On 23 December 2021 the European Commission published the third Anti-Tax Avoidance Directive (hereinafter: “ATAD 3”).
The purpose of ATAD 3 is to prevent tax abuse of shell companies, letterbox companies and flow-through companies.
Legal entities lacking the minimal substance and economic activity continue to pose risk of being used for improper tax purposes, such as tax evasion and tax avoidance.
The European Commission admits that there may be valid reasons for the use of such entities but it is necessary to take 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. This leads to a lower taxpayers’ overall tax liability.
ATAD 3 introduces a filtering system for the entities in scope, which have to comply with a number of indicators. These levels of indicators constitute a type of “gateway”. ATAD 3 sets out three gateways (explained below). If a company crosses all three gateways, it will be required to annually report more information to the tax authorities through its tax return
STEP 1: Does the entity fall within the scope of ATAD 3? (Self-Assessment)
The scope of ATAD 3 is broad and covers all undertakings that are considered a tax resident and are eligible to receive a tax residence certificate in a Member State.
STEP 2: Does the entity cross all 3 gateways? (Self-Assessment)
Once it has been established that the entity falls within the scope of ATAD 3, the entity must self-assess whether it meets the cumulative gateway criteria.
- CRITERIUM 1: more than 75% of the revenues accruing to the undertaking in the preceding two tax years is relevant income.
- CRITERIUM 2: the undertaking is engaged in cross-border activity on any of the following grounds
- more than 60% of the book value of the undertaking’s assets that fall within the scope was located outside the Member State of the undertaking in the preceding two tax years;
- at least 60% of the undertaking’s relevant income is earned or paid out via cross-border transactions;
- CRITERIUM 3: in the preceding two tax years, the undertaking outsources the administration of day-to-day operations and the decision-making on significant functions.
- This does not mean general outsourcing, however it concerns outsourcing of key functions of the entity.
STEP 3: Does the entity fail to meet all three substance indicators?
Once the entity passes the three gateways, the entity must report the following in its tax return:
(i) if the undertaking has own/exclusive premises in a Member State;
(ii) if the undertaking has at least one own active bank account in the EU;
(iii) if the undertaking’s directors or full-time employees are appropriately qualified and resident close to the undertaking
All of the above must be substantiated with a satisfactory documentary evidence.
If the entity does not meet the minimum substance or it does not provide satisfactory documentary evidence, the entity is deemed to be a “shell”.
Under conditions, the entity may request an exemption from its obligations under the ATAD 3.
The entity is deemed a shell. What’s next?
If the entity is considered to be a shell, several tax consequences will occur.
- In regards to relevant income:
- Member State disregards tax treaties concluded with Member State of the shell.
- Member State of the shareholder taxes the income and deducts any tax paid at the Member State of the shell or at source.
- If the tax payer is outside the European Union, the Member State of the shareholder shall tax the income of the shell as if it had directly accrued to the shareholder.
- If the shareholder is outside the European Union, the Member State of the payer shall apply withholding tax in accordance with its national law.
- In taxing the income, Member State shall take into account tax treaties with non-EU countries.
- In regards to property:
- Immovable property owned by the shell:
- shall be taxed in the Member State where it is situated.
- for income tax purposes, shall be considered as owned directly by the shareholder and as such form part of the tax
base in the Member State of the shareholder.
- Movable property of high value owned by the shell shall be considered as owned directly by the shareholder and taxed by the Member State of the shareholder.
- Tax treaties will remain applicable.
To facilitate the implementation of these consequences, the Member State of residence of the company will either deny the shell company a tax residence certificate or the certificate will specify that the company is a shell.
- Immovable property owned by the shell:
Can a company deemed to be a shell contest this decision?
Entities that do not meet all substance indicators will still have the opportunity to rebut the presumption of being a shell. They will have to present additional evidence, such as detailed information about the commercial, non-tax reason of their establishment, the profiles of their employees and the fact that decision-making takes place in the Member State of their tax residence.
From when?
The ATAD 3 is expected to enter into force on 1 January 2024 and should be implemented by the Member States by 30 June 2023.
It must, however, be noted that the ATAD 3 substance test includes a look-back period of two years. The substance test may therefore apply as of 1 January 2022.
If you want to verify if ATAD 3 would have any implications to your situation, please feel free to contact us.
The information herein is general in nature and cannot be considered as advice.
