Explanatory Memorandum to COM(2021)565 - Rules to prevent the misuse of shell entities for tax purposes - Main contents
Please note
This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2021)565 - Rules to prevent the misuse of shell entities for tax purposes. |
|---|---|
| source | COM(2021)565  |
| date | 22-12-2021 |
1. CONTEXT OF THE PROPOSAL
• Reasons for and objectives of the proposal
On 18 May 2021, the European Commission adopted a Communication on Business Taxation for the 21st century 1 to promote a robust, efficient and fair business tax system in the European Union. It sets out both a long-term and short-term vision to support Europe's recovery from the COVID-19 pandemic and to ensure adequate public revenues over the coming years. It aims to create an equitable and stable business environment, which can boost sustainable and job-rich growth in the Union. This proposal is one of the short-term, targeted initiatives which were announced in the Communication as a means to improve the current tax system with a focus on ensuring fair and effective taxation.
While important progress has been made in this area in the last years, especially with the adoption of the anti-tax avoidance directive (ATAD) 2 and the expansion of scope of the directive on administrative cooperation (DAC) 3 , legal entities with no minimal substance and economic activity continue to pose a risk of being used for improper tax purposes, such as tax evasion and avoidance, as confirmed by recent massive media revelations 4 . While there can be valid reasons for the use of such entities, there is a need for further action to tackle situations where taxpayers evade their obligations under tax law or act against the actual purpose of tax law by misusing undertakings that do not perform any actual economic activity. The outcome of such situations is to lower the taxpayers’ overall tax liability. Such outcome leads to a shift of the tax burden at the expense of honest taxpayers and distorts business decisions in the internal market. Unless it is effectively tackled, this situation creates an environment of unfair tax competition and unfair tax burden distribution. This Directive applies to all undertakings that are considered tax resident and are eligible to receive a tax residency certificate in a Member State.
Having the aim of combating tax avoidance and evasion practices, which directly affect the functioning of the internal market, this Directive lays down anti-tax avoidance and evasion rules in a specific area. It responds to a request from the European Parliament for EU action to counter the misuse of shell entities for tax purposes and, more generally, to the demand of several Member States, businesses and civil society for a stronger and more coherent EU approach against tax avoidance and evasion.
• Consistency with existing policy provisions in the policy area
This Directive is part of the central EU strategy on direct corporate taxation with a view to ensuring that everybody pays their fair share. The Commission has been consistent in the pursuit of policies to fight tax avoidance and tax evasion in the last decade.
In particular, and by way of an example, in 2012, the Commission published a recommendation on Aggressive Tax Planning, recommending to Member States specific measures against double non-taxation and artificial arrangements for tax purposes. In 2016, the anti-tax avoidance directive (ATAD) was adopted to ensure coordinated implementation in Member States of key measures against tax avoidance stemming from the international Base Erosion and Profit Shifting Project actions. In parallel, the directive on administrative cooperation (DAC) has, since its adoption in 2011, been revised and expanded on several occasions to allow a large-scale and timely exchange of tax related information across the EU, including on tax rulings and mandatory reporting of arrangements by tax intermediaries mandatory. From an international angle, the EU list of non-cooperative jurisdictions in tax matters has been launched since 2017, amongst others, to protect Member States’ tax bases from third countries’ harmful tax practices.
Existing tax instruments at EU level do not contain, however, explicit provisions targeting shell entities, i.e. entities that do not perform any actual economic activity, even if they are presumably engaged with one, and that can be misused for tax avoidance or evasion purposes. The risk that such entities may pose for the Single Market and specifically for Member States’ tax bases has been highlighted by recent tax-related scandals.
• Consistency with other Union policies (possible future initiatives of relevance to the policy area)
This Directive follows up to the Commission’s Communication on Business Taxation for the 21st century for a robust, efficient and fair business tax system in the EU and reflects one of the policy initiatives envisaged in such Communication. As such it complements a number of other policy initiatives promoted by the Commission in parallel, in the short- and long-term. These include a proposal for a Directive on ensuring a global minimum level of taxation for multinational groups in the Union. This Directive, which aims to discourage the use of shell entities established in the Union for tax purposes, has a broader scope than the Directive on a minimum level of taxation, as it encompasses all entities and legal arrangements resident for tax purposes in the Union, without any threshold based on revenues. On the other hand, the legal framework on the minimum level of taxation applies only to MNE groups and large-scale domestic groups with combined revenues that exceed EUR 750 million. Such groups also fall within the ambit of this Directive. This is because the two initiatives have different purposes.
The legal framework on the minimum level of taxation exclusively pertains to the rate, i.e. level of taxation. It does not touch upon potentially harmful features of the tax base. Neither does it involve examining whether an entity possesses sufficient substance to carry out the activity that it is supposed to. It is true that the implementation of the rules on the minimum level of taxation may gradually discourage the creation of shell entities to some extent. Yet, this is yet an unknown outcome which cannot be guaranteed at this stage.
