New tax regime for taxation of non-distributed income of low-taxed CFCs

The program-law dated 22 December 2023 has radically changed the Belgian Controlled Foreign Company (“CFC”) regime. In this newsletter, we summarize the main characteristics of the new regime – which is likely to have an important impact on multinational groups present in Belgium. 

1. Background

The Anti-Tax Avoidance Directive of 12 July 2016 (“ATAD”) obliged Member States to implement a CFC regime, the objective of which is to tax non-distributed profits of low-taxed controlled subsidiaries in the hands of their parent company. 

ATAD provides two versions of the CFC regime: Model B targets income of a CFC “arising from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage”, whereas Model A targets “passive income” derived by a CFC. 

In 2017, Belgium opted for Model B of the CFC rule. Belgium has now switched to Model A. 

2. What is a CFC? 

A  foreign entity (i.e. foreign company, foreign permanent establishment of a Belgian company or foreign permanent establishment of a foreign company) qualifies as a CFC if it meets the participation and taxation conditions.

2.1 Participation condition:

This condition is met if the Belgian company and/or its associated entities, holds a participation of at least 50% in the foreign entity (in the form of capital, voting rights, or profit-sharing rights). 

An associated entity refers to an individual, a legal person or an entity without legal personality which, directly or indirectly, either holds in the taxpayer or in which the taxpayer holds a participation of at least 25% (in the form of capital, voting rights, or profit-sharing rights).

2.2 Taxation condition: 

This condition is met if the CFC is subject to an income tax in its jurisdiction which amounts to less than 50% of the income tax which would have been due in Belgium in accordance with the Belgian income tax rules. In determining the “equivalent” income tax, one can apply the tax deductions available in Belgium.

The taxation condition is presumed to be met if the CFC is established in one of the countries (e.g. Russia, Bahamas, Panama, etc.) listed on the EU list of non-cooperative jurisdictions or on the Belgian list of tax heavens (Article 307, § 1/2, ITC). 

In practice, the taxation condition may be met even by entities established in “non-suspicious” countries (e.g. France, United States, Luxembourg, etc.) but which benefit from a favourable tax rule that is not available in Belgium in similar circumstances (e.g. a tax integration/consolidation regime, an exemption from taxation of a specific category of income; accelerated depreciation of certain assets; a dividend received deduction with lower thresholds or different taxation conditions than those applied by Belgium, transparency mismatches for participations, deductibility of capital losses on shares, etc.).

3. Exceptions to the CFC rule

The CFC rule does not apply (i.e. no taxation in the hands of the Belgian company) in three cases:

• Substance carve-out: this exception applies if the CFC carries on a substantive economic activity supported by staff, equipment, assets and premises, as evidenced by relevant facts and circumstances. Carrying on an economic activity is defined as the offering of goods and services on a certain market. According to the preparatory works, intra-group services do not qualify as an economic activity as long as they are not offered on arm’s length terms. The compatibility of this definition with the freedom of establishment and the related case law of the ECJ on tax abuse is questionable;
• Financial undertakings: this exception applies if (i) the CFC qualifies as a financial undertaking within the meaning of Article 198/1, § 6, 1° to 12° ITC (i.e. same list as for the EBITDA interest limitation rule which includes credit institutions, insurance companies, UCITS and AIFs, certain pension funds, etc.), and (ii) a third or less of its profits derive from transactions with the Belgian company or its associated enterprises; and,
• One-third or less of passive income: less than one-third of the income of the CFC qualifies as passive income.

4. How is the income of the CFC attributed to its Belgian parent company? 

The profits of the CFC profits are calculated as if the CFC were tax resident in Belgium. Only profits realised during a taxable period that ended during the Belgian company's taxable period are taken into account. Profits realised by the CFC through permanent establishments in countries with which the CFC jurisdiction has concluded a Double Tax Treaty are not taken into account (but the permanent establishment itself can qualify as a CFC).

Taxation of the CFC profits in the hands of the Belgian company is then limited by application of the following three pro rata rules. 

• Undistributed income: only undistributed profits of the CFC can be taxed in the hands of the Belgian company.
• Passive income: only passive income can be taxed in the hands of the Belgian company, which is broadly defined as:
  • interest and similar income (including income assimilated to interest by the Royal Decree implementing the ITC in the framework of the EBITDA interest limitation rule);
  • dividends and other income from the disposal of shares, bonds, options and similar securities;
  • income from intellectual property;
  • income from rent, or from operational or financial leasing;
  • income from financial activities (asset management, investment, insurance, banking, etc.); and
  • income from sale of goods or service to which little to no added value is provided by the CFC.
• Direct participation of the Belgian company in the CFC: the profits to be included in the tax base shall be calculated in proportion to the Belgian company’s direct participation in the CFC (based on the highest participation between voting rights, capital and profits entitlement).

5. Avoidance of double taxation

Foreign income taxes paid by the CFC on its profits may be offset proportionally against the Belgian corporate income tax due on the CFC's income. Foreign income taxes include taxes paid in advance by the CFC, but not tax increases or other administrative fines or penalties. Any foreign tax credit that cannot be used in the year in which the CFC income is included in the tax base can be carried forward.

Profit distributions by the CFC in a subsequent assessment year are exempt in Belgium if those profits have already been taxed under the CFC rules in a previous assessment year. A similar rule applies to the capital gains on shares in the CFC.

6. Obligation to declare CFCs in the corporate income tax return

Belgian companies have to declare the existence of each CFC in their corporate income tax return. Based upon a literal reading, also CFCs in which the Belgian company does not hold a direct participation must be reported.

For each CFC, the following information must be provided (i) the name, (ii) the address of the seat of management or administration, (iii) the identification number of this company, (iv) the percentage of the Belgian company's participation in the CFC (capital, voting rights or rights to profit distribution), and (v) which exemption, if any, applies.

7. Interplay with the new Cayman tax regime

In non-listed company groups with Belgian individual shareholders, depending on the exact facts of each case, entities qualifying as CFCs may also qualify as a legal construction for Cayman tax purposes. The CFC rules have precedence over the Cayman tax rules. Companies should therefore pay attention to the fact that certain measures aimed at avoiding the application of the CFC rules (e.g. dividend distribution, use of indirect subsidiaries, etc.) may end up triggering the application of the Cayman tax regime for their ultimate Belgian individual shareholders, at a higher rate. 

8. Interplay with the global minimum tax (Pillar II)

CFC taxes paid in Belgium should generally be pushed down as “covered taxes” to the level of the CFC for purposes of the global minimum tax calculation. 

9. Entry into force

The new CFC rules have entered into force from assessment year 2024 and onwards. Therefore, they already apply to income year 2023. 

10. Next steps

Through advising clients, we have seen that the CFC rules can apply in the most unexpected circumstances, also in an EU context. This is often due to technical mismatches between the Belgian and foreign tax rules (see section 2.2 for examples). A review of your group structure, focusing on a number of key features and entities, is therefore recommended.