This proposal serves the purpose of discouraging the use and creation of shell companies within the EU. Stricter substance requirements are laid down and if these conditions are not met, the benefits of tax treaties could be denied, resulting in a higher withholding tax burden and in some cases even to penalties.
The new Directive aims to target companies in the EU with limited operational substance and especially entities that have engaged third party service providers to act as the management of the company in order to meet the current minimum substance requirements. The EU aims to consider such entities as 'risk' entities. In order to be labeled by the EU as such, three conditions have to be met:
- More than 75 percent of the revenues of the company is passive or mobile income (e.g. interest, royalties and dividends) in the previous two years;
- The company is engaged in cross-border activity and;
- The company outsources the corporate management and administration services on significant functions instead of performing them in-house in the previous two years.
Certain categories are excluded from the reporting obligations, even if the conditions to be regarded as a so called 'risk' company are met. Such as, amongst others:
- Stock listed entities;
- Regulated financial undertakings;
- Undertakings with at least five full-time employees.
Reporting: substance test
If the under ATAD 3 mentioned conditions are met the entity is regarded as a 'risk' entity and therefore must declare in its annual tax return whether certain substance requirements are met. In case a 'risk' entity fails to report or files incorrect reports, Member States may introduce a fine of up to five percent of the annual revenues.
An entity is required to meet the following three criteria in order not to be regarded as a risk entity, with the third one being the most notable, as the EU has not provided any information in the proposal based on working from home due to COVID-19:
- The entity has an office space or exclusive use of an office space;
- The company has at least one active bank account in the EU and;
- The entity meets one of the following two:
- At least one director of the company is resident (or lives close to) the jurisdiction of the entity, is qualified and authorized to make relevant decisions and actively uses this authorization and is not an employee or director of any other unrelated entity;
- The majority of the employees are resident or live close to the jurisdiction of the entity.
Exemption from reporting
If the entity does not meet these requirements, the entity has a chance to rebut the presumption of not having sufficient substance. Furthermore, an exemption can be requested if the existence of the entity does not reduce the tax liability of its beneficial owner(s). A Member State may grant an exemption for one tax year, which can be extended up to five years (a total of six years). The conditions to grant this exemption are to be assessed by each individual Member State.
Consequences of not meeting the substance requirements
In the member state of the entity
If such a 'risk' entity does not meet the substance requirements confirms this in the annual Dutch corporate income tax return, this will have the following consequences:
- An entity will be known to all EU Member States, as there is a central databank accessible to all Member States, which shows whether an entity meets the requirements or not. If the requirements are not met a Member State can deny application of tax treaties and disregard the application of the Parent-Subsidiary and Interest and Royalties Directives on outgoing payments to the 'risk' entity. This results in a higher withholding tax burden for the company;
- Such an entity will not receive a residency certificate anymore from the Dutch tax authorities, which in most EU countries is required to apply for the lower withholding tax rate on the outgoing payment.
In other member states
Members states other than the residence state of the entity will deny access to the tax treaties. If the 'risk' entity has a EU shareholder, the incoming passive income will deemed to be paid directly to the EU shareholder (by disregarding the 'risk' company). A credit could be available for any taxes paid at the level of the ‘risk’ entity.
Current status of the proposal
The EU introduced the proposal on December 22, 2021. All Member States have to review the proposal. It might be the case that the proposal will be altered by some Member States. If unanimously accepted, the goal is that the EU Member States will have to implement this Directive into their domestic tax legislation by June 30, 2023. The tax legislative will then apply from January 1, 2024.
Please note that, in order to determine if a company is regarded as a so called 'risk' company for ATAD 3 purposes, a two-year look-back rule shall be applied. Therefore, the company’s position as of January 1, 2022 may already be a reference point.
How can we help?
With the probable reference point of this proposed legislation of January 1, 2022, we recommend entities to start assessing the current situation and the consequences of the implementation of ATAD 3 for the company. As such we recommend to already anticipate and take necessary actions to be ready and be compliant with ATAD 3. We can assist you in this by means of the following:
- Review your current situation with regards to substance and possible exemptions;
- Provide you with the latest information on new legislation that could affect your business;
- Perform a tax sanity check on your structure.
Do you have questions or do you need more detailed information? Please contact your contact person within Grant Thornton.