In addition, an exclusion from the scope of this Directive of the groups within the scope of the Directive on a minimum level of taxation would create unequal treatment against ‘shell’ entities belonging to smaller-sized groups that do not meet the threshold of EUR 750 million. It would namely be mostly large MNE groups that would receive a waiver from the transparency requirements and the tax consequences under this Directive.
Additional announced initiatives involve proposals to require all EU entities to publish their effective tax rate on an annual basis and to tackle the tax bias in favour of debt financing by placing equity financing in the single market on an equal footing to debt. In addition, this Directive is consistent with, and complementary to, Union policies in relation to transparency of beneficial ownership information.
2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY
• Legal basis
Direct tax legislation falls within the ambit of Article 115 of the Treaty on the Functioning of the EU (TFEU). The clause stipulates that legal measures of approximation under that article shall be vested the legal form of a Directive.
• Subsidiarity (for non-exclusive competence)
This proposal complies with the principle of subsidiarity. The nature of the subject requires a common initiative across the internal market.
The rules of this Directive aim to tackle cross-border tax avoidance and evasion practices and provide a common framework to be implemented into Member States' national laws in a coordinated manner. Such aims cannot be achieved in a satisfactory manner through action undertaken by each Member State while acting on its own.
The use of legal entities and arrangements without minimal substance for tax avoidance or tax evasion purposes is usually not limited to the territory of only one Member State. A key feature of relevant schemes is that they involve the tax systems of more than one Member State at a time. Several Member States could therefore be impacted by a scheme that would include the use of a shell entity located in another Member State.
The review of Member States anti-tax avoidance and evasion rules indicates fragmentation. Some Member States have developed targeted rules or practices, including criteria on substance, to counter abuse by shell entities in the area of taxation. However, most Member States do not apply targeted rules, but may rely on general anti-abuse rules, which they tend to apply on a case-by-case basis. Even amongst the few Member States that have developed targeted rules at national level, the rules differ significantly, and reflect more national tax systems and priorities, rather than target the internal market dimension.
The existing fragmentation could be replicated and possibly worsened, were Member States to take action individually. Such an approach would perpetuate the present inefficiencies and distortions in the interaction of distinct measures. If the objective is to adopt solutions that function for the internal market as a whole and improve its (internal and external) resilience against tax evasion and tax avoidance practices that affect or can affect equally all Member States, the appropriate way forward involves a coordinated initiative at the level of the EU.
Furthermore, an EU initiative would add value, as compared to what a multitude of actions taken at national level can attain. Given that the envisaged rules have a cross-border dimension and that shell entities are commonly used to erode the tax base of a Member State different from that where the shell entity is located, it is imperative that any proposals balance divergent interests within the internal market and consider the full picture, to identify common objectives and solutions. This can only be achieved if legislation is designed centrally. Moreover, a common approach towards shell entities would ensure legal certainty and reduce compliance costs for businesses operating within the EU.
Such an approach is therefore in accordance with the principle of subsidiarity, as set out in Article 5 of the Treaty on the European Union.
• Proportionality
The envisaged measures do not go beyond ensuring the minimum necessary level of protection for the internal market. The Directive does not therefore prescribe full harmonization but only a minimum protection for Member States' tax systems.
In particular, the Directive lays down a test to facilitate Member States to identify manifest cases of shell entities misused for tax purposes in a coordinated manner across the EU. National rules, including rules transposing EU law, shall continue to apply to identify shell entities not captured by this Directive. The application of these latter national rules should also be facilitated by virtue of the measures of this Directive, as Member States will have access to new information concerning shell entities. Furthermore, the Directive lays down consequences for shell entities taking into due account agreements and conventions in place between Member States and third countries for the elimination of double taxation of income, and where applicable, capital.
Thus, the Directive ensures the essential degree of coordination within the Union for the purpose of materializing its aims. In this light, the proposal does not go beyond what is necessary to achieve its objectives and is therefore compliant with the principle of proportionality.
• Choice of the instrument
The proposal is for a Directive, which is the only available instrument under the legal base of Article 115 TFEU.
3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER CONSULTATIONS AND IMPACT ASSESSMENTS
• Ex-post evaluations/fitness checks of existing legislation
Existing anti-tax avoidance legislation does not include measures targeted to undertakings that do not have minimum substance for tax purposes. Therefore, evaluation is not relevant.
• Stakeholder consultations
On 4 June 2021, TAXUD launched a public consultation on a potential initiative to fight the use of shell entities and arrangement for tax purposes. It contained 32 questions aimed, inter alia, at delineating the problem and its drivers and identifying the appropriate form of EU action and the key features of shell entities being at risk to be misused for tax purposes. The consultation closed on 27 August 2021 with a total of 50 replies.
