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The Formula for Apportionment of Income Among Entities of a Group in the

Common Consolidated Corporate Tax Base of the European Union.

Oswaldo A. Gonzalez

1. Introduction

2. The Apportionment formula

2.1 Scope

2.2 The Sharing Mechanism: A formulary apportionment method.

2.3 Taxable Income

2.4 Taxable year

2.5 Profit generating factors

2.5.1 Labour

2.5.1.1 Scope of the Work Force

2.5.1.2 Cost

2.5.1.3 Location of the work force

2.5.2 Assets

2.5.2.1 Scope

2.5.2.2 Value

2.5.2.3 Location

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2.5.3 Sales

2.5.3.1 Scope of sales

2.5.3.2 Value

2.5.3.3 Location

2.6 Specific Formulas

2.7 Safeguard Clause

3. Conclusions.

1. Introduction

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The main purpose of this paper is to present a clear and concise explanation of the

apportionment formula that would be applied to the common consolidated corporate tax

base (CCCTB) within the EU under the current work of the European Commission and

its Working Group on CCCTB. This paper describes the main features and elements that

conforms the formula, comments the different approaches among the EU Member States,

and quotes variables on the formula for other specific economic sectors.

2. The Apportionment Formula

The possible elements of a mechanism to share the Common Consolidated Corporate Tax

Base (CCCTB) has been discussed intensely by the EU Commission Working Group, and

especially by a subgroup set up in December 2006 to analyze more closely the issue. The

result of those discussions and studies was condensed in the CCCTB Working Paper 0601,

which serves as a base for purposes of this paper. Nevertheless, the above mentioned

document is neither a definitive proposition nor a comprehensive answer to the formulary

apportionment mechanism.

2.1 Scope

The scope of the mechanism involves the same rules for sharing the tax base among the

1 Common Consolidated Corporate Tax Base Working Group (CCCTB WG). CCCT:

Possible elements of the sharing mechanism. Working Document CCCTB/WP060.

Brussels, November 13 2007.

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consolidated group including a single resident entity with Permanent Establishments

within the Community, non-EU-resident entities with subsidiaries or PEs in the EU, and

the possible combinations of consolidated groups. The mechanism would be also

applicable in a purely domestic situation to determine the exact amount of the

apportioned tax base of each of the member of a domestic consolidated group.

2.2 The Sharing Mechanism: A formulary apportionment method.

The Commission Services considers that “the sharing mechanism itself is not the purpose

of the comprehensive tax reform, but a necessary and unavoidable consequence of the

consolidation”2. Therefore, the mechanism should be easy for the taxpayer to apply, easy

to audit for the tax administrations, difficult to manipulate for taxpayers, fair and

equitable to distribute the tax base among the various entities concerned, and neutral in

terms of tax competition.

Under those principles, the CCCTB WG discussed several methods to share the tax base

including a particular macro-based approach, and two micro-based approaches: a Value

Added method and the formulary apportionment methods. The macro-based factors

observe overall economic ratios as GDP or sector ratios, eliminating the possibility for

manipulation and tax planning. However, those factor disregard the actual economic

performance of the enterprises in a given member state.3 The formulary apportionment

2 See Working Document CCCTB/WP060 pg. 5

3 Spengel Christoph. Concept and Necessity of a Common Tax Base-an academic

introduction. In: A Common Consolidated Corporate Tax Base for Europe. Springer.

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approach was finally selected after several discussions.4 Under that mechanism the shares

of the consolidated tax base are distributed to the various entities of the consolidated

group on the basis of several factors that contributed to the generation of profits of each

individual taxpayer. Those factors involve both the supply and the demand side of the

economic activities. Factors related to production/supply are labour and capital,

meanwhile the demand side is represented by the sales factor. Recognizing the political

implication of the weighting of the factors, those three factors are assumedly weighted in

equal proportions by the Working Group. 5

The Working Group considers that the application of the formula should be uniform

across all Member States without domestic variations. However, there could be a set of

variations to the standard formula for specific economic sectors. 6 There is a consensus

over the entity based apportionment rather than member state based apportionment due to

Berlin 2008.Pg. 42.

