European Commission publishes draft Directive to prevent the misuse of shell entities
On 22 December 2021, the European Commission (EC) published a draft Directive as part of its fight against the use of entities that do not perform any economic activity, so-called shell entities, and which are assumed to be used for improper tax purposes. In spite of representations to the contrary, the EC has specifically stated that this particular initiative is needed notwithstanding the plethora of other initiatives taken over the last few years.
Any entity that is considered to be tax resident and carrying on an economic activity in the EU is considered to be an “undertaking” and thus in scope. To be noted is that there is no minimum threshold as is the case for other initiatives, for example the minimum tax proposals known as Pillar 2.
However, an undertaking will only have reporting obligations if it is not specifically excluded (there is a lengthy list) and if it meets each of three criteria, referred to as “gateways” and being:
- It has a certain level of income that is considered to be inherently mobile, referred to as “relevant income”
- It engages in a certain level of cross border activity
- It outsources the administration of day to day operations and the decision making on significant functions
Undertakings that pass through these three gateways are required to include in their annual tax returns information as to whether they satisfy the following minimum substance criteria (with suitable evidence):
- It has its own premises or has exclusive use of premises in its country of residence
- It has at least one active bank account in the EU
- It has either at least one local executive director with a certain level of qualification and authority or a majority of its employees are locally resident and have suitable qualifications
Meeting these criteria creates a presumption of having minimum substance. Not meeting them creates a presumption the other way although there will be scope to rebut the presumption.
An undertaking may seek exemption from any reporting where its existence is tax neutral.
The consequences of not having minimum substance involve largely depriving the structure containing the undertaking of any tax benefits that might otherwise arise from its existence. This will involve treating the undertaking as transparent although it will continue to be treated as a taxpayer under its local rules.
Once adopted by Member States (by no later than 30 June 2023), the proposals should come into force as of 1 January 2024.
It would appear that there is a period of 8 weeks from the date of publication of the draft for the submission of comments on the draft. One area that may receive attention is the use of holding companies. However, what is unlikely to happen is that the number of areas of imprecise drafting is likely to remain. It is hoped that member states will issue detailed guidance on the practical implementation of the Directive.
The press release can be found here.
The FAQs can be found here.
The draft Directive can be found here.