All respondents acknowledge that in spite of the recent EU anti-tax avoidance measures the problem of tax avoidance and evasion persists, including through the misuse of shell entities. While some respondents welcome new targeted measures to tackle abuse in the tax area, others consider that they are potentially premature.
Respondents point to the low capacity of Member States’ tax administrations and inadequate administrative cooperation as the main problem drivers.
As regards the features common in shell entities that present a risk for being misused for tax purposes, there is broad agreement that absence of an own bank account is one of them and is indicative. There is also wide convergence that another common feature is where the directors, in their majority, do not reside in the country where the entity is located. However, there is no wide agreement on the pertinence of other factors, such as the number of employees.
Furthermore, respondents agree that shell entities at risk to be misused are more likely to be identified amongst those engaged with the activity of holding and managing equity or intellectual property or with financing and leasing activity. While respondents consider that a shell entity prone to misuse can be set up in any legal form, they seem to find trusts to be at slightly higher risk. Whether an entity is a small or medium enterprise (SME) does not arise as a relevant feature to be taken into account.
Notably 33 respondents, in particular business and professional associations, provided extensive input which goes beyond the consultation questions. A significant part of these respondents, differently for the other respondents, has concerns that new EU legislation targeted to tax avoidance and evasion through the misuse of shell entities might not be timely, also in light of the international discussions towards global minimum effective taxation.
Moreover, these respondents stress that defining what is a shell entity is challenging and that assessing lack of substance depends on the facts and circumstances of each specific entity. In this regard, they highlight that taxpayers should have an effective right to provide evidence of their specific circumstances. Usefully, these respondents have also provided specific examples of structures that could be considered not to have substance, i.e. to be shell, but are not put in place to obtain tax advantages but rather for valid commercial reasons.
In addition to the public consultation, national experts in direct taxation have been consulted in a targeted manner. A meeting of Working Party IV on tax questions was held on 22 June 2021 and bilateral consultations followed. Overall Member States expressed support for a new EU initiative targeting the misuse of shell entities to obtain tax advantages. Member States welcomed the definition of common rules on the misuse of shell entities together with a framework for administrative cooperation. Member States also argued for a broad scope of the new measures and stressed that SMEs should be equally covered. Amongst the available policy options, Member States expressed support for regulatory action.
In forming its proposal, the Commission took into account the results of the consultation. In particular, amongst the various policy options, the Commission decided to proceed with a proposal for regulatory and binding action, i.e. a directive under art. 115 TFEU. Furthermore, the directive proposed distinguishes entities at risk to be shell and misused to obtain tax advantages by reference to a set of features common in such entities. Specific shell entities are however carved out upfront as they are commonly used for good commercial reasons. In designing the distinctive criteria that would single out entities at risk and in defining the cases that should be excluded because they do not present tax avoidance or evasion risks, the Commission relied on the input of the stakeholders. SMEs are not excluded from the proposal as there is wide agreement that they do present relevant risks. In recognition of the fact that substance is ultimately a matter of facts and circumstances the directive includes a mechanism allowing taxpayers to challenge the outcome of the test therein, including by evidencing the commercial, non-tax motives, underlying a certain structure. In the same vein, structures that are not put in place with the main purpose to obtain a tax advantage may avail of a mechanism to request an upfront exemption.
As regards the question whether measures targeted to the misuse of shell entities for tax purposes would be timely or premature, the Commission holds that there is indeed a clear need for such measures. The need for such measures arises clearly in the aftermath of continuous scandals on the misuse of shell entities worldwide and specifically in the single market. The future application of the rules on global minimum effective taxation would not fully address the issue of shell companies as those rules would only apply to multinational companies that meet the EUR 750 million threshold, thus leaving all companies below this threshold out of the scope. In the same vein, the Commission appreciates that the protection of Member States’ taxable bases is all the more important to ensure a sustainable economy under the exceptional circumstances imposed by the health crisis.
• Collection and use of expertise
In identifying appropriate measures to tackle the misuse of shell entities for tax purposes, the Commission drew on an extensive study conducted by the International Bureau of Fiscal Documentation (IBFD). The study was submitted to the Commission in the context of the public consultation. It concludes that existing EU anti-avoidance measures do not suffice to tackle tax related issues surrounding shell companies and coordinated action promoting cross-border consistency in the applicable tax treatment to shell arrangements is to be welcomed. It also observes that Member States’ rules targeting specifically shell arrangements are relatively uncommon. In addition, the Commission relied on a study on letterbox companies carried out by an external contractor and commissioned independently from this initiative.
