Progress bar
Insight

ATAD III Proposals - key changes

Insight 13 January 2022

ATAD III Proposals - key changes

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.

7 steps

ATAD III introduces 7 steps to understand the requirements behind shell entities:

  1. Undertakings that should report (due to being found to be ‘at risk’)
  2. Reporting
  3. Possibility of gaining exemption from reporting for lack of tax motives
  4. Presumption of lack of minimal substance
  5. Possibility of rebuttal
  6. Tax consequences
  7. Exchange of information automatically and tax audit

Relevant Income

  • interest or any other income generated from financial assets[1]
  • royalties or any other income generated from intellectual or intangible property or tradable permits
  • dividends and income from the disposal of shares
  • income from financial leasing
  • income from immovable property
  • income from movable property (other than cash), shares or securities, held for private purposes and with a book value higher than €1Mn
  • income from insurance, banking and other financial activities
  • income from services which the undertaking has outsourced to other associated enterprises

Associated enterprise

  • Participating in the management of another person[2] by exercising significant influence
  • Holding 25% or more voting rights of another person
  • Holding 25% or more capital of another person
  • Being entitled to 25% or more of the profits of another person

[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.

Which entities are not considered as reporting undertakings?

Undertakings falling within any of the below are not subject to reporting requirements.

  1. Companies which have a transferable security admitted to trading, or listed on a regulated market or multilateral trading facility.
  2. Regulated financial undertakings:
    • Credit institutions and MiFID II investment firms
    • AIFMs, including EUVECA, EUSEF, ELTIF managers and AIFs
    • UCITS managers and UCITS
    • Solvency II insurance and reinsurance undertakings, insurance holding companies or a mixed financial holding company that is part of an insurance group subject to supervision group level.
    • Institutions for Occupational Retirement Provision
    • Pension institutions operating pension schemes considered to be social security schemes[1]
    • Central counterparties
    • Central Securities Depositories
    • Insurance or reinsurance special purpose vehicle
    • Securitisation Special Purpose Entities
    • Payment institutions and electronic money institutions
    • Crowdfunding Service Providers
    • Crypto-Asset Service Providers, where performing one or more crypto-asset services within the MiCA Regulation
  3. Undertakings with the main activity of holding shares in operational businesses in the same Member State, while their beneficial owners are also tax resident in the same Member State.
  4. Undertakings with holding activities that are tax resident in the same Member State as the undertaking’s shareholder(s) or the ultimate parent entity.
  5. Undertakings with at least 5 own full-time equivalent employees exclusively carrying out relevant income generating activities.

Gateway

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:

  1. Own premises (or premises for its exclusive use) in the Member State,
  2. One own and active bank account in the EU
  3. One of the following indicators:
    1. One or more directors:
      • Tax resident in the Member State of the undertaking[1]
      • Qualified and authorised to take decisions on activities that generate relevant income for the undertaking or in relation to the undertaking’s assets
      • Actively, independently and regularly use the authorisation referred to above
      • Are not employees of an enterprise that is not an associated enterprise and do not perform the function of director or equivalent of other enterprises that are not associated enterprises
    2. The majority of the undertaking full-time equivalent employees are tax resident in the same Member State as the undertaking[2], and such employees are qualified to carry out the relevant income generating activities

An undertaking not meeting any one indicator will then be presumed to be a “shell entity”.

Supporting information

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:

  • A document allowing to determine the commercial rationale behind the undertaking’s establishment.
  • Information about the employee profiles, including the level of their experience, their decision-making power in the overall organisation, role and position in the organisation chart, the type of their employment contract, their qualifications and duration of employment.
  • Evidence that decision-making concerning the activity generating the relevant income is taking place in the undertaking’s Member State.

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.

Exemptions

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.

Administrative consequences

  • Denial of requests for tax residence certificates for use outside the jurisdiction of this Member State.
  • Granting of a tax residence certificate with, however, wording specifying that the undertaking is a shell entity, and the potential outcome for such entity not to be eligible to the benefits tax treaties.

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.

Other insights from Paul Séjournant

Image
Insight 4 August 2022
Bringing new insights to regulatory compliance: Private Funds CFO feature
Card link - Go to a specific page
Image
Insight 2 August 2022
Q2 2022 regulatory update
Card link - Go to a specific page
Image
Insight 29 July 2022
Update on the Trust Registration Service
Card link - Go to a specific page