portugal holds the presidency of the Council of the EU, which has a perennial line item on its agenda: public country-by-country reporting.

Portugal is prioritizing public CbC reporting after a year of little attention from its presidency predecessors, Croatia and Germany. Over the years, successive EU Council presidencies have kicked the public CbC reporting can down the road, unable to reach an agreement on one of the EU’s most controversial tax-related proposals. Will the can stop rolling in 2021?

The European Commission is prioritizing public CbC reporting for its 2021 action plan, but that doesn’t mean much if it is unable to get a sufficient number of member states onboard. There are a few developments that could make the proposal more promising. The biggest is that a qualified majority of member states are reportedly poised to support it. This will become clearer after member states discuss the matter on February 25.

The second is that this reported group would presumably support the European Commission’s legal basis for the measure, under article 50(1) of the Treaty on the Functioning of the European Union, which addresses the freedom of establishment and is normally used for company law proposals. It only requires a qualified majority for approval. If passed as a tax measure under article 115 of the TFEU, the proposal would require unanimity. But the proposal currently before lawmakers is based on article 50(1).

The third development is that public pressure on governments and multinationals for tax transparency measures has only heightened during the COVID-19 pandemic.

Of course, anything is possible, particularly in a process that has been hashed and rehashed over nearly five years and at least 19 different working party on company law meetings. Portugal hopes that EU finance ministers at the February 25 meeting will find a resolution. This could open up trilogue negotiations with the European Parliament and commission.

If the EU Council does approve public CbC reporting, that doesn’t mean the debate is over. Assuming the measure is approved, a question worth pondering is whether dissenting states might challenge it before the Court of Justice of the European Union, whose annulment law is growing by the day. The EU Council and commission are in uncharted territory in applying article 50 to a proposal that some dissenting member states and even the EU Council Legal Service maintain is fundamentally a tax measure.

This Time’s the Charm?

A quick refresher: The EU released its public CbC reporting proposal in 2016. Broadly speaking, it seeks to amend an accounting directive, Directive 2013/34/EU regarding disclosure of income tax information by some undertakings and branches. The proposal would require multinationals that do business in the EU to file a public CbC report if their annual worldwide turnover exceeds €750 million. It would require them to disclose their income tax expenses and accruals, revenue from related and unrelated parties, pretax profits, and employee headcount for their affiliated groups. Operations would be broken down by EU member state and aggregated for non-EU operations. The disclosures would also extend to activities in jurisdictions that are on the EU’s list of noncooperative jurisdictions.

If enacted, the proposal will have significant ripple effects. As EU lawmakers have noted, it would be the first time that EU and non-EU businesses operating locally through branches have the same reporting obligations.

The last time the EU Council seriously addressed the issue was in December 2019, after 12 countries rejected the Finnish presidency’s proposal. Finland’s successor, Croatia, didn’t advance the issue. The next presidency, held by Germany, ran from July 2020 to December 2020 and didn’t include public CbC reporting in its agenda — a controversial choice that led some lawmakers and civil society organizations to call the presidency obstructionist, given Germany’s years of opposition to public CbC reporting.

Portugal has revived the Finnish proposal (the compromise proposal). A few things are notable about this version. By all accounts, it has been slightly revised to strengthen the case for why its legal basis should be rooted in article 50(1) TFEU as a corporate reporting measure instead of an article 115 tax measure. The Finnish presidency drafted these changes because it felt they could help clear up concerns about the legal basis of the proposal under article 50(1) TFEU, introduced by the European Commission.

The compromise proposal includes additional language explaining why public CbC reporting is important as a transparency measure, including the following passage in recital 2:

Providing for such scrutiny is also necessary to promote a better informed public debate regarding in particular the level of tax compliance of certain multinational undertakings active in the Union and the impact of this on the real economy. The setting of common rules on corporate income tax transparency will also serve the general economic interest by providing for equivalent safeguards throughout the Union for the protection of investors, creditors and other third parties generally, and thus contributing to regaining the trust of citizens of the Union in the fairness of the national tax systems.

That language frames the reports using a broader environmental, social, and corporate governance lens, and is repeated elsewhere in the proposal. The same paragraph in the first 2016 draft emphasized the benefit that public CbC reporting presents to tax authorities and tax collections.

Earlier language stressed that CbC reports are solely useful for high-level transfer pricing risk assessments. The current proposal does not make those promises. It strikes the following language from the proposal in recital 6(b):

The information in the Country-by-Country Report on its own does not constitute conclusive evidence that transfer prices are or are not appropriate and that information should not be used as a substitute for a detailed transfer pricing analysis of individual transactions and prices based on a full functional analysis and comparability analysis.

Again, the suggestion is meant to move the proposal away from the idea that it will be relied upon for corporate tax compliance.

“The most important thing is that this is not a tax file; it does not concern the taxation of individual companies, nor the tax rate, nor tax paid. It is exclusively about corporate reporting. At its core it is about corporate reporting,” Finnish Minister of Employment Timo Harakka said in 2019.

Also, the compromise proposal seeks to extend a grandfathering rule on sensitive information. Initially, the commission proposed that multinationals could wait four years to release sensitive information. However, the compromise proposal suggests a six-year hold.

Sticking Points

The future is uncertain because there are several bases on which member states can reject the proposal. Aside from the legal basis, some have expressed discontent with the content, while others have expressed discontent with the negotiation forum. Prior discussions have occurred within the Competitiveness Council instead of the Economic and Financial Affairs Council, as some member states preferred. Some countries want the proposal to go a little further, although it doesn’t appear that those preferences are dealbreakers. Lithuania has suggested disaggregated data for the whole world, while the Netherlands has suggested that the council strike a comply-or-explain rule, which would exempt companies from publishing a report if they explain why they cannot.