4 CCCTB/WP/052 in

http://ec.europa.eu/taxation_customs/taxation/company_tax/common_tax_base/

article_3831_en.htm

5 The discussion about the weighting of each of the factor is not over, and some analysts

argued that the Commission’s Proposal “will leave to the member states the decision on

how to weight each of these factors”. Aujean Michel cited by Weiner Joann. Aujean

Maintains Support for CCCTB. Tax Notes International. October 06, 2008. Pg. 15-16.

6 Discussion on specials rules for the financial sector in CCCTB/WP/68 Brussels July

02 2008.

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the need of certainty in terms of preexisting loses and tax credits to be offset by the

entities

2.3 Taxable Income

In terms of taxable income, the Commission supports the idea of including all taxable

income earned by the group in a consolidated income pool to which the formula should

be applied in order to apportion the share of the tax base of each individual entity of the

group. There is a position that supports the idea of distinguishing between “business

income” as income earned in the ordinary course of business and “non business income”

as business arising from interest, royalties and dividends. In the latter approach, the

business income is to be shared following the formula results and the non business

income is allocated directly to the member state of source. In the view of the WG official

position, the distinction would increase the complexity of the system and create room for

profit shifting.

2.4 Taxable year

It seems to be a consensus over an annual period for computing the common consolidated

tax base. Therefore, in any given year when the result is positive or a net profit, the

allocation would be made for that year. Nonetheless, any negative result or net loss would

be carried forward to be offset against future consolidated profits at the group level. With

respect of entities entering and leaving the group, the future proposal would include rules

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for splituing the tax period in two parts and applying consolidation and sharing for one of

those periods.

2.5 Profit generating factors

2.5.1 Labour

The proposal featured by the CCCTB Working Group supports the idea of including as

elements of the labour factor the payroll and the number of employees of the entity which

are weighted equally. Once determined, a comparison is made between the elements

attributable to that entity and those attributable to the entire group.

In order to determine the two elements that constitute the Labour factor, the proposal

would include three main features: scope of the work force, the cost and the location.

2.5.1.1 Scope of the Work Force

The work force of a given entity would include all personnel employed, even managers

and directors. The definition of employee should be referred to the national law of the

member country where the activity is performed. The performance of services directly

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related to the activity of the entity is the distinctive criteria to identify the scope of the

work force. Then, interim or temporary personnel should be included into the scope and

ordinary employees that perform services to unrelated parties should be excluded. In case

of intergroup rendering of services, the Commission criteria would assign the labour cost

to the entity where the services are rendered.

2.5.1.2 Cost

The cost element includible in the formula is defined by the amount currently deductible

as expense for remuneration of the work force including fringe benefits, social

contributions and stock options. Despite discussing the convenience of introducing rules

for adjustment based on the different levels of wages among member states, the Work

Group took the position of excluding those adjustments.

2.5.1.3 Location of the work force

This feature is determined by the place where the services were rendered which in most

cases is the same place of location of the entity. In cases when the services are performed

by an employee of one entity in another entity, the allocation rule directs the payment to

the destination place. In order to alleviate the compliance cost, the proposal would

include a kind of “de minimis” rule to considerate the reallocation of the cost and the

number of employees.

In a later meeting, the Working Group recognize concern about including the number of

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staff members as a factor. This concern is sustained firstly by the fact that economic value

is measured in terms of monetary value and not in terms of number of items. Secondly,

this approach would suggest the inclusion of the number of assets as a part of the factor

as well. Nevertheless, the original position of the Working Group seems not to be

changed.7

2.5.2 Assets

This factor is calculated upon the comparison between the value of the qualifying assets

attributable to an given entity and the value of the qualifying assets of the consolidated

group. Similarly to the labour factor, there are three elements to be determined in order to

calculate the factor: scope, value and location.

2.5.2.1 Scope

Only fixed tangible assets would be included in this calculus. From the point of view of

the European Commission, intangibles and financial assets should be excluded from the

formula. In the case of intangibles8, the exclusion has been explained by reasons of

7 Common Consolidated Corporate Tax Base Working Group (CCCTB WG). Summary

Record of the Meeting of the Common Consolidated Tax Base Working Group. Working

Document CCCTB/WP063. Brussels, March 04 2008. Pg. 6.