The Commission relied on the results of these studies in defining the specific features that should single out the entities at clear risk to be shell and be misused to obtain tax advantages.
• Impact assessment
An impact assessment was carried out to prepare this initiative.
On 22 October 2021 the Regulatory Scrutiny Board (RSB) issued a positive opinion with reservations on the submitted impact assessment regarding the present proposal, including several suggestions for improvement. 5 The Impact Assessment report (IA) was further revised along these lines, as explained below.
The IA examines four policy options in addition to the baseline scenario, i.e. no action. Option 1 was the pursuit of soft law action by expanding the mandate of an existing peer review instrument, the Code of Conduct (Business Taxation). As an alternative, the IA examined the possibility for the Commission to adopt a recommendation to Member States. However, soft law instruments may be expected to be of limited effect in resolving the problem of the misuse of shell entities for tax purposes, this is a cross-border issue and requires a consistent approach across the EU, which cannot be ensured via soft law.
Options 2, 3 and 4 are regulatory and prescribe a set of rules that should be put in place in all Member States. They differ on the extent to which coordination is sought. Option 2 envisaged coordination of the criteria and processes to identify shell entities as well as coordination on their treatment. Option 3 includes, in addition to Option 2, a mechanism for automatic exchange of information. Option 4 adds to Option 3 a prescription of sanctions against non-compliant entities.
The various Options have been compared against the following criteria: a) effectiveness in reducing the misuse of shell entities, b) tax gains for public finances, c) compliance costs for businesses, d) compliance costs for tax administrations, e) indirect effects on the single market, f) indirect effects on competition among firms, g) indirect effects on EU competitiveness, h) indirect effects – social impacts and i) coherence. The comparison revealed that Options 2, 3 and 4 can be expected to be, despite their costs, effective in meeting the objectives of this initiative. Amongst them, Option 4 appears to perform best. Specifically, it is expected to be the one ensuring the highest level of compliance by the entities in scope, while it is coherent with the current EU agenda on fighting tax avoidance and evasion and builds on existing systems for exchange of information.
Contents
- Economic impacts
- Benefits
- Costs
- Main changes implemented
- Undertakings that should report
- Reporting
- Presumption of lack of minimal substance and tax abuse
- Rebuttal
- Exemption for lack of tax motives
- Consequences
- oThird country source / payer: may apply domestic tax on the outbound payment or may decide to apply the treaty in effect with EU shareholder jurisdiction
- Exchange of information
- Penalties
The assessment of the economic impacts was subject to data limitations, because the initiative concerns a type of entity for which there is severe lack of data and no commonly acceptable definition.
Nevertheless, the preferred option (Option 4) is expected to have a positive economic impact. As main direct benefit, it is expected that there will be an increase in the collection of tax revenues by reducing the misuse of shell entities in the EU. Even a small reduction of the current estimated tax loss (estimated at around EUR 20 billion in the EU) will represent significant additional public resources. Option 4 is the most effective as the outcome of identifying the existence of a shell entity is reinforced by implications: the exchange of information between Member States and a common sanctions regime at EU level. Some additional direct benefits could be obtained from the regulatory charges due to the sanctions. The initiative will also provide significant indirect benefits. Thanks to this action, valuable information will be collected to better understand the phenomenon of shell entities for tax purposes. It will also signal that the EU is committed to ending tax avoidance and evasion within its borders encouraging tax compliance.
The main costs related to the selected option are the increase in compliance costs for businesses and tax administrations. Tax compliance costs for business are expected to increase in a limited manner. Overall, costs should be relatively limited because the number of companies in scope of this initiative is expected to be low (less than 0.3% of all EU companies), and the additional data to be reported by those in scope should be easy to retrieve and relatively simple to provide. For tax administrations, costs are also expected to increase modestly. Tax administrations should expand their capabilities in order to administer the information that they will have access to, implement the systems supporting the exchange of information and enforce the proposed sanctions. This proposal aims, by design, to find a good balance between positive impacts and additional burden. There are risks in the capacity of Member States to deal with the new responsibilities, for example in the management of tax rulings.
