In December 2021, the European Commission submitted its proposal for Anti-Tax Avoidance Directive III (ATAD III) laying down rules to prevent tax fraud through the misuse of shell companies in the EU.
The ATAD III endeavor was triggered by the fact that many individuals and legal entities establish shell companies (entities with no economic substance or commercial purpose) in EU countries with preferential tax regimes, in order to avoid the taxation of income in the source country.
Based on ATAD III, which is still under negotiations through the competent EU bodies, all entities with tax residency in EU countries and engaged in cross-border activities must go through a number of tests to determine whether they are presumed to be shell companies. An exemption is provided to companies listed on a regulated market, regulated schemes such as UCITS and AIFs, as well as to domestic holding companies that hold shares of operating companies that are residents of the same country. Exemptions are examined on an entity-by-entity rather than a group basis; a company that is owned by a regulated entity could fall within the scope of ATAD III if it is not regulated itself.
The substance of companies falling within the scope of ATAD III is tested on three key factors, referring to the preceding two tax years:
- More than 65% of the entity’s revenue is relevant income (including inter alia dividends, interest, royalties, real estate income, bank and financial activity, financial leasing, and services that are rendered through related companies);
- More than 55% of the entity’s relevant income derives or is paid out via cross-border transactions, or more than 55% of the book value of the company’s assets is located outside the jurisdiction of the entity;
- The company outsourced the administration of day-to-day operations and the decisionmaking on significant functions to a third party.
A company meeting the above conditions must declare, in its annual tax return, whether it meets the minimum substance indicators and must provide documentary evidence to support that declaration. The minimum substance indicators are that the entity has (i) its own premises (or premises shared with group entities), (ii)at least one active bank account or e-money account in the EU, and (iii) at least one (adequately qualified) director resident in the territory, who is not a director of more than four entities which are not associated, and/or the majority of full-time equivalent employees have their habitual residence in the company’s state of residence.
Groups with cross-border structures and payments must consider the impact of the proposals at an early stage
A company deemed to be a shell company may not benefit from double tax treaties and EU Directives and cannot obtain a tax residence certificate; taxation occurs at the level of the shareholders. The draft ATAD III also provides for a penalty of 2% and 4% of the company’s annual revenue for non-compliance failure and making a false substance declaration respectively. It is worth noting that the draft directive includes a look-back period of two years, making it imperative that groups with cross-border structures and payments, both intra-EU and between the EU and third countries, consider the impact of the proposals at an early stage.