8 Experts like Prof. Spengel argued that self-created intangibles should be included in

capital, measured by the labor cost of creating them. Therefore, the respective royalties

should be included in allocable business income. Shepard Lee, EU Tax Commissioner

Puts CCCTB Proposal on Hold. Taxanalyst. Doc 2008-18921.

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difficulties and complexity of valuating methods, especially for self-generated intangible

assets, uncertainty of the location of the intangible, and the possibility for tax planning

through tax free transfers. With respect to financial assets, arguments of mobility and tax-

base shifting practices have been mentioned in order to deny that inclusion. Nonetheless,

the Working Group has been studying special rules applicable only to permit the

inclusion of that kind of assets in the case of financial institutions.

Due to reasons of mobility and easy manipulation, the proposal would not include

inventory within the determination of the assets factor.

2.5.2.2 Value

The EU Commission Work Group has considered that the existing valuation method that

reflects most closely the market value of assets is the tax written down value which takes

the tax depreciation out of the historical cost of the assets. This method is supported on

the idea of taking the tax written down value of individual assets from the calculations

prepared for the tax base of the entity. With respect of pooled assets, the tax written down

value of the pool at the end of the year is used for purposes of determining the factor. In

the released paper9, there is no determination on whether to choose for the year-end tax

written down value or an annual average value of the tax written down value of the assets

due arguments of simplicity versus equity in the treatment of fluctuation or transfers of

assets.

2.5.2.3 Location

9 See CCCTB/WP060 pg.10.

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The general rule would link the location of assets to the entity which is effectively using

the assets. Despite being located to the effective ownership of the assets in most of the

cases, sometimes there could be intergroup leased/rented assets which are depreciated by

an entity and effectively used by another. In this case, the rule would be the place of use.

Off course, this rule would not be applicable on leases between non related parties.

With respect to transfer of assets, the Working Group recognizes that even when no

taxation arises from transfers between members of the group, (without modification of

the consolidated base) the apportionment results would be affected because the location

of the assets determines the entitie’s share on the consolidated tax base, leaving room for

tax planning techniques. For that reason, the design of an anti-avoidance rule would

reassign the asset to the entity that first owned the asset in a higher tax member state.

2.5.3 Sales

The inclusion of this factor in the formulary apportionment has been defended not only

with economic arguments as mentioned above, but also in the current experience of the

apportionment systems of the US and Canada.

As noted by the CCCTB Working Group,10 the most controversial issue during the

discussion was the sales factor as a part of the formulary apportionment. Most of the

member states experts would prefer the concept of sales by origin which observes only

10 See CCCTB/WP060 pg.12. Par. 44.

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the place where the goods are shipped. Despite its popularity, the Commission considers

this concept as a weak indicator of the generation of income because it plays the same

roll that the other two factors explained above, disregards the effect of the contribution of

intermediate inputs to the generation of income, and could be easily manipulated through

changes of the place of shipment.

On the other hand, the EU Commission prefers the sales by destination concept because

of having an economic argument that involves the demand side in the generation of

income, representing a lower risk of factor shifting due to the presence of transport costs

and decrease of the profit margins, and the impossibility to manipulate the location of

customers. In order to reflect the total final outcome of the group, the Working Paper

emphasizes the exclusion of intra-group sales factor.

Accordingly with the other two factors, the value of the qualifying sales of an entity

should be compared to the sales of the consolidated group in order to define the factor.

Thus, the three elements should be determined: scope, value and location

2.5.3.1 Scope of sales

It is clear from the Working Paper11 that the scope of sales to be included in the formula

regards only the proceeds of sales and rendering of services that constitute the core

business of a given entity. On the other hand, exempt income, extraordinary income and

passive income should be excluded from the factor. Nevertheless, there is room for

11 See CCCTB/WP060 pg.13. Par. 50.

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exceptions in the case of passive income accrued in the ordinary business of the entity.

2.5.3.2 Value

Under the Working Group paper,12 the value of sales would depends on the monetary

consideration of the relevant transaction, such as the price of goods, or services, and the

market price where the consideration for the transaction is non monetary.