The RSB issued a positive opinion with reservations on the IA. In particular, the RSB noted that IA is not clear on why tax avoidance and evasion should be addressed together and what distinguishes legitimate shell entities from those misused for tax purposes. The RSB also noted that the IA does not provide sufficient overview of possible alternative and/or complementary measures, beyond the introduction of EU legislation. Furthermore, the RSB noted that the IA should be enhanced as regards quantitative estimates, in particular compliance costs for businesses, and should better reflect the different stakeholder views in the main analysis. Annex I to the Impact Assessment explains how the RSB reservations were addressed. Several parts of the IA were revised and new parts were added in order to address the concerns raised by the RSB. First, a new section has been added in order to explain, also by way of examples, how shell entities can serve both tax avoidance and tax evasion practices in similar ways and why, therefore, there is room to address them together. In addition, the IA has been revised in order to clarify that the distinction between legitimate and non-legitimate shells is a matter of how they are used rather than one of construction. Second, the IA has been expanded in order to reflect in detail the various alternatives considered at an early stage to tackle the problematic use of shell entities in the tax area. In this respect, it has been explained why the option of regulating trust and company service providers, as a standalone or complementary measure, has not been promoted. The reasons why the introduction of substance requirements has been considered the option fit for purpose have also been further analysed. Third, the IA has been revised to include further details on the estimated compliance costs for business and administrations, and in particular, details on the reasoning behind the estimations, additional arguments and new evidences. Moreover, several sections of the main part of the IA have been revised in order to include relevant stakeholder input, gathered through public and specific consultations procedures.
4. BUDGETARY IMPLICATIONS
See Legislative Financial Statement.
5. OTHER ELEMENTS
• Implementation plans and monitoring, evaluation and reporting arrangements
This proposal, once adopted as a Directive, should be transposed into Member States’ national law by 30 June 2023 and come into effect as of 1 January 2024. For the purpose of monitoring and evaluation of the implementation of the Directive, Member States shall provide the Commission, on a yearly basis, with relevant information per tax year, including a list of statistical data. The relevant information is set out in Article 12 of the Directive.
The Commission shall submit a report on the application of this Directive to the European Parliament and to the Council every five years, which should start counting after [1 January 2024]. The results of this proposal will be included in the evaluation report to the European Parliament and to the Council that will be issued by [1 January 2029].
• Detailed explanation of the specific provisions of the proposal
The Directive is broadly inclusive and aims to capture all undertakings that can be considered resident in a Member State for tax purposes, regardless of their legal form. In this vein, it also captures legal arrangements, such as partnerships, that are deemed residents for tax purposes in a Member State.
The Directive targets a specific scheme used for tax avoidance or tax evasion purposes. The scheme targeted involves the setting up of undertakings within the EU which are presumably engaged with an economic activity but that, in reality, do not conduct any economic activities. Instead, the reason for which they are in place is to enable certain tax advantages to flow to their beneficial owner or to the group to which they belong, as a whole. For example, a financial holding undertaking may collect all payments from financial activities of undertakings in different EU Member States, taking advantage of the exemptions from withholding taxes under the Interest and Royalty Directive 6 and then pass on this income to an associated enterprise in a low tax third country jurisdiction, exploiting favourable tax treaties or even domestic tax law of a specific Member State. In order to tackle this scheme, this Directive lays down a test that will help Member States to identify undertakings that are engaged in an economic activity, but which do not have minimal substance and are misused for the purpose of obtaining tax advantages. This test can be commonly referred to as a “substance test”. In addition, the Directive attaches tax consequences to the undertakings that do not have minimal substance (shells). It also envisages automatic exchange of information as well as potential request by one Member State to another for tax audits for a broader group of undertakings that are treated as being at risk (as they fulfil certain conditions) but are not necessarily deficient in substance for the purposes of this Directive. The definition of the appropriate tax treatment and the information exchange should discourage the targeted scheme by neutralising any tax advantages gained or that can be gained.
In light of the above, the Directive is structured so as to essentially reflect the logical sequence of each step of the aforementioned substance test. There are 7 steps: undertakings that should report (due to being found to be ‘at risk’); reporting; possibility of gaining exemption from reporting for lack of tax motives; presumption of lack of minimal substance; possibility of rebuttal; tax consequences; exchange of information automatically via making data available on a Central Directory as well as potential request for the performance of a tax audit.
The first step divides the various types of undertakings in those at risk for lacking substance and be misused for tax purposes vs. those at low risk. Risk cases are those that present simultaneously a number of features usually identified in undertakings that lack substance. These criteria are commonly referred to as ‘gateway’. Low-risk cases are those that present none or only some of these criteria, i.e. those that do not pass the gateways.
The relevant criteria that set up the gateways aim to distinguish as at risk those undertakings that seemingly engage with cross-border activities which are geographically mobile and in addition rely on other undertakings for their own administration, in particular professional third party service providers or equivalents.
Low-risk cases that do not cross the gateway are irrelevant for the purposes of the Directive. Resources can therefore focus on the most risky cases, i.e. those that present all relevant features and hence cross the gateway.
For tax certainty, undertakings performing certain activities are carved out explicitly and are therefore considered from the outset as being of low-risk and irrelevant for the purposes of the Directive. These include undertakings that would either not cross the gateway or, if they did, they would be found irrelevant for the purposes of the Directive at a later step of the test. Undertakings that fall in the scope of any of the carve-outs do not need to consider whether or not they cross the gateway.
