EU ‘Unshell’ – Rules to prevent the misuse of shell entities for tax purposes

[Martin Everson]

‘Unshell’ – Rules to prevent the misuse of shell entities for tax purposes [EU Legislation in Progress]

The Commission's initiatives concerning the taxation of corporate entities are part of its broader taxation agenda, which aims for a tax system guided by the principles of fairness, efficiency and simplicity in order to strengthen the single market, alongside a balanced tax revenue mix.

epthinktank.eu

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The changes the proposal would bring The proposal introduces a multiple-step filtering procedure to help Member States identify undertakings in the EU that are engaged in an economic activity, but which do not have minimal substance and are misused for the purpose of obtaining tax advantages. To ensure equal treatment, the directive does not introduce a threshold based on company turnover and applies to all shell entities, regardless of whether they are owned by an SME or a multinational.

At first, a 'gateway test' (Article 6) is set up: companies would need to check via three gateways whether they are 'at risk' of lacking substance and being misused for tax purposes. Some types of shell entities (Article 6(2)), particularly in the area of financial services, would be exempted from the proposal and would thus not need to apply the gateway test, as the Commission argues they are 'commonly used for good commercial reasons'. The three gateways are:

> more than 75 % of an entity's income is 'relevant income' (as defined in Article 4), which broadly covers passive income (interest, dividends, royalties);

> more than 60% of the book value of the entity's assets has been located outside the undertaking's Member State for at least two years, or more than 60% of the entity's relevant income is earned through cross-border transactions;

> the entity has outsourced the administration of its day-to-day operations and decision-making.

If the entity passes all three gateways, it will be obliged to report, through its annual tax return to its tax authority, information regarding the entity's level of substance (Article 7) concerning:

> the premises of the company;
> whether it has its own, active bank account in the EU;
> the tax residency of its director(s) and the majority of its full-time employees.

All declarations will need to be accompanied by supporting evidence.

If an entity lacks substance in one of these criteria, it is presumed to be 'a shell' for the purposes of the directive. A company has the right to rebut this presumption (Article 9), and it can do so by providing at least additional evidence on the commercial rationale of the undertaking, information about their employees (such as their level of experience, their decision-making power and role in the overall organisation, or their employment contract), and evidence showing that decision making on the activity generating the relevant income takes place in the Member State where the undertaking is located. Additional information which the entity believes to be crucial can be provided. If the tax authority accepts the taxpayer's rebuttal, the rebuttal is valid for the tax year and may remain valid for an additional five years, if the factual and legal circumstances of the company do not change.

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[Onassis]

Tax consequences of not having minimum substance

Where an entity does not have minimum substance for tax purposes in the Member State where it is resident for tax purposes, that Member State should deny any request for a certificate of tax residence to the entity for use outside the jurisdiction of that Member State.

When denying a request for such certificate, the Member State should issue an official statement duly justifying such decision and prescribing that the entity is not entitled to the benefits of agreements and conventions that provide for the elimination of double taxation of income, and, where applicable, capital, or of international agreements with a similar purpose or effect.

Source: Unshell (ATAD 3): Proposal for a Council Directive

This would prevent pulling out dividends out of EU companies tax free through Cypriot Ltds with no substance:

2.4 Consequence: no tax certificate resulting in the loss of tax advantages from tax treaties and EU law
[...]
This means that the entity will be disallowed any tax advantage gained through bilateral tax treaties of the entity’s resident jurisdiction or through EU Directives (e.g. Parent-Subsidiary Directive and the Interest and Royalties Directive)

Source: Proposal for a Directive to prevent misuse of shell entities (ATAD 3) and the amendments proposed by the European Parliament