On 12 September 2023, the European Commission presented a proposal for a Head Office Tax system, or the so-called “HOT system”, for micro, small and medium sized enterprises (”SMEs”).
The purpose of the HOT system is to benefit SMEs operating within the EU, by allowing qualifying SMEs with permanent establishments (PEs) in other EU Member States to calculate their tax liability, including the taxable results of its PE(s), based solely on the tax rules of the Member State where their head office is located. However, the taxable result of a PE would remain subject to the tax rate of the Member State in which the PE is located and would as such not affect the right to determine the applicable tax rate or the applicability of a bilateral tax treaty. This will enable SMEs to file a single tax return with their head office’s tax administration. By streamlining the taxation process for SMEs, the aim is to enhance the competitiveness of the single market and simplify doing business in the EU.
The proposal is structured to cover scope and eligibility requirements of the HOT system, the calculation of PE tax liability at the head office level, and administrative procedures. For eligibility, SMEs must meet certain criteria, and election should apply for periods of five years. The scope of these rules would be limited to standalone SMEs with PEs and would not apply to SME groups with subsidiaries. Therefore, an SME that grows into a group will no longer be entitled to the simplification framework. It would have the possibility to continue to apply for the HOT system, but only up to the end of the five-year election period.
The European Commission intends to initiate a public consultation process on the proposal, allowing stakeholders to provide feedback. The HOT system proposal complements the Business in Europe: Framework for Income Taxation (BEFIT) proposal, which primarily targets larger groups operating in the EU.