2.5.3.3 Location

Following the principle of sales destination, the attribution of sales is made to the entity

which is located in the country of final identifiable physical delivery. As noted before, as

long as intra-group sales are excluded from the formula, transfer pricing issues would not

arise. In order to simplify the determination of the location of sales, the existing VAT

rules have been analyzed as a starting point.

With respect to immovable property, the EU Commission would consider allocating the

sale in the Member State where the property is located. In the case of services related to

immovable property, the same rule would apply and the service would be located in the

Member State where the immovable property is located.

On the other hand, under the principle of sales destination, the sales of movable property

would be located in the Member State where the good are physically delivered. From the

12 See CCCTB/WP060 pg.13. Par. 52 and CCCTB/WP057 pg. 13. Par 43.

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standpoint of the Commission, the concept of effective place of delivery would reduce

the possibility of manipulation inherent in other nominal indicators such as the billing

address. Accordingly, the supply of other services could be located in the Member State

where the services are rendered or where the consumer is resident.

The Commission Work Group gives consideration to the fact that in some cases when the

sale occurs in a Member State or a third country where the group does not have presence,

(Subsidiary or PE) the sales could be apportioned among the group proportionally to the

other factors. This solution, called the “spread throw-back rule”, has been subject to

criticism13 because it can lead to results similar to the sales by origin approach.

In contrast, a different solution has been analyzed with respect to cases of no substantial

presence of the group in a given country (no-where sales). This is the apportionment

based on the presence of at least one of the three factors that establishes an economic

nexus in a given jurisdiction. However, the Commission Working Group prefers an

apportionment based on a physical presence in a Member State and the throw back rule.

2.6 Specific Formulas

The importance of designing special rules for the formulary apportionment of the tax

base for several economic sectors has been recognized by the Commission Working

Group as the latest development of the entire project. Thus, special formulae would be

13 See CCCTB/WP060 pg.14. Par. 59

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drafted for financial services, transportation services and television and broadcasting

services. Actually, the 13th meeting of the Working Group held in Brussels on April 13-

15 2008 had as one of the central items on the agenda the discussion of the tax base rules

and the sharing mechanism for the financial sector.14 However, describing the main

features of those special rules is out of the scope of this paper.

2.7 Safeguard Clause

Notwithstanding the voluntary adoption of the CCCTB for related taxpayers, the Working

Group suggested a safeguard provision15 that would allow a specific company to request

an authorization from the tax administration or administrations to use an alternative

method to share the base, but, without applying separate accounting and arm’s length

pricing.

14 See CCCTB/WP068 pg.5-7

15 The inclusion of the safeguard clause has been strongly recommended by the US an

Canadian Tax Administrations. See CCCTB/WP063. Pg.7.

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3. Conclusions.

Apart of being an example of the highest level of tax harmonization of income tax law

within the European Union, the adoption of a formulary apportion formula to share the

common consolidated income tax base among the EU Member States is probably the

most controversial issue of the whole proposal. The discussion about the determination

and weight of the analyzed formula factors within the EU Commission Working Group

reflect an impressive scenario for analysis of the EU and international tax policy.

Moreover, the definition of the scope, value and location for each of the three factors that

constitute the apportionment formula is not yet over and the future presentation of the

legislative proposal would be subject again to political discussions in times of economic

crisis.

Nevertheless, it can be said that the three factors of the formula denotes common

features:

1. The weigh of the factor on the formula is likely to reflect equality among them.

2. Two of the factors, (Labour and Assets) would be focused on the production/supply

side of the economic equation, thus, reflecting an allocation according to the effective

role of those factors among generating income activities.

3. On the other hand, the demand side of the economic equation would be represented by

the sales factor which influences the apportionment of the common consolidated tax base

by giving reference to the place of market of destination of the sales and services.

4. The proposal would exclude some elements (such as non-business income, intangible

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assets, and financial assets) from the factors in order to achieve simplicity and avoid

opportunities for abuse.

5. The proposal would permit the design of other specific formulas for economic sectors

as financial services, transport services and broadcasting and information activities.

However, those formulas should respect the main features of the basic formula to share

the tax base: without applying arm’s length pricing and separate accounting.