European Commission publishes far-reaching legislative tax proposals

If adopted by all EU Member States, the Shell Directive (also referred to as ATAD3) will introduce a reporting obligation for undertakings that meet certain criteria, also referred to by the European Commission as the ‘gateways’. An undertaking is described as ‘any entity engaged in economic activities, regardless of its legal form, that is a tax resident in a Member State’. In principle, a reporting obligation applies to the undertaking, if the following cumulative criteria are met:

1. More than 75% of the revenues of the undertaking in the preceding two tax years consists of passive income including interest, royalties, dividends, income from financial lease or real estate (“Relevant Income”). If more than 75% of the book value of the assets of the undertaking consists of real estate or other private property with a value of more than € 1 million or if more than 75% of the book value of the undertaking consists of shares, the first criterium is deemed to be met, irrespective of whether income from these assets has accrued to the undertaking in the preceding two years.
2. At least 60% of the Relevant Income is earned or paid out via cross-border transactions or more than 60% of the book value of the undertaking’s real estate or other private property of high value are located outside the jurisdiction of the undertaking in the preceding two years.
3. The undertaking outsourced the administration of day-to-day operations and the decision making on significant functions in the preceding two years.

Carve outs from this reporting obligation exist if the taxpayer is subject to an adequate level of transparency (in brief: regulated financial undertakings or undertakings with transferable listed securities), in domestic holding situations, or if the taxpayer has at least five full-time employees exclusively carrying out the activities generating the Relevant Income.

Furthermore, an exemption from the reporting obligation can be requested if the presence of the undertaking in the structure does not lower the tax liability of its beneficial owner or of the group as a whole. If granted, this exemption can be extended for another five years if the legal and factual circumstances do not change.

An undertaking that falls within the gateways (and did not obtain an exemption) will be required to declare in its annual tax return whether it meets the following indicators of minimum substance (“Substance Indicators”):

1. The undertaking has own premises or premises available for the exclusive use of the undertaking;
2. The undertaking has at least one own and active bank account in the EU; and
3. At least one qualified director of the undertaking that is authorized to take decisions in relation to the activities generating the Relevant Income is a tax resident in the Member State of the undertaking (or resides sufficiently close to the Member State to perform the duties) and is not employed by a non-associated enterprise and does not perform the function of director in another non-associated enterprise, or alternatively, the majority of the qualified full-time employees of the undertaking is tax resident in the Member State of the undertaking (or reside sufficiently close to the Member State to perform their duties).

The annual tax return will furthermore need to include documents evidencing that the Substance Indicators are indeed met. If the undertaking provides satisfactory supporting documents, it is presumed to have (at least) minimum substance for that tax year. This presumption does not exclude that the tax administrations still find that such undertaking is a shell or lacks substantial economic activity under domestic rules. Furthermore, despite the presumption, tax authorities can still scrutinize the undertaking’s beneficial ownership with respect to specific items of income.

If the undertaking declares not to meet the Substance Indicators, or does not provide sufficient supporting evidence, it is presumed to lack minimum substance for that year (i.e., the undertaking is presumed to be a shell). Such presumption may however be rebutted with (i) information on the commercial rationale behind the establishment of the undertaking, (ii) information on the employee profiles and (iii) concrete evidence that decision-making concerning the Relevant Income generating activity takes place in the Member State of the undertaking. If successfully rebutted, the validity of the rebuttal can be extended for another five years if the legal and factual circumstances do not change.

(i) Exchange of information

Information will be exchanged among Member States through a central directory – by way of an update of the DAC – when undertakings fall within the gateways. Information exchange will also apply where the tax administration of the Member State decides to certify that an undertaking has rebutted the presumption of being a shell or should be exempt from the obligation under the Shell Directive. In conclusion, only if an undertaking does not fall within the gateways no information will be exchanged.

(ii) Shell ignored for tax purposes

Once an undertaking is considered to be a shell for purposes of the Shell Directive it will not be able to access the benefits of the tax treaties of its Member State concluded with other EU Member states and/or of the EU directives.

The Member State where the shell is resident will either deny the shell company a tax residency certificate or the certificate will specify that the company is a shell. This will serve as an administrative practice to inform the relevant source country that it should not grant tax treaty benefits or apply EU directives towards the shell. Nevertheless, the Member State of the shell would remain free to continue to consider the shell as resident for local tax purposes and levy tax on the relevant income flows and/or assets.

At the same time:

• EU source jurisdictions shall ignore the shell for tax purposes and will tax or exempt the outbound payment according to the tax treaty or EU directive in effect with the country of the shareholder(s) of the shell, or in absence of such treaty in accordance with its national law.
• Third country source jurisdictions may apply domestic tax on the outbound payment or may decide to tax according to the tax treaty in effect with the jurisdiction of the shareholder(s) of the shell.
• EU shareholder jurisdictions shall include the payment received in the shareholder’s taxable income and may allow relief for any tax paid at source, but will also deduct any tax paid by the shell in its Member State.
• Third country shareholder jurisdictions are not compelled to apply any consequences but may consider applying a tax treaty in force with the source jurisdiction to provide relief.

