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).
The Directive will cover all legal forms of entities resident for tax purposes in the EU, without any revenue thresholds, and will therefore have 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 EUR750 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.
The proposal lays down a seven-step substantive test to help Member States identify such entities. In addition, the proposal attaches tax consequences to entities that do not have a minimal substance (“shell entities”). It 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 higher-risk entities.
An entity without a significant economic presence (“shell entity”) is defined based on the following three economic substance indicators:
- Is the bulk of the entity’s income passive (dividends, interest on bonds, etc)?
- Are the 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.