In mid-January 2023, the European Parliament approved the European Commission’s draft directive to prevent misuse of shell entities for tax purposes (known as ATAD 3, or the Proposed Directive), as amended by its Committee on Economic and Monetary Affairs. ATAD 3 introduces a number of indicators of minimum substance in order to assess whether an entity has no or minimal economic activity, which would result in a refusal of certain tax benefits. ATAD 3 is therefore expected to have a substantial impact on European holding structures.
1. Context
1.1 Introduction
In mid-January 2023, the European Parliament approved the European Commission’s draft directive to prevent misuse of shell entities for tax purposes (known as ATAD 3, or the Proposed Directive), as amended by its Committee on Economic and Monetary Affairs.
ATAD 3 introduces a number of indicators of minimum substance in order to assess whether an entity has no or minimal economic activity. In that case, the national tax authorities could deny a tax residence certificate, resulting in a refusal of certain tax benefits based on treaties or EU directives, such as the withholding tax exemption on dividends, interests or royalties.
If and when adopted, ATAD 3 will have a substantial impact on European holding structures. Unlike Pillar 2, ATAD 3 is not limited to international or domestic groups with global revenues exceeding EUR 750 million (cf. https://www.stibbe.com/publications-and-insights/pillar-two-a-new-reality-for-the-tax-position-of-mnes). It will therefore affect many small and medium-sized enterprises with an EU presence and will increase the administrative burden.
1.2 Next steps
The text as amended by the European Parliament cannot be considered a ‘final’ text since (i) the European Council is not bound by it and (ii) the European Council may itself still amend the Proposed Directive or even decide to ultimately not issue a directive at all.
Even though they are not binding, the European Council is likely to consider at least some of the proposed amendments, as they do meet some of the criticism on the initial proposal. The European Council will have the final vote on the Proposed Directive.
According to the Dutch Secretary of State for Taxation and Revenue Mr. van Rij, ATAD 3 will be on the agenda of the European Council Ecofin meeting of 16 May 2023.
1.3 Planned effective date: 1 January 2024
Even after the amendments of the European Parliament, Member States are meant to transpose ATAD 3 into domestic law by 30 June 2023, in which case ATAD 3 would therefore apply as from 1 January 2024. This is important because the analysis of sufficient substance (i.e., the “gateway test”) is based on the two previous tax years. This means that the facts and circumstances as at 1 January 2022 are taken into account in determining whether an entity will pass the gateway test.
However, the European Commission may relax the timeframe to some extent at a later stage, in light of the short timeframe for final adoption and subsequent implementation.
2. Shell company assessment
The amendments made by the European Parliament lower some gateway thresholds, bringing more entities into scope, but further clarify that the intra-group outsourcing of the administration of day-to-day operations and the decision-making on significant functions is not considered a gateway. The European Parliament has also removed the exemption for entities with at least five full-time employees or staff of their own, which will make it more difficult for some entities to fall outside the scope of ATAD 3.
2.1 Entities concerned (the “gateway test”)
ATAD 3 aims to target passive undertakings that are tax resident in an EU Member State and that do not conduct any economic activity because they are deemed not to have minimum substance.
If an undertaking crosses all three gateways, it is considered a risk and is required to meet certain information reporting requirements in its annual tax return:
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Passive element – More than 65% (75% in the initial version) of an entity's overall revenue in the preceding two tax years is ‘relevant income’. ‘Relevant income’ broadly covers passive income such as interest, including any other income generated from financial assets, such as crypto assets, royalties, dividends, income from immovable property, income from certain movable property with a book value exceeding EUR 1 million, income from services that have been outsourced to other associated enterprises, etc.
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Cross-border element – Over the course of the preceding two tax years, at least 55% (60% in the initial version) of the entity’s relevant income is earned through or paid out via cross-border transactions. Alternatively, more than 55% (60% in the initial version) of the book value of certain assets (mainly immovable property or movable property with a book value exceeding EUR 1 million) is located outside the Member State of the entity.
- Third-party outsourcing element – The entity concerned has outsourced the administration of day-to-day operations and the decision-making on significant functions in the preceding two tax years. Based on the initial version of ATAD 3, it was unclear whether this condition would be met if such services and functions were outsourced within the group. The European Parliament proposes to clarify this by only requiring outsourcing to “a third party”. This would be a welcome clarification for groups with such centralised functions.
Certain entities will still benefit from a carve-out and will be exempt from reporting obligations, even if all three elements are met. These entities notably include UCITS, AIFs, AIFMs and certain domestic holding companies. In short, such domestic holding companies benefit from the carve-out only if (i) their main activity is holding shares in operational businesses in the same Member State while their beneficial owners are also resident for tax purposes in the same Member State, or (ii) they are resident for tax purposes in the same Member State as the entity’s shareholder(s) or the ultimate parent entity.
