Head Office Tax system (HOT) – simplifying cross-border taxation for SMEs

Introduction

The Head Office Tax System for micro, small and medium sized enterprises (HOT) issued on 12 September is a Directive proposed by the European Commission to encourage cross-border expansion of SMEs. HOT’s purpose is to reduce the tax related administrative burden SMEs face when they open permanent establishments[1] in other Member States. Accountants should be aware of this proposal to consider the impact for their SME clients.

This webpage provides a high-level summary of the main provisions. For more details please refer to proposed Directive full text.

HOT is a proposed Directive, all provisions and timelines are therefore subject to change during the legislative process.

HOT proposal’s key features

What are the benefits?

The proposals concern corporate income tax exclusively (or its equivalents). They aim to simplify the tax calculations and filing requirements for SMEs that operate in other Member States through permanent establishments.

Once an SME has joined the system, it will only be obliged to report and pay the corporate income tax in respect of the profits of the Head Office and all permanent establishments to the Member State in which the Head Office is located.

The impact assessment indicates that this would help reduce cost in corporate income tax compliance by 32%. This amounts to a maximum total saving for SMEs across the EU of €3.4 billion per year.

What can SMEs expect from HOT?

The taxable profits will be computed for both the Head Office and its permanent establishments using the tax rules of the Head Office’s jurisdiction.

The amount of tax for the permanent establishments will be based on these adjusted results multiplied by the appropriate rate of tax in force in the Member State where each of the permanent establishments are based (the ‘Host’ jurisdictions).

Who will be eligible, and as of when?

Qualifying SMEs will be able to apply for the system, which is proposed to come into effect with a projected date of 1 January 2026. HOT is not compulsory for SMEs.

To qualify, the business must first:

• be an SME per the 2013 Accounting Directive (see box), and
• be a separate legal entity in the form of a company or equivalent (e.g., limited partnership), and
• operate in other Member States exclusively through one or more permanent establishments (distance selling to other Members States is permitted), and
• be a sole entity – not part of a group or an associated enterprise (as defined in the 2013 Accounting Directive)

If an SME is in scope, it also needs to meet these eligibility criteria in order to apply for HOT:

• joint turnover of all permanent establishments must be less than or equal to an amount double of the turnover generated by the head office
• Head Office must have been tax resident in the Head Office Member State for the last two fiscal years
• Head Office does not derive income from shipping activities subject to tonnage tax.

Examples – Operation of the turnover criterion

What are the main practicalities?

SMEs should apply for HOT to the relevant authority in the Head Office Member State at least 3 months before the end of the fiscal year preceding the fiscal year in which the SME wishes to start applying the rules. For example, if an SME wishes to use HOT for the fiscal year ended 31 December 2028, it must apply, at the latest, by 30 September 2027.

The Head Office must then apply HOT rules for five fiscal years. If the eligibility criteria are still met, there is an option to renew, which must be exercised at least six months before the expiry of the current term.

If the Head Office tax authority declines the HOT application, SMEs have a right of appeal.

Can SMEs loose eligibility?

Head Office rules will automatically cease to apply with effect from the following fiscal year if either of the following occurs:

• the SME moves its tax residence out of the Head Office Member State (even if it is to another Member State)
• the joint turnover from its permanent establishments exceeds an amount which is triple the turnover of the head office in the last two fiscal years.

Preliminary thoughts

If the current provisions are approved by Member States, the HOT proposal will:

• provide a significant reduction in the administrative burden of dealing with the tax authorities of other Member States when opening up a cross-border permanent establishment.
• considerably save cost for SMEs as computing taxable profits will be based only on the rules of the Head Office jurisdiction (however, some tax benefits could be lost by the permanent establishments using the Head Office jurisdiction’s tax rules rather than the Host jurisdictions’ rules.)
• allow SMEs to submit all information in the Head Office language

From the perspective of preservation of Member States’ tax base, opportunities for SMEs to profit shift to more beneficial tax regimes are restricted by both the upper limit on the respective turnover of permanent establishments and by the fact that moving the jurisdiction of the Head Office ends the existing HOT scheme.

Next steps

The proposal will follow the normal legislative process for a tax file, meaning unanimity decision by all EU Member States in the Council, and a non-binding opinion by the European Parliament.

[1] “‘permanent establishment’ means a fixed place of business situated in another Member State, as defined under the relevant bilateral convention on the avoidance of double taxation or, in absence thereof, in national law.”