EU Tax Proposal Aims to Simplify Tax Rules

EU businesses increasingly operate under complex, outdated, or overlapping taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rules that are applied unevenly across Member States, raising compliance costs and weakening the Single Market. The European Commission’s Tax Omnibus proposal would amend six directives on direct taxation to simplify the framework, reduce administrative burdens, and strengthen competitiveness. These are worthwhile objectives, but the proposal should be judged by whether it meaningfully reduces barriers to investment and makes EU tax rules more coherent.

Broader Exemptions Would Support Capital Mobility in the Single Market

Current EU rules are designed to prevent cross-border dividend, interest, and royalty income from being taxed twice. In practice, however, access to relief depends on several conditions, including company form, corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. liability, tax residence, participation thresholds, and beneficial ownership, with different specifics depending on which directive applies. The Tax Omnibus goes beyond simply aligning the requirements in the Parent-Subsidiary Directive and the Interest and Royalties Directive, as it removes the participation requirements and extends the flexibility of eligible company forms. The proposal would also limit administrative barriers to relief. Member States would no longer be able to require ex-ante attestations of eligibility, a change that directly addresses concerns raised in the Tax Omnibus’ call for evidence about the complexity of national exemption and refund procedures.

The potential gains are substantial. According to the European Commission’s impact assessment, eliminating minimum participation requirements and ex-ante administrative procedures could generate annual savings of up to €5.34 billion. These savings would come from three sources: (1) lower direct compliance costs, (2) reduced opportunity costs, when businesses must wait for withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount the employee requests. tax refunds, and (3) tax relief that eligible taxpayers may currently forgo because claiming it is not worth the administrative burden. The Commission also estimates broader economic effects, including a 0.07 percent increase in the capital stock, positive spillovers for employment and wages, and a 0.04 percent increase in GDP.

More Targeted Anti-Abuse Rules Would Reduce Overreach and Compliance Costs

The EU tax framework already contains several layers of anti-abuse rules. Since 2022, these rules have operated alongside the Pillar Two Directive, which implements the global minimum tax by applying a minimum effective tax rate of 15 percent to the largest groups of companies. This has made the interaction between existing anti-avoidance rules and Pillar Two increasingly important. In this context, two of the most relevant Anti-Tax Avoidance Directive (ATAD) measures are the controlled foreign company (CFC) rules and the interest limitation rule, both of which are designed to address base erosion and profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens..

Under the CFC rules, Member States must tax certain undistributed income of foreign subsidiaries when control and low-taxation thresholds are met. Currently, they can choose between two approaches: Model A and Model B. The former attributes the foreign subsidiary’s passive income to the parent company, while the latter attributes the foreign subsidiary’s income arising from non-genuine arrangements designed to obtain a tax advantage to its parent. Both models also provide exclusions for certain taxpayers.

The Tax Omnibus would narrow and simplify the CFC framework. It would remove Model B and make the passive-income model—Model A—the only approach. Furthermore, it would make the option of excluding companies whose passive income accounts for less than one-third of their total income from the scope of the CFC mandatory. It would also add important mandatory exclusions. Companies belonging to small and medium-sized groups, small or medium-sized undertakings, and companies that are part of a group subject to Pillar Two would fall outside the scope of the CFC rules. The Pillar Two exclusion is especially important because it addresses an overlap between rules aimed at tackling similar risks. Without this adjustment, businesses could face double compliance burdens and, in some cases, double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. if a qualified domestic minimum top-up tax is not creditable under a Member State’s CFC rules. Removing that overlap would make the anti-abuse framework more targeted and less burdensome. Previous Tax Foundation Europe analysis has pointed to the value of reforms such as this.

From a legal perspective, a question arises as to whether these changes would be fully binding on Member States. ATAD is a minimum-harmonization directive, meaning Member States can generally adopt stricter rules to protect their tax bases. However, the wording of the Tax Omnibus proposal suggests that the new CFC mandatory exclusions should be implemented by Member States. Curiously, that wording does not cover the one-third of passive income exclusion, nor Model A, making it unclear whether Member States would be obliged to implement those as well. This creates tension between the proposal’s mandatory wording—“the Member States shall”—and its selective clarification that only some changes are mandatory. That uncertainty could undermine the proposal’s goal of simplification and uniformity.

