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On 22 December 2021, the European Commission issued its proposal for “laying down rules to prevent the misuse of shell entities for improper tax purposes and amending Directive 2011/16/EU”, or more commonly, ATAD III.
The main purpose of the Directive is the prevention of the use of shell companies for tax evasion and tax avoidance purposes. With recent EU estimates on tax losses relating shell entities at €23Bn[1] per annum, the introduction of ATAD III aims to create a common framework to identify such entities, allow Member States to exchange information and create common sanctions. Scheduled to become effective in 2024, the Directive will go under a review period until February 2022.
The rules, in their current form, are set to have a significant impact on investment funds which have traditionally been relying on holding companies in several key EU jurisdictions such as Luxembourg and the Netherlands.
[1] Commission Staff Working Document – Executive Summary of the Impact Assessment Report Accompanying the Document Proposal for a Council Directive laying down rules to prevent the misuse of shell entities for tax purposes and amending Directive 2011/16/EU.
The Directive is broad and captures all undertakings that can be considered tax resident in a Member State, regardless of their legal form.
ATAD III introduces 7 steps to understand the requirements behind shell entities:
Relevant Income |
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Associated enterprise |
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[1] Includes crypto-assets
[2] Persons mean both legal and natural persons
All non-exempt undertakings which cross the below “gateway” will be considered “risk cases” and required to report to their national tax authorities.
Undertakings falling within any of the below are not subject to reporting requirements.
All three conditions above must be met for an undertaking to be considered a “risk case”. Undertakings that only meet some or none of the gateways are considered “low-risk cases”. Given the proposal’s target effective date is set for 1 January 2024, relevant entities that could potentially be in scope will need to start assessing their substance from 1 January 2022.
[1] as well as any legal entity set up for the purpose of investment of such schemes
Undertakings that cross the “gateway” will need to declare annually, in their tax returns, whether they meet the below indicators of minimum substance:
Undertakings shall accompany their tax return declaration with documentary evidence as shown below
[1] or within commuting distance
[2] or within commuting distance
Undertakings that are presumed to be shell entities will have the opportunity to rebut the presumption by providing supporting evidence, as shown below:
The undertaking must prove that it had continuous control and borne the risks relating to relevant income[1] generative activities. Importantly, and to reduce administrative burdens, a successful rebuttal will be valid for five years after the rebuttal.
An undertaking may request an exemption from the Directive if it can prove that its existence does not reduce the tax liability of its beneficial owner(s) or of the group, as a whole, of which the undertaking is a member.
[1] Or assets, if there is no income.
Once an undertaking is presumed to be a shell and does not rebut that presumption, the Directive introduces tax consequences. These are meant to be proportionate and disallow the tax advantage obtained (or which could be obtained). They can be divided between administrative and actual tax consequences.
The Directive proposal lays out four scenarios, which we have summarised below:
Scenario | Entity | EU? | Consequences |
Scenario 1 Shell and shareholder in scope of the Directive | Source / payer | No | May apply domestic tax on the outbound payment or may decide to apply the treaty in effect with the EU shareholder jurisdiction. |
Shell | Yes | Will continue to be resident for tax purposes in the respective Member State and will have to fulfil relevant obligations as per national law, including by reporting the payment received. May also need to provide evidence of the tax applied on the payment. | |
Shareholder | Yes | Shall include the payment received by the shell undertaking in its taxable income and may be able to claim relief for any tax paid at source in accordance with the applicable treaty with the third country. Will also consider and deduct any tax paid by the shell. | |
Scenario 2
All jurisdictions in scope of the Directive | Source / payer | Yes | Will not have a right to tax the payment but may apply domestic tax on the outbound payment if it cannot identify whether the undertaking’s shareholder(s) are in the EU. |
Shell | Yes | Will continue to be resident for tax purposes in the respective Member State and will have to fulfil relevant obligations as per national law, including by reporting the payment received. May also need to provide evidence of the tax applied on the payment. | |
Shareholder | Yes | Will include the payment received by the shell in its taxable income, as per the national law and may be able to claim relief for any tax paid at source, including by virtue of EU directives. Will also consider and deduct any tax paid by the shell. | |
Scenario 3 Only source and shell in scope of the Directive | Source / payer | Yes | Will tax the outbound payment according to treaty in effect with the third country shareholder’s jurisdiction, or in accordance with its national law (if no treaty). |
Shell | Yes | Will continue to be resident for tax purposes in a Member State and will have to fulfil relevant obligations as per national law, including by reporting the payment received. May also need to provide evidence of the tax applied on the payment. | |
Shareholder | No | While not compelled to apply any consequences, it may be asked to apply a tax treaty in force with the source Member State to provide relief. | |
Scenario 4 Only shell in scope of the Directive | Source / payer | No | May apply domestic tax on the outbound payment or apply tax according to the tax treaty in effect with the third country jurisdiction of the shareholder(s) if it wishes to look through the EU shell entity. |
Shell | Yes | Will continue to be resident for tax purposes in a Member State and fulfil relevant obligations as per national law, including by reporting the payment received; it may be able to provide evidence of the tax applied on the payment. | |
Shareholder | No | While not compelled to apply any consequences, it may be asked to apply a treaty in force with the source jurisdiction to provide relief. |
The proposals include provisions for information, starting from the first step and including rebuttals and exemption assessments, to be exchanged between Member States without the need for a recourse to request such information. Such information would be exchanged via a Central Directory.
The proposal includes a minimum penalty of 5% of the undertaking’s turnover in the relevant tax year.