It’s also unclear how much of an influence Germany poses. Public CbC reporting is a divisive issue among German lawmakers — the government hasn’t taken an official position — and that tension spilled over into its EU presidency, when it did not put the issue before the EU Council despite promising to do so. Some have essentially called the country obstructionist. That said, German Finance Minister Olaf Scholz does support EU-wide public CbC reporting.

The legal basis issue could also leave the proposal vulnerable to an annulment action from any member state. Under article 263(1) of the TFEU, member states can seek an annulment for legislative acts like regulations and directives, as well as acts of the European Council other than recommendations and opinions. The CJEU generally has jurisdiction over actions brought against the EP and the EU Council.

An incorrect legal basis is grounds for an annulment because all legal acts must conform with the EU’s treaties and Charter of Fundamental Rights. Choosing a legal basis is not a discretionary choice; it’s a choice of constitutional importance, based on the EU legal principle of conferral of competences. The EU, as a body, does not have its own competences. It can only act within the competences conferred to it by member states via treaties.

Importantly, member states have the right to bring an action for annulment even if they support a measure during the legislative process. They can approve an act in the EU Council but later raise questions about its legality. They’re not required to have an interest in the case; they can file an action based on legality. We know in the case of public CbC reporting that some countries, like Malta, have said the legal basis combined with the fact that the proposal is being negotiated within the Competitiveness Council instead of the Economic and Financial Affairs Council could create a “dangerous precedent” and enable qualified majority voting on tax matters.

While the EU Council Legal Service says the proposal is a tax matter and can only be adopted with unanimity, the EP’s Committee on Legal Affairs says the fact that taxing authorities can benefit from public CbC reporting doesn’t detract from the fact that the proposal is, at heart, a transparency and disclosure provision.

In a 2017 opinion predating the compromise proposal, the EP legal affairs committee said it’s clear that the aim is to enhance transparency and public scrutiny of corporate income tax and to foster corporate responsibility via disclosure.

“The proposed directive . . . considers that a link exists between transparency and public scrutiny, which are the aims it pursues, and the interests of ‘members and others,’” the opinion said. Why is it important that the proposal apply to the interests of “members and others”? Article 50(2)(g) TFEU gives the legislature the right to coordinate safeguards protecting the interests of members and others. The CJEU has construed “others” broadly (Verband Deutscher Daihatsu-Händler v. Daihatsu Deutschland GmbH, C-97/96 (CJEU 1997)). In the case of public CbC reporting, this would mean that “members and others” includes the public and is not limited to parties directly affected by a multinational’s business or its contractual or pre-contractual partners. In other words, the proposal isn’t meant for taxing authorities alone.

Of course, just because the commission says public CbC reporting is meant to be a transparency measure doesn’t mean that’s how it will be used. The legal opinion says the fact that tax authorities will benefit doesn’t undermine the corporate reporting angle. Beyond that, article 50 does not have a carveout for fiscal provisions, according to the opinion. It remains to be seen whether these arguments will be persuasive.

The Public Trust Argument

It also doesn’t hurt that Portugal is advancing the proposal at a time when some companies are saying it’s too costly to opt out of the public transparency discussion. That’s the conclusion that Vodafone reached a few years ago, prompting it to release public CbC reports. By the company’s accounts, the move has been a success.

For multinationals concerned about how their data may be construed (or misconstrued), public CbC reporting arguably gives them an opportunity to tell their total tax story, particularly if they treat public CbC reporting requirements as a floor. Environmental, social, and governance initiatives like those undertaken by the World Economic Forum and the European Business Tax Forum are focusing on “total tax contribution,” or the idea that companies should share information about all the taxes they collect and remit, not just corporate income taxes. Some companies like Vodafone, Unilever, and BHP Billiton are already doing this on their own. Context is everything, and seeing pure CbC data without clarification doesn’t provide a complete tax picture. A mix of public CbC reporting and total tax contribution could provide the best spread of information for the public and multinationals alike.

Conclusion

In recent years EU-wide public CbC reporting seemed out of reach. The fact that it now appears to be a viable contender underscores just how much dynamics have flipped.

If the EU can make progress on this, it will appear at a time when the EU’s international partners are being confronted with the same issue. The OECD is in the midst of reviewing the base erosion and profit-shifting project’s action 13 on CbC reporting, and while its consultation did not seek input on public CbC reporting, several stakeholders cast it as a natural evolution from current CbC reporting standards and urged the organization to incorporate it.

Some of that feedback came from U.S. Democratic lawmakers, who are pursuing both international and domestic angles. These include Sen. Chris Van Hollen, D-Md., and Rep. Cynthia Axne, D-Iowa. The duo have become dominant transparency voices in Congress and are among 33 senators and representatives who wrote the OECD requesting public CbC disclosures. They’ve also introduced public CbC reporting legislation, including the Disclosure of Tax Havens and Offshoring Act, which would amend the Securities Exchange Act of 1934 by requiring SEC public CbC financial reports.

If experience with the recently passed Corporate Transparency Act is to serve as any sort of guide, Democrats have a long road ahead of them before any of this is actionable. Importantly, they’ll need some bipartisan support. But every measure starts somewhere, and as the EU has shown, fortune can turn on a dime.

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