By Ivan Dimitrov
Important tax changes were introduced in Bulgarian last week, including first-ever controlled foreign company (CFC) rules and update to Bulgaria’s thin capitalization regime which differs significantly from a previously circulated draft version.
The corporate income tax amendments were published November 27, along with other tax laws and new rules aimed fighting practices that affect the functioning of the internal market.
Bulgaria thin cap update
The amendments introduce new Art. 43a CITA, which implements EU Council Directive 2016/1164.
The Bulgarian amendments follow the directive’s “interest-to-profit approach” and provide that any excess borrowing costs shall be deductible in the tax period in which they incurred only up to 30 percent of the taxpayer’s earnings before EBITDA.
The new rule allows the taxpayers to carry forward, without time limitation, the excess borrowing costs.
The new article provides that the 30 percent limitation will be applicable if the sum of the borrowing expenses exceeds EUR 3,000,000 (approx. USD 3,407,000). This threshold reproduces the upper limit of the directive above which the new rule is mandatory and excludes small business enterprises from the scope of the provisions.
Current Article 43 CITA is also retained and aligned with the new rules, allowing carry forward without time limitation, and under specific conditions, allowing deduction of excess borrowing costs.
This update abandons the previous restraint of 5-year limitation for carrying forward the interest costs.
Introducing Bulgaria’s first CFC provisions
The other major update is the introduction of CFC rules, which aim to combat the diversion of income by resident taxpayers to companies they control and which are resident in countries imposing low or no taxation.
Under the new measure, upon falling within the definition of a CFC, the undistributed taxable profit of the taxpayer’s controlled foreign entities and permanent establishments (PEs) will be subject to tax in Bulgaria.
The law deems ‘control’ over a foreign company or PE to exist if the taxpayer holds directly or indirectly more than 50 percent of the voting rights, ownership, or entitlement to receive more than 50 percent of the entity’s profits.
Following the EU directive, the CFC rules will not be applicable where the controlled company carries on “substantive economic activity” supported by staff, equipment, assets, and premises.
One step back
The CFC rules were broadly discussed in Bulgaria.
The new rules are largely the expected result of the implementation of the directive’s CFC rules. A significant exception, however, is controversial paragraph 4 of Art. 47c CITA, which differs from the initial draft.
The final version of the new law provides that the CFC rules will not apply if the CFC is not subject to corporate taxation on profits in its residence country.
This results in an exclusion of the profits of CFCs and PEs which are residents in tax havens and which are not levied to taxation.
The final rules thus significantly narrow the scope of the CFC rules as compared to the draft, and, one may say, take one step back as distinguished from the principles laid down in the directive.
However, it is a matter of time to see whether the introduced changes will contribute to the protection against aggressive tax planning in the internal EU market.
The above mentioned CFC and thin capitalization rules will take effect as of 1 of January 2019.
Other measures against aggressive tax planning
Like the initial draft, the final law does not include other provisions required by EU law to be implemented into local legislation.
The EU directive provided the opportunity to postpone the transposition of some rules to the extent provided by the European Counsel.
For example, EU implementation of so-called “exit taxation,” which settles the taxation, under certain conditions, of transfer of assets/business from one Member State to another is postponed until the end of 2019.
Also deferred are rules that neutralize the effect of hybrid mismatch arrangements, i.e., arrangements exploiting a difference in the tax treatment of an entity or instrument under different countries’ laws that result in lowering the aggregate tax burden of the contracting parties.
The uncertain political will in the EU for adoption of all measures under the mentioned directive leaves space for dialog on implementation of the mentioned provisions.
– Ivan Dimitrov is in-house legal counsel at an international payroll and accounting company based in Bulgaria and can be contacted at [email protected].
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