Belgium's federal government has adopted new rules governing the taxation of the non-distributed profits of a controlled foreign company (CFC). The reform represents a shift from Model B (transactional approach) to Model A (entity approach) of the EU Anti-Tax Avoidance Directive (ATAD). The new rules are applicable as from assessment year 2024, applying to financial years ending on or after 31 December 2023.

The previous CFC regime, in effect since assessment year 2020, aimed to tax undistributed profits from controlled low-taxed subsidiaries or branches resulting from an artificial arrangement or a series of arrangements set up with the essential purpose to obtain a tax benefit. For this approach to apply, the significant people functions generating the CFC's income had to be based in Belgium. The new rules mainly focus on taxing the passive profits of a CFC that is directly owned by the Belgian controlling company and is subject to low taxation abroad, unless the CFC has sufficient economic substance.

To assess whether a portion of the profit of a foreign company should be included in the taxable basis of the Belgian controlling company, one must first determine whether the foreign company qualifies as a CFC. Subsequently, one must assess whether the CFC is eligible for an applicable safe harbor. If that is the case, its profits are not to be included in the taxable basis of the Belgian controlling company. If no safe harbor applies, the amount of the CFC's undistributed profit to be included in the taxable basis of the Belgian controlling company should be computed.

Identifying a CFC

A foreign company qualifies as a CFC if both the participation and taxation conditions are met.

• The participation condition is met when a Belgian company, either on a standalone basis or together with its associated companies, (i) has the majority of voting rights on all shares, (ii) holds at least 50% of the capital, or (iii) is entitled to at least 50% of the profits of a foreign company. A foreign Permanent Establishment (PE) automatically satisfies this condition. As the test is to be applied at the group level and the rights of "associated companies" must be considered, one can infer that a company that is only 10% owned by a Belgian company qualifies as a CFC because at least 40% is held by other associated companies. This is an important change and broader than under the previous legislation.
• The taxation condition is met for a foreign company or PE that is either (i) not subject to income tax or (ii) is subject to income tax that amounts to less than half of the Belgian corporate income tax that would have been due if the foreign company or PE had been established in Belgium. This condition is presumed to be met by entities established in jurisdictions listed as tax havens by the European Union or Belgium, although this presumption is rebuttable.

Safe harbors

Even if an entity qualifies as a CFC, the new legislation provides three safe harbors, available at the level of the Belgian controlling company, for certain foreign profits. Specifically, the CFC income inclusion should not be applied if:

• The Belgian controlling company provides evidence that the CFC is carrying out a substantial economic activity, supported by personnel, equipment, assets and buildings defined as "the offering of goods or services on a particular market." In this regard, the Memorandum of Understanding clarifies that the offering of intercompany services does not meet this definition, unless respective transactions are carried out at arm's length.
• Less than one-third of the CFC's total income originates from so-called "passive income."
• The CFC is a regulated financial institution to which the earnings before interest, taxes, depreciation and amortization (EBITDA) interest deduction limitation does not apply and for which one-third or less of total income is derived from transactions with the Belgian controlling company or entities associated with it.

Taxation of undistributed passive profits

Unless one of the safe harbors applies, certain passive non-distributed CFC profits shall be included in the taxable basis of the Belgian controlling company in relation to its direct participation in the CFC.

Four steps must be considered to determine the amount of the CFC's profits that will be included in the Belgian taxable basis:

1. Calculate the profit of the CFC based on Belgian accounting and tax rules as if the CFC were located in Belgium.
2. Limit the profits in proportion to the profits that are not distributed.
3. Limit the profits in proportion to the CFC's passive income.
4. Allocate the CFC's profits in proportion to the highest of the Belgian company's (a) direct voting rights, (b) direct ownership rights in the share capital and (c) rights to the profits of the CFC.

The methodical calculation of the profits that may need to be included as CFC income according to Belgian accounting and tax rules is likely to be quite complicated and may lead to inclusion of income that is not recorded as income in the CFC's financial statements following the "Belgian" calculation. A detailed calculation, understanding and assessment of the rules and definitions is advised to properly understand the potential impact.

An important change from the previous CFC rules is thus that only direct participations and direct branches (as well as branches from a direct participation) are envisaged now; the previous CFC rules also targeted indirect participations and branches where the Belgian controlling company did not hold any direct stake. The application only to "direct participations" is less stringent than the provisions of ATAD. The Belgian legislature opted to apply the CFC income inclusion to direct participation to avoid inclusion at different levels.

Passive income is broadly defined and includes income from interests, royalties, dividends, income from disposal of shares, income from rental and leasing, certain financial activities, and even income from the purchase and sale of goods and services to which the CFC adds little or no economic value.

Note for instance that intermediate passive holding companies may therefore trigger CFC inclusion in the hands of the Belgian controlling shareholding when they receive dividends from companies that would not qualify for the Belgian participation regime.

Avoiding double taxation

The new rules foresee three ways in which double taxation can be avoided:

1. Unlike the previous rules, the new rules provide a carryforward nonrefundable foreign tax credit (FTC). This FTC, determined by certain foreign income tax paid by the CFC (on its profits), can be proportionally set off against the Belgian corporate income tax due on the CFC's profits.
2. Upon a profit distribution of the CFC, the old rule is maintained; i.e., the Dividend Received Deduction regime (the Belgian implementation of the participation exemption) can be applied to the extent that the Belgian controlling company demonstrates that these profits have already been included in the taxable basis under the CFC rules in a prior tax year in the hands of the Belgian company.
3. As for capital gains realized on a disposal of a participation in a CFC, double taxation can be avoided through a specific capital gain exemption provided that:

• The profits have already been included in the taxable basis under the CFC rules in a prior tax year in the hands of the Belgian controlling company.
• These profits have not yet been distributed.
• At the time of the disposal, these profits still existed on a separate liability account of the balance sheet.
• The taxable amount of the capital gain exceeds the total impairments previously assumed on the disposed shares, minus the already-taxed portion of those impairments.
• A specific anti-abuse rule with respect to the change in ownership is not triggered.

Reporting obligation

Belgian companies are required to disclose the existence of a CFC in their corporate income tax return. This disclosure requirement becomes effective as soon as both the participation and taxation condition have been met, even if no CFC profit is actually included in the Belgian taxable basis.

Implications for businesses

The new CFC rules shift the focus from income generated as a result of artificial arrangements to passive income that a CFC generated without sufficient economic substance, resulting in a broader scope of application. Note that the assessment on sufficient economic substance will be essential for the new rules and the expectation is that the Belgian tax authorities will scrutinize the economic substance.

Direct minority shareholdings in a CFC may lead to a proportionate CFC income inclusion if the CFC is controlled together with other associated entities for more than 50%. On the other hand, the CFC income inclusion can now only apply to direct participations. The newly created FTC possibility also lowers the double-taxation risk. Considering the complexity of the rules, the broad reporting obligation and the specific "Belgian" calculation requirements, a proactive approach is highly recommended as the rules apply as from assessment year 2024. The interaction with the Pillar Two rules should also be closely monitored for the in-scope Multinational Enterprises.