Only the undertakings considered at risk at the first step proceed to the second step, which is the core of the substance test itself. Due to the fact that they are at risk, these undertakings are asked to report on their substance in their tax return.
Reporting on substance means providing specific information, normally already arising from the undertaking’s tax return, in a way that facilitates the assessment of the activity performed by the undertaking. The focus is on specific circumstances that are normally present in an undertaking that performs substantial economic activity.
Three elements are considered important: first, premises available for the exclusive use of the undertaking; second, at least one own and active bank account in the Union; and third at least one director resident close to the undertaking and dedicated to its activities or, alternatively, a sufficient number of the undertaking’s employees that are engaged with its core income generating activities being resident close to the undertaking. A director’s dedication to the activities of the undertaking may be demonstrated in his qualifications, which should be such as to allow the director to have an active role in the decision-making processes, the formal powers that he/she is vested and the director’s actual participation in the day-to-day management of the undertaking. Where no director with the necessary qualifications is resident close to the undertaking, alternatively it would be expected that the undertaking has adequate nexus to the Member State of claimed tax residence if most of its employees that perform day-to-day functions are resident for tax purposes close to that Member State. Decision-making should also take place within the Member State of the undertaking. These specific elements have been selected drawing on the international standard on substantial economic activity for tax purposes.
It must be kept in mind that these elements are set with regard to undertakings with cross-border activities that are geographically mobile and which do not have own resources for their own administration.
Furthermore, the reporting must be accompanied by satisfactory documentary evidence, which should be attached to the tax return as well, if not already included. The evidence required is aimed at allowing the tax administrations to verify directly the truth of the reported information as well as to form a general overview of the situation of the undertaking so as to consider whether to initiate a tax audit.
The third step of the test prescribes the appropriate assessment of the information that the undertaking reported in the second step in terms of substance. It sets out how the outcome of the reporting, i.e. the declaration of the undertaking that it has or does not have the relevant elements, should be qualified, at least at first sight.
An undertaking that is a risk case, since it has crossed the gateway, and whose reporting also leads to the finding that it lacks at least one of the relevant elements on substance, should be presumed to be a ‘shell’ for the purposes of the Directive, i.e. lacking substance and being misused for tax purposes.
An undertaking that is a risk case but whose reporting reveals that it has all relevant elements of substance, should be presumed not to be a ‘shell’ for the purposes of the Directive. However, this presumption does not exclude that the tax administrations still find that such undertaking:
·is a shell for the purposes of the Directive because the documentary evidence produced does not confirm the information reported; or
·is a shell or lacks substantial economic activity under domestic rules other than this Directive, taking into account the documentary evidence produced and/or additional elements; or
·is not the beneficial owner of any stream of income paid to it.
The fourth step involves the right of the undertaking which is presumed to be shell and misused for tax purposes, for the purposes of the Directive, to prove otherwise, i.e. to prove that it has substance or in any case it is not misused for tax purposes. This opportunity is very important because the substance test is based on indicators and as such, may fail to capture the specific facts and circumstances of each individual case. Taxpayers will therefore have an effective right to make the claim that they are not a shell in the sense of the Directive.
To claim a rebuttal of a presumption of shell the taxpayers should produce concrete evidence of the activities they perform and how. The evidence produced is expected to include information on the commercial (i.e. non-tax) reasons for setting up and maintaining the undertaking which does not need own premises and/or bank account and/or dedicated management or employees. It is also expected to include information on the resources that such undertaking uses to actually perform its activity. It is also expected to include information allowing to verify the nexus between the undertaking and the Member State where it claims to be resident for tax purposes, i.e. to verify that the key decisions on the value generating activities of the undertaking are taken there.
While the above information is essential and required to be produced by the rebutting undertaking, the undertaking is free to produce additional information to make its case. This information should then be assessed by the tax administration of the undertaking’s State of tax residence. Where the tax administration is satisfied that an undertaking rebuts the presumption that it is a shell for the purposes of the Directive, it should be able to certify the outcome of the rebuttal process for the relevant tax year. As the rebuttal process is likely to create a burden for both the undertaking and the tax administration while leading to the conclusion that there is minimum substance for tax purposes, it will be possible to extend the validity of the rebuttal for another 5 years (i.e. for a total maximum of 6 years), after the relevant tax year, provided that the legal and factual circumstances evidenced by the undertaking do not change. After this period, the undertaking will need to renew the process of rebuttal if it wishes to do so.
An undertaking that might cross the gateway and/or does not fulfil the minimum substance could be used for genuine business activities without creating a tax benefit for itself, the group of companies of which it is part or for the ultimate beneficial owner. Such an undertaking should have an opportunity to evidence this, at any time, and to request an exemption from the obligations of this Directive.
