EU Commission pushes for further (anti-avoidance) initiatives in direct corporate taxation

Flash
2 February 2022

The European Commission tried to end 2021 with a bang, as it proposed two tax Directives simultaneously on 22 December. The first proposal aims to tackle the misuse of shell entities (the “Unshell Proposal”). The second focuses on the implementation at the EU level of the so-called Pillar 2 agreement reached by OECD/G20 countries in October 2021 with a view to a minimum level of taxation for multinational groups (the “EU Pillar 2 Proposal”).

The Unshell Proposal

The Unshell Proposal is one of many initiatives taken at the EU level aiming at combatting tax avoidance and evasion (such as, for instance, the Anti Tax Avoidance Directives and various amendments to the Directive on Administrative Cooperation) and at protecting the Member States against harmful tax practices of third countries (by drawing up a list of non-cooperative jurisdictions).

This Proposal is based on a threefold approach: identification of shell entities, denial of certain tax benefits to them, and mandatory exchange of information. To this end, the Proposal introduces a “substance test” to identify “shell companies” used for avoiding or evading direct corporate taxation. Simply put, the Commission intends to curb schemes whereby undertakings that do not effectively perform any economic activities (even if they are engaged in an economic activity) and do not have any minimal economic substance are set up within the EU in order to lower the overall tax liability of the group or its beneficial owner.

The Directive would apply to all undertakings that are considered tax resident in a Member State, including legal arrangements like partnerships that would qualify as a tax resident of a Member State. Strangely enough, the Proposal does not concern permanent establishments within the EU of entities established in third countries – a separate initiative is expected in this respect.

The Proposal lays down seven steps allowing the identification of entities without any minimal substance that are misused for tax purposes and providing for tax sanctions:

In the first step, three cumulative conditions are provided to identify “risk cases” (linked to certain types of revenues, cross-border activities and outsourcing the decision-making on significant functions or the management of day-to-day activities). Exceptions are provided for listed and regulated entities (financial and credit institutions, various investment funds and undertakings, insurance companies, etc.), holding companies investing in operational companies that are tax resident in the same Member State and whose beneficial owners also have their tax residence in the same State, holding companies resident for tax purposes in the same Member State as their shareholders or ultimate parent entity, and entities employing at least five own FTEs or staff members exclusively carrying out the activities generating the relevant income.

Under the second step, the identified “risk undertakings” must report on their substance in their tax return and submit satisfactory documentary evidence. This reporting should focus on specific minimum substance indicators. The Commission identifies three crucial indicators: the availability of premises, the holding of an own and active bank account in the EU, and the residency of a director close to the undertaking.

In the third step, the Member State evaluates the report. If at least one of the minimum substance indicators is lacking, the undertaking is presumed to be a “shell”.

However, in the fourth step, the undertaking has the right to rebut this presumption with concrete evidence.

Also, the fifth step grants an undertaking the opportunity to request an exemption from the Directive’s obligations if its existence does not reduce the tax liability of its beneficial owners or the group.

If the presumption is not rebutted, the sixth step provides for tax consequences for the shell entity, such as denial of the tax advantages from double tax treaties, the Parent-Subsidiary Directive and the Interest & Royalties Directive.

Finally, in the seventh step, the Commission proposes an automatic exchange of information and grants Member States the right to request tax audits.

The Commission proposes to apply the provisions of the Unshell Directive from 1 January 2024 (national transposition by 30 June 2023). However, the proposal must first be unanimously approved within the Council. Nevertheless, the Commission seems hopeful, as it has already indicated that it will present an initiative regarding non-EU shell entities later this year.

 

EU Pillar 2 Proposal

Through the second proposed Directive, the Commission “translates” the OECD Pillar 2 Model Rules for use in the EU. The proposal applies to entities located in the EU that are members of a group with a consolidated annual revenue of at least EUR 750 million. Both multinational and large-scale domestic groups are targeted. However, certain entities are excluded, such as pension funds. Furthermore, to reduce compliance burdens in low-risk situations, the Commission proposes to apply a de minimis exclusion.

In line with the agreement at OECD level, the EU Pillar 2 Proposal aims at ensuring a minimum level of taxation of 15% in jurisdictions where the group operates. To achieve this goal, firstly, an “Income Inclusion Rule” (IIR) is presented. When a constituent entity is taxed at a low rate in a given jurisdiction, the group must pay a top-up tax in order to reach the threshold of 15%. Secondly, the Commission proposes an “Undertaxed Payments Rule” (UTPR). Under this UTPR, top-up tax will be applied, for instance, when the ultimate parent company is located in a third country that does not impose the global minimum tax rate.

Furthermore, the Proposal contains a filing obligation for constituent entities located in EU Member States. They must file a top-up tax information return with their tax administration. This return must include information concerning the multinational group that they are part of, such as the information that is necessary for the calculation of the top-up tax.

The proposed Directive will require unanimous approval within the Council. Although the Commission does not expect this to be an obstacle, as all Member States (except Cyprus) formally support the OECD agreement on Pillar 2, finance ministers from Estonia, Hungary and Poland have recently expressed serious concerns about the envisaged timetable and requested that the Proposal should be made conditional on the rollout of a global tax on the world’s largest 100 enterprises as agreed at OECD level. These Member States fear that the US will not follow the initiative, leaving the EU at an economic disadvantage. The Commission proposes to apply the provisions from 1 January 2023 (national transposition by 31 December 2022), with the exception of the UTPR which is to be applied as of 1 January 2024. The question remains whether this timing is still realistic.

Should you have any questions in this respect, please do not hesitate to reach out to your usual contact in our tax team.