It is worth mentioning that the Committee on Economic and Monetary Affairs had proposed introducing a carve-out also for entities owned by regulated financial undertakings that have as their object the holding of assets or the investment of funds. For the time being, this proposed amendment has not been retained in the version of the Proposed Directive that was approved by the European Parliament.
2.2 Annual reporting obligation
If an entity passes all three gateways, while none of the carve-outs apply, it will have to report through its annual tax return certain information (with documentary evidence) regarding the following indicators of minimum substance:
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Premises – the entity must have its own business premises in the Member State, or premises for its exclusive use. The European Parliament now adds that shared use of business premises by entities of the same group also counts;
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Bank account – the entity must have at least one active bank account or e-money account of its own in the EU through which the relevant income is received;
- Directors and employees – at least one of the following two requirements must be met:
- one or more directors of the entity concerned:
- are tax resident in the EU Member State in which the entity concerned is resident, or reside at a distance that it is compatible with the proper performance of their duties; and
- are authorised to make decisions in relation to activities that generate relevant income, or the assets of the entity concerned
Based on the initial proposal, directors were also required to use such authorisation actively and independently on a regular basis. In addition, the directors could not be employees or directors (or equivalent) of other non-associated enterprises. The European Parliament has deleted these requirements;
- the majority of the full-time equivalent employees of the entity concerned:
- have their habitual residence, as set out in Regulation (EC) No 593/2008, in the Member State of the entity concerned, or are resident or reside at a distance that it is compatible with the proper performance of their duties; and
- are qualified to carry out the activities that generate relevant income for the entity concerned.
Failure to comply with the reporting obligation triggers a penalty of at least 2% (5% in the initial version) of the revenue of the entity concerned. In the event of a false declaration, an additional penalty of at least 4% of the entity’s revenue would be due. In order to also target deemed shell entities with zero or low revenue, the European Parliament suggests adding that for such entities the penalty should be based on their total assets (instead of revenue).
2.3 Rebuttal of presumption or evidencing exemption
If an entity lacks substance in one of these indicators or fails to provide adequate supporting documentation, that entity is presumed to be a shell entity.
However, an entity has the right to rebut this presumption. It can do so by providing any additional evidence of the business activities which it performs to generate relevant income such as the. business rationale for setting up an entity with a low level of substance, information about the employees’ profiles (including their level of experience, decision-making power, qualifications, etc.) and concrete evidence that the decision-making concerning the activity generating the relevant income is taking place in the entity’s Member State.
In addition, an entity can also request an exemption from the reporting requirement under the gateway-test if its existence does not reduce the tax liability of its beneficial owner(s) or of the group as a whole, i.e. its interposition does not lead to a tax benefit for them.
If the tax authority accepts the entity’s rebuttal or request for exemption, the rebuttal or exemption is valid for the tax year and may remain valid for an additional five years, if the factual and legal circumstances of the entity remain unchanged.
The European Parliament adds that a request for rebuttal or exemption should be processed by tax authorities within nine months and will be considered approved if the respective tax authority fails to decide within this period. This should make it easier for businesses to obtain clarity in a timely manner.
2.4 Consequence: no tax certificate resulting in the loss of tax advantages from tax treaties and EU law
If the entity cannot rebut this presumption, it will not receive a certificate of tax residence from its EU Member State of residence. 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),
In the initial proposal, EU Member States would still be able to issue a certificate of tax residence that would state, however, that the entity is not entitled to certain benefits. The European Parliament removed this possibility in the amended proposal.
2.5 Exchange of information regardless of classification as a shell
Regardless of whether the entity is classified as a shell, the reported information will be exchanged automatically.
Even if the entity were not considered a shell, the compliance obligation and the exchange of information could trigger additional costs. Avoiding the reporting obligation by not meeting all three gateways will therefore become increasingly important.
3. Further initiatives to restrain use of shell entities and aggressive tax planning
In addition to ATAD 3, the European Commission is also working on a new taxation package intended to further restrain the use of shell entities and aggressive tax planning. This includes the Securing the Activity Framework of Enablers initiative, the so-called SAFE initiative (as a supplement to the ATAD 3 proposal by targeting enablers setting up structures using non-EU shell entities). The European Commission is expected to issue a draft directive in this respect. The new taxation package also includes the FASTER proposal, aiming to introduce a new EU-wide system for withholding tax in order to prevent tax abuse in the field of withholding taxes. The European Commission aims to adopt a directive proposal for a more efficient withholding tax relief procedure in the EU in the coming months.
Since both initiatives may have an important impact, the existing structures should be carefully checked on a case-by-case basis prior to the relevant date of entry into force. Stibbe’s tax team is available to help you in your assessment of the impact of these measures on your structures and operations. We will keep you informed of further developments.
Other Stibbe Insights in this respect:
Christophe Martin-Raynaud
Senior Associate Luxembourg
Johan Léonard
Partner Luxembourg
