The European Union's regulation of “shell companies” begins with the Commission's Proposal for a Directive No. 565 of 22nd December 2021, in order to establish standards for companies that have in fact been unregulated for a very long time.
The (at the time preliminary) proposal for a directive was thus approved with 97% of the votes in the European Parliament in the middle of last January.
Amongst technical uncertainties and the date of implementation, the so-called “Unshell” or “ATAD 3 (Anti-Tax Avoidance Directive)” contains a regulatory framework, which, once implemented, will enable Member States to prevent, detect and combat the misuse of shell companies for tax purposes.
However, let us see how and why this proposed directive and its repercussions were arrived at.
What is the goal of ATAD 3?
The purpose of the ATAD3, which is planned to enter into force on 1st January 2024, is to identify companies that over the years have repeatedly misused the tax exemptions and/or tax benefits provided by the EU Parent-Subsidiary Regime, the EU Interest and Royalties Regime, and double taxation treaties, by disallowing them tax breaks and legal benefits.
In fact, these entities often also took advantage of double “non-taxation” by both Member States concerned.
The objective of the directive, therefore, is to implement appropriate and useful measures to promote a solid, efficient and fair tax system in the EU itself.
What are shell companies and to which companies the ATAD 3 directive will apply
By definition, shell companies are those entities that are “non-operational”, i.e. they do not carry out an actual business activity and do not meet entrepreneurial requirements. Instead, they pursue other purposes, such as merely holding and/or managing assets on behalf of the economic beneficiary.
According to Article 1, all companies that are part of the European Community (with the exception of certain regulated entities such as banks, insurance companies, investment funds, and quoted companies) are subject to this directive by being are qualified as tax resident and eligible for a tax residence certificate in a Member State.
A first step in the application of the directive is to verify that a company simultaneously satisfies the indicators known as the “gateway test” governed by Article 6 of the draft directive and are as follows:
- The majority of the income comes from passive sources such as interest, royalties and dividends (so-called passive income) in the last two tax years, i.e. more than 65% of its income or more than 75% of its assets consist of real estate and movable property for the use of its shareholders;
- The Company has been mainly involved in cross-border activities in the two last tax years (operates more than 60% outside its Member State)
- Day-to-day management and decision-making is not carried out at the company's head office.
If these requirements (gateway test) are not meet, a company is not presumed shell companies and therefore there is no further obligation beyond year-end reporting.
If these requirements are met, the company is presumed to be a shell company. Hence, the company is required to provide adequate documentation to support its year-end tax declaration.
Potential implications and sanctioning consequences for shell companies
Once it has been proven that the entity is a shell company, it will have to provide some supporting evidence (by means of documentary evidence) of what it has indicated in its annual tax return the so-called genuineness requirements (or substance test) and they are:
1. Availibility of physical offices in the country of the company's tax residence;
2. Availability of an active bank account within the European Union;
3. An effective administrative organization. On the one hand, directors of the company will have to be resident in the same country of residence of the entity and have skills that are compatible with the activity carried out by the company. On the other hand, the company will have to prove that it has employees dedicated to its activity.
If these three requirements of the substance test are met, you will be able to apply for the non-application of the penalty of the directive and will not be considered a shell company (Article 8 of the draft directive).
A company that does not meet these three requirements incurs various consequences for tax purposes (Chapter III of the draft directive).
A first implication is the refusal of the granting of the tax residence certificate by the Member State of residence. This denial, should not call into question the national rules of the company's Member State regarding tax residency and related obligations. However, denies the company access to the directives and treaty benefits.
For clarification, they do not change the tax residency of the shell company or prevent that Member State from taxing the structure. Indeed, a tax residence certificate is issued.
This certificate certifies that the company is not entitled to the benefits of agreements and treaties concerning the elimination of double taxation on income, capital, and international agreements with similar purposes or effects, as well as Articles 4, 5 and 6 of Directive 2011/96/EU (Parent Subsidiary Directive) and Article 1 of Directive 2003/49/EC (Interest and Royalties Directive).
A further consequence in order to decrease the use of shell companies by their shareholders is the application of financial penalties (Chapter IV of the proposed directive).
The administrative-tax authorities of the shareholder's Member State of residence may claim against it for that part of the profits, on which no taxation has in fact been applied.
The penalties foreseen will be effective, proportionate and dissuasive, and in practice, equal to 5 % of the turnover of the company in the relevant tax year, if the entity itself does not comply with the minimum disclosure requirements or if it makes a false declaration in this respect (so-called “look-through” principle).
If the company has no or low revenues compared to the actual tax liability, it may also have its assets taxed.
ATAD 3 Regime Roadmap
The European Community has indeed set a rather ambitious timeframe for the application and implementation of ATAD 3 by the Member States.
The EU Council will now have the final word on the adoption of ATAD3, and the goal is still officially to have the EU Member States implement ATAD3 in their national legislation, in order to make the directive effective from 1st January 2024.
It is important to emphasize that the ATAD3 is adopted according to the special legislative procedure with consultation, which means that its adoption is subject to the unanimous vote of all Member States, which, however, is not guaranteed today.
In fact, some Member States are reportedly reluctant to apply the sanctions regime, and in favor of limiting the consequences to the denial of benefits under EU directives only, eliminating any reference to tax consequences, e.g. Sweden.
As of today, the timing of the EU Council vote is not yet known, but no change on the date of entry into force has been made.
ATAD 3 outstanding points
All Member States are generally in favor of a rule limiting the misuse of shell companies within the EU, although there are still several arguments that would need more clarity from the European legislator.
A first point relates to the tax consequences, which are not yet clear, where a non-EU country is involved and which could lead to double taxation. In this case, there is a lot of uncertainty as to whether a financial penalty will be imposed and to what extent.
Another unclear point concerns how national legislators will transpose the directive. Indeed, it is assumed that there will be a fragmented implementation, with a shift of entry into force to 1st January 2025. Although, in other cases, Member States have simply adopted the text of the directives largely unchanged, as in the case of DAC 6. In addition, Members States legislative guidelines could lead to differences in interpretation, e.g. in relation to gateway tests and the question whether an agreement gives rise to a tax benefit.
Finally, the effect of ATAD 3 on the management of compliance costs of corporate groups operating across the EU with regard to the burden of proof, especially for larger structures, should not be underestimated. It tends to be the case that when the current anti-abuse provisions apply, it is up to the tax authorities to prove that the entity under scrutiny is a kind of empty box. With the implementation of ATAD3, however, it will be up to the taxpayer itself to prove that it is not a shell company, based on the criteria set forth in the directive. Moreover, for the company under consideration, it will not be possible to avoid the automatic exchange of information between Member States, thus triggering potential additional risks related to the denial of the benefits of the directives and conventions.
The same burden will not only be borne by the company defined as a shell company, but also by the administrative and tax authorities, which will have to provide the appropriate resources to verify the documentation provided by the company, which, without the application of the directive, it would not have had to provide.
It could therefore happen that some Member States oppose the unanimity required for the adoption of the rule.
In conclusion, given the considerable impact on companies conducting business in the European Union and the legislator's aspiration to have the directive enter into force soon, International groups and companies that might fall within the scope of ATAD 3, must urgently assess the implications of these rules on their corporate structure and any changes to be done.