The Shell Directive leaves it to the Members States to lay down penalties applicable against a violation of the reporting obligations. However, penalties should include an administrative pecuniary sanction of at least 5% of the undertaking’s turnover in the relevant tax year.

Member States will be able to request the Member State of the undertaking to perform tax audits when it has reason to believe that an undertaking has not met its obligations under the Shell Directive.

Once adopted, the Shell Directive should be transposed into Member States’ national law by 30 June 2023 and come into effect as of 1 January 2024. As the gateways of the Shell Directive use a reference period of the two preceding years, this reference period may already start as of 1 January 2022.

In 2022, a separate EU proposal is expected for non-EU shell entities.

The Pillar Two Implementation Directive aims to implement most of the OECD Pillar Two rules that seek to introduce a minimum effective tax rate (“ETR”) of 15% for large enterprises (referred to as the “GloBE rules”). The released GloBE rules concern the Income Inclusion Rule (“IIR”) and the Undertaxed Payment Rule (“UTPR”). The IIR gives top-up taxing rights to in principle the ultimate parent entity (the “UPE”) of the group; the UTPR is the backstop rule and gives top-up taxing rights to the constituent entities in the jurisdictions that have implemented the UTPR. The European Commission explicitly mentions to closely follow the OECD GloBE rules that were released on 20 December 2021. We refer to our Tax Flash.

To ensure compliance with EU law, the Pillar Two Implementation Directive extended the scope of the GloBE rules to include large-scale domestic groups that have a combined annual group turnover of at least € 750 million based on consolidated financial statements. The adjusted scope therefore also includes purely domestic groups and is - according to the European Commission - necessary to comply with the EU fundamental freedoms.

As to the application of the IIR, the Pillar Two Implementation Directive requires Member States to ensure that the entity that applies the IIR (generally the UPE) also ensures that domestically the minimum ETR is met (applying the IIR principles to itself and to its domestic subsidiaries). This deviates from the OECD GloBE rules, which provide that the jurisdiction which applies the IIR takes into account the ETR of only foreign constituent entities. According to the European Commission, this deviation is provided in the OECD Commentary to the GloBE rules (expected to be published early 2022).

An optional local domestic top-up tax mechanism is set forth by the Pillar Two Implementation Directive, in line with the GloBE rules. Member States can opt to apply (i.e., charge and collect) the top-up tax domestically to constituent entities located in its territory. If the option is exercised, the entity applying the IIR will be obliged to give a credit for the domestic top-up tax when calculating the top-up tax in respect of the relevant jurisdiction.

In addition to the GloBE rules, the Pillar Two Implementation Directive obliges Member States to implement penalties that will apply to taxpayers that breach the national rules implementing the Pillar Two Implementation Directive. Furthermore, when an entity does not meet the annual compliance requirement, an administrative penalty of 5% of the stand-alone turnover of that respective year shall apply.

The recently increased EU climate ambitions include reducing net greenhouse gas emissions in the EU by at least 55% by 2030 compared to 1990. To achieve these ambitions, the European Commission already presented a package of legislative proposals known as the “Fit for 55 package” (“FF55”) in July 2021. This package includes a revision of the EU Emissions Trading System (“EU ETS”) and the introduction of a Carbon Border Adjustment Mechanism (“CBAM”).

The EU ETS is the European carbon market for emission allowance trading. This system sets a cap on emission allowances based on a 'cap-and-trade' principle. With the FF55 it is planned to strengthen the current EU ETS, primarily by reducing the amount of available emission allowances (the cap). The CBAM, also part of the FF55, will put a carbon price on imports of certain goods to the EU, corresponding to what would have been paid if the goods had been produced in the EU. This mechanism will apply to specific sectors and should reduce the risk of carbon leakage (transfer of industrial production to countries with lower charges on emissions).

On 22 December 2021, the European Commission published proposals to introduce three new categories of own resources (main sources of revenue for the EU budget). These proposals are complementary to the FF55. Currently, there are four own resources for which the Gross National Income (“GNI”) is the main source for contribution. All Member States contribute according to their share in the EU27 GNI. The proposed new categories are the revised EU ETS, the CBAM and the re-allocated profits to Member States under Pillar One.

Most revenues from the EU ETS allowances are currently transferred to national budgets. The European Commission proposed that 25% of these revenues are contributed to the EU budget. In addition, the European Commission proposed a contribution of 75% of the revenues generated by the CBAM. