“Another brick in the wall” by Pink Floyd
On December 22, 2021 the European Commission proposed an important new Directive (‘Proposal’) to prevent the misuse of shell entities, i.e. entities lacking economic activity and or substance that can therefore be used for tax avoidance. Entities resident in a Member State are in scope of this Proposal, regardless of their legal form or size.
With this Proposal the Commisison seeks to discourage the use and creation of shell companies within the European Union (EU). The Proposal contains a set of criteria (so-called ‘gateways’) to identify whether an entity qualifies as a shell. Entities that meet the cumulative criteria are considered high-risk and are therefore pressumed to lack economic substance. Consequently these entities should report in their tax returns additional information for the tax authorities to ascertain if there is a risk of abuse.
Entities commonly used for sound commercial reasons are excluded from the scope of the Directive. Among those excluded are listed companies and financial institutions. Entities with at least five (full-time equivalent) employees or members of staff, exclusively carrying out the activities generating relevant income, are also automatically exempt under the Proposal.
In recognition of the fact that substance is ultimately a matter of facts and circumstances, the Proposal includes a mechanism allowing entities at risk to challenge the outcome of the test therein, including by evidencing the commercial, non-tax motives, underlying a particular structure. Structures lacking a tax motive, may also request an upfront exemption.
Tax consequences will kick in once it is established that an entity lacks real economic activity and does not succeed in providing additional information to rebut a presumption of abuse. An entity that qualifies as a shell, will no longer be entitled to a certificate of residence from its Member State. Member States of source of the payer to the shell furthermore must deny the shell tax benefits provided under the parent subsidiary and or interest and royalties directives. The Proposal also envisages an automatic exchange of information as well as a potential request by one Member State to another for tax audits of entities that are at risk (as they meet certain conditions) but are not necessarily deficient in substance for the purposes of the Proposal. The proposed tax treatment and exchange of information should discourage the targeted scheme by neutralising any tax advantages gained or that can be gained.
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