A proposal for a new EU Directive to combat „shell entities” for tax purposes

On 22 December 2021, the European Commission published a proposal for a Directive laying down rules to prevent the misuse of shell entities for tax purposes and amending Directive 2011/16/EU. This is the second action point of the European Commission's new tax concept, Business in Europe: Framework for Income Taxation (BEFIT - more details: here), which aims to combat shell entities for tax purposes.

The Directive will cover all legal forms of entities and legal arrangements resident for tax purposes in the EU, without any revenue thresholds, and will therefore has a broader scope than the future minimum tax rate Directive, which will initially cover only multinational groups and individual companies with consolidated turnover of at least EUR 750 million.

The Directive aims to discourage specific schemes of tax avoidance or tax evasion which involve establishing companies which are tax resident in the EU, but which in reality do not carry out any economic activity; their sole purpose is to enable certain tax benefits to flow to their beneficial owner or the group of companies which they belong to. For example, a financial holding company may collect all the payments from the financial activities of companies operating in different EU Member States, taking advantage of the exemption from withholding tax under the Interest and Royalties Directive, and then pass on this income to a related company in a low-tax third country jurisdiction, exploiting favourable tax treaties or even the domestic tax laws of a particular Member State.

The directive proposal lays down a 7-step substantive test to help Member States identify such entities. In addition, the draft Directive attaches tax consequences to entities that do not have a minimal substance ("shell entities"). The directive proposal also provides for automatic exchange of information and for the potential request by one Member State to another to initiate a tax audit of a wider range of entities that are considered to be higher risk (because they fulfil certain conditions), but have not necessarily failed the substantive test.

An entity without a significant economic presence ("shell entity") is defined on the basis of the following three economic substance indicators:

• Is the bulk of the entity’s income passive (dividends, interest on bonds, etc)?
• Are a majority of transactions cross-border?
• Are management and administration outsourced?

If the answer is ‘yes’ in all three cases, the entity will qualify as an entity without a substantive economic presence and will be subject to new tax reporting obligations related to economic substance of its activities. If an entity fails at least one of the substance indicators, it will be presumed to be a shell and, until the presumption is rebutted, will not be able to benefit from tax advantages intended to support real economic activity.

Once the proposal is adopted as a Directive, its provisions should be transposed into Member States’ national law by 30 June 2023 and come into effect as of 1 January 2024.

13 January, 2022

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This newsletter provides general information and does not constitute tax advice