On 22 December 2021, the European Commission (“EC”) published a proposal for a directive to prevent the abuse of shell entities for improper tax purposes (hereafter: “ATAD3 Directive”). The ATAD3 Directive is expected to enter into force on 1 January 2024, whereby a two-year look-back rule is in place.
At first sight, the directive seems to target substance-less shell entities, often managed by corporate service providers. However, upon closer inspection of the details of the proposal, the directive may have a broader scope and (unconsciously) target all kinds of businesses, applying more often than probably expected. For example, private equity as well as fund structures and multinationals that make use of central management companies (from which activities are performed for the rest of the group) may also be in scope. Is this an (unintended) overkill?
Here we further discuss the details of the ATAD3 Directive and our takeaways.
What are shell entities?
The draft ATAD3 Directive introduces the following three “gateway” criteria to determine whether a shell entity is in place:
- Relevant income: more than 75% of a company’s revenue (in the previous two tax years) should consist of passive and mobile income, such as royalties, dividends and income from assets.
- Cross-border activities: at least 60% of the relevant income is received or paid via cross-border transactions.
- Relevant functions/day-to-day management: the entity has outsourced the administration of day-to-day operations and the decision making on significant functions.
If all three gateways are met, the entity is considered a shell entity and is subject to further reporting obligations. This reporting obligation requires the shell entity to include specific information about its substance in its tax return (e.g. own premises, own active EU account, a qualified director, employees).
If the minimum substance indicators are not met, the entity will qualify as a presumed abusive shell entity for the purposes of the ATAD3 Directive. In practice, this means that certain tax benefits may be denied. Furthermore, we note that in-scope entities can provide counter evidence in cases of assumed misuse.
Some further remarks and takeaways
For more details of the proposed ATAD3 Directive, we refer to a publication of our European Tax Law Center
We have listed below some questions and takeaways that we identified when discussing the possible impact of the ATAD3 Directive with our clients.
- It is currently uncertain how “outsourcing of administration and day-to-day management” should be interpreted. Does this only cover external outsourcing (e.g. corporate service providers), or also outsourcing to group companies? We note that the Netherlands has issued a formal response to the ATAD3 Directive in which only outsourcing to third parties was mentioned. However, looking at the preamble of the draft directive, this also seems to cover outsourcing to group companies. This may, under circumstances, lead to an overkill.
- Furthermore, we wonder how the ATAD3 Directive relates to existing tax treaties with non-EU countries; is there a treaty override? The fact that the EU intrudes into the tax treaties concluded between Member States and third countries appears to be a very liberal approach, going beyond what the EU is actually permitted to do under its own founding treaties.
- The next question is whether the ATAD3 Directive may have an impact on participation exemption regimes (e.g. in the Netherlands), in the case of insufficient substance at the level of the EU subsidiary/shell company. One may expect that the existing participation exemption regime in the EU will be re-examined (sharpened) for such cases.
- Moreover, some governments already expressed their concerns on the short deadline for the exchange of information (only 30 days).
- Finally, the proposal provides a 5% penalty (of the entity’s turnover) for late (or false) filings. One may wonder whether such a penalty should be linked to an entity’s turnover, instead of e.g. its income.
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