To claim such an exemption, the undertaking is expected to produce elements allowing to compare the tax liability of the structure or the group to which it is part with and without its interposition. This is similar to the exercise recommended to be undertaken in order to assess any type of aggressive tax planning schemes (Commission Recommendation of 6 December 2012 on aggressive tax planning 7 .
As is the case with the rebuttal of the presumption, the tax administration of the place of claimed tax residence of the undertaking may be considered best placed to assess the relevant evidence produced by the undertaking. Where the tax administration is satisfied that the interposition of a specific undertaking within the group does not impact on the tax liability of the group, it should be able to certify that the undertaking is not at risk of being found a ‘shell’ under this Directive for a tax year. As the process for obtaining an exemption could create a burden for both the undertaking and the tax administration while leading to the conclusion that there is no tax avoidance or evasion purpose, it will be possible to extend the validity of the exemption for another 5 years (i.e. for a total maximum of 6 years), provided that the legal and factual circumstances evidenced by the undertaking do not change. After this period, the undertaking will need to repeat the process of requesting for an exemption if it wishes to continue being exempt and can substantiate that it remains entitled to.
Once an undertaking is presumed to be a shell for the purposes of the Directive, and does not rebut such presumption, tax consequences should kick in. These consequences should be proportionate and aim at neutralising its tax impact, i.e. disallowing any tax advantages which have been obtained, or could be obtained, through the undertaking in accordance with agreements or conventions in force in the Member State of the undertaking or relevant EU directives, in particular Council Directives 2011/96/EU on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States and 2003/49/EC on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States. These advantages would be in effect disallowed if the relevant agreements, conventions and EU directives were disregarded with regard to the undertaking that was found not to have minimum substance and did not prove the contrary.
Given that to obtain these advantages, an undertaking normally needs to provide a certificate of residence for tax purposes, in order to accommodate for an efficient process, the Member State of tax residence of the shell will either not issue a tax residence certificate at all or will issue a certificate with a warning statement, i.e. including an explicit statement to prevent its use for the purposes of obtaining the above advantages. Not issuing a tax residence certificate or issuing a special certificate, including the warning described above, does not set aside the national rules of the Member State where the shell is tax resident with regard to any tax obligations linked to the shell. It will only serve as an administrative practice to inform the source country that it should not grant the benefits of its tax treaty with the Member State of the shell (or of applicable EU directives) to payments towards the shell.
If tax advantages accorded to the undertaking are disallowed, it should be determined how income flows to and from the undertaking, as well as any assets owned by the undertaking, should actually be taxed. In particular, it should be determined which jurisdiction should have a right to tax such income flows and/ or assets. Such determination should not affect any tax that may apply at the level of the shell itself; the Member State of the shell would thus remain free to continue to consider the shell as resident for tax purposes in its territory and apply tax on the relevant income flows and / or assets as per its national law.
The allocation of taxing rights should take into account all jurisdictions that may be affected by transactions involving the shell. Such jurisdictions, except for the Member State of the shell, are:
(i)In the case of income flows: on the one hand, the source jurisdiction or jurisdiction where the payer of the income is located and on the other, the jurisdiction of final destination of the flow, i.e. the jurisdiction of the shareholder of the undertaking;
(ii)In case of real estate assets: on the one hand, the source jurisdiction or jurisdiction where the assets are situated and on the other, the jurisdiction where the owner resides, i.e. the jurisdiction of the shareholder of the undertaking;
(iii)In case of valuable movable assets, such as art collections, yachts etc.: the jurisdiction of the owner, i.e. of the shareholder of the undertaking.
The allocation of taxing rights necessarily affects only Member States, which are bound by this Directive, i.e. it does not and cannot affect third countries. However, situations involving third countries are indeed likely to arise, e.g. where income from a third country flows to the shell or where the shareholder(s) of the shell are in a third country or where the shell owns assets situated in a third country. In these cases, agreements for the avoidance of double taxation between a Member State and a third country should be duly respected as regards allocation of taxing rights. In absence of such agreements, the Member State involved will apply its national law.
In detail, four scenarios can be envisaged:
Third country source jurisdiction of the payer – EU shell jurisdiction – EU shareholder(s) jurisdiction
In this case the source jurisdiction is not bound by the Directive, while the jurisdictions of the shell and of the shareholder fall in scope.
oThird country source / payer: may apply domestic tax on the outbound payment or may decide to apply the treaty in effect with EU shareholder jurisdiction
oEU shell: it will continue to be resident for tax purposes in the respective Member State and will have to fulfil relevant obligations as per national law, including by reporting the payment received; it may be able to provide evidence of the tax applied on the payment
oEU shareholder(s): shall include the payment received by the shell undertaking in its taxable income, as per the national law and may be able to claim relief for any tax paid at source, in accordance with the applicable treaty with third country source jurisdiction. It will also take into account and deduct any tax paid by the shell.