ATAD’s interest limitation rule restricts the deductibility of net borrowing costs to address base erosion through excessive debt financing. Under the current framework, Member States should cap deductions at 30 percent of a taxpayer’s earnings before interest, taxes, depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and disco, and amortization (EBITDA), but they can also adopt stricter limits. The Netherlands and Finland, for example, apply lower thresholds of 24.5 percent and 25 percent, respectively.

The Tax Omnibus would make the 30 percent EBITDA threshold a mandatory standard, preventing Member States from applying lower limits. It would also make most existing options mandatory and add three exclusions. These changes would improve the design of the interest limitation rule by reducing overreach while preserving its anti-abuse purpose. A common 30 percent EBITDA standard would also make the rule more consistent across Member States and reduce compliance costs for cross-border businesses.

From a legal perspective, the proposal appears to make all these changes binding: unlike some of the CFC amendments, it states that Member States should not maintain or introduce rules that conflict with the new standard.

R&D Incentives May Help, but a Broader Cost RecoveryCost recovery refers to how the tax system permits businesses to recover the cost of investments through depreciation or amortization. Depreciation and amortization deductions affect taxable income, effective tax rates, and investment decisions. Would Better Support Competitiveness

The Tax Omnibus proposal would introduce a minimum research and development (R&D) expenditure-based incentive by allowing full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. for certain tangible assets used for R&D purposes.

Generally, capital expenses are depreciated over an asset’s useful life. Tax rules can follow that accounting treatment or provide more favorable cost recovery through accelerated depreciation or immediate expensing. Under full expensing, a company deducts the full cost of an investment in the year it is incurred. This matters because depreciation for tax purposes over time erodes the real value of deductions through inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spendin, the time value of money, and opportunity costs, effectively increasing the tax base. As the Commission’s recommendation for the Clean Industrial Deal recognizes, full expensing is the most favorable form of capital allowanceA capital allowance is the amount of capital investment costs, or money directed towards a company’s long-term growth, a business can deduct each year from its revenue via depreciation. These are also sometimes referred to as depreciation allowances. for the taxpayer.

Tax Foundation has often explained that full expensing is most neutral when it applies to all assets. Limiting it to certain assets can distort investment decisions by encouraging companies to invest in assets that qualify for the benefit rather than those that make the most sense from a market perspective. It can also divert time and resources from productive activity toward qualifying for the incentive, creating deadweight loss in the economy.

The Tax Omnibus proposal would limit full expensing to tangible assets used for R&D. Taxpayers could deduct the full amount of those capital expenses in the year of purchase or within four years. Because this is a minimum level of harmonization, Member States could still provide more generous allowances. As with the extended withholding tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax., the European Commission estimates that the measure would reduce corporate income tax revenues by 1.9 percent, but that this would be almost fully offset over the longer run as the economy would be larger than it would without the policy change. The broader economic benefits include a 0.43 percent increase in the capital stock and a 0.17 percent increase in GDP.

Economically, a broader full expensing rule would be more neutral if it applied to all capital expenditure. In practice, however, both the Commission and Member States must account for Pillar Two when designing the measure. An all-encompassing rule could partly expose in-scope companies to the recapture rule and, therefore, to a top-up tax, neutralizing the benefits of full expensing. Where Pillar Two allows it, though, the Commission and Member States should be as ambitious as possible and extend the R&D allowance to both tangible and intangible assets used for research and development.

Final Thoughts

Overall, the Tax Omnibus proposal appears to make a meaningful contribution to its objectives of simplification, reduced administrative burdens, and stronger competitiveness. It does so by reducing overlaps between rules, introducing full expensing for specific R&D investments, and broadening access to certain EU benefits. While pro-growth reforms may come at unavoidable short-term revenue trade-offs, this should not prevent Member States from making the leap forward, as the positive macroeconomic benefits resulting from such reforms would likely provide some offsets in the long run. And given the challenges of unanimity, the EU should be as ambitious as possible when pursuing simplified harmonization rules, as making changes later requires renewed consensus among Member States.