EU source jurisdiction of the payer– EU shell jurisdiction – EU shareholder(s) jurisdiction
In this case, all jurisdictions fall in the scope of the Directive and are therefore bound by it.
oEU source / payer: it will not have a right to tax the payment but may apply domestic tax on the outbound payment to the extent it cannot identify whether the undertaking’s shareholder(s) are in the EU
oEU shell: it will continue to be resident for tax purposes in the respective Member State and will have to fulfil relevant obligations as per national law, including by reporting the payment received; it may be able to provide evidence of the tax applied on the payment
oEU shareholder(s): will include the payment received by the shell undertaking in its taxable income, as per the national law and may be able to claim relief for any tax paid at source, including by virtue of EU directives. It will also take into account and deduct any tax paid by the shell.
EU source jurisdiction of the payer – EU shell jurisdiction – third country shareholder(s) jurisdiction
In this case only the source and the shell jurisdiction are bound by the Directive while the shareholder jurisdiction is not.
oEU source / payer: will tax the outbound payment according to treaty in effect with the third country jurisdiction of the shareholder(s) or in the absence of such a treaty in accordance with its national law.
oEU shell: will continue to be resident for tax purposes in a Member State and will have to fulfil relevant obligations as per national law, including by reporting the payment received; it may be able to provide evidence of the tax applied on the payment.
oThird country shareholder(s): while the third country jurisdiction of the shareholder(s) is not compelled to apply any consequences, it may be asked to apply a tax treaty in force with the source Member State in order to provide relief.
Third country source jurisdiction of the payer – EU shell jurisdiction – third country shareholder(s) jurisdiction
oThird country source / payer: may apply domestic tax on the outbound payment or may decide to apply tax according to the tax treaty in effect with the third country jurisdiction of the shareholder(s) if it wishes to look through the EU shell entity as well.
oEU shell: will continue to be resident for tax purposes in a Member State and fulfil relevant obligations as per national law, including by reporting the payment received; it may be able to provide evidence of the tax applied on the payment
oThird country shareholder(s): while the third country shareholder jurisdiction is not compelled to apply any consequences, it may consider applying a treaty in force with the source jurisdiction in order to provide relief.
Scenarios where shell undertakings are resident outside the EU fall outside the scope of the Directive.
All Member States will have access to information on EU shells, at any time and without a need for recourse to request for information. To this effect, information will be exchanged among Member States from the first step, when an undertaking is classified as being at risk for the purposes of this Directive. Exchange will also apply where the tax administration of a Member State makes an assessment based on facts and circumstances of individual cases and decides to certify that a certain undertaking has rebutted the presumption of being shell or should be exempt from the obligations under the Directive. This will ensure that all Member States are in a position to become aware, in a timely manner, of the discretion exercised and the reasons behind each assessment. Member States will also be able to request the Member State of the undertaking to perform tax audits where they have grounds to suspect that the undertaking might be lacking minimal substance for the purposes of the Directive.
To achieve that the information is available to all Member States that may have an interest to it in a timely manner, the information will be exchanged automatically through a central directory by deploying the existing mechanism of administrative cooperation in tax matters. Member States will exchange the information in all above scenarios without delay and in any case within 30 days from the time the administration has such information. This means within 30 days from receiving tax returns or within 30 days from when the administration issues a decision to certify that an undertaking rebutted a presumption or should be exempt. Automatic exchange will also take place within 30 days from the conclusion of an audit to an undertaking at risk for the purposes of the Directive, if the outcome of such audit has an impact on the information already exchanged or that should have been exchanged for this undertaking. The information to be exchanged is prescribed in Article 13 of this Directive. The principle is that such information should allow all Member States to receive the information reported by undertakings at risk for the purposes of this Directive. In addition, where a Member State’s administration assesses a rebuttal of presumption or an exemption from the obligations of the Directive, the information exchanged should allow other Member States to understand the reasons for this assessment. Other Member States should always be able to request from another Member State a tax audit on any undertaking that passes the gateway of this Directive, if they have doubts on whether or not it has the minimal substance required. The requested Member State should perform the tax audit within a reasonable timeframe and share the outcome with the requesting Member State. If there is a finding of ‘shell’ entity, the exchange of information should be automatic in accordance with Article 13 of this Directive.
The proposed legislation leaves it to Member States to lay down penalties applicable against the violation of the reporting obligations provided by this Directive as transposed into the national legal order. The penalties shall be effective, proportionate and dissuasive. A minimum level of coordination should be achieved amongst Member States through the set of a minimum monetary penalty as per existing provisions in the financial sector. Penalties should include an administrative pecuniary sanction of at least 5% of the undertaking’s turnover. Such minimum amount should take into account the circumstances of the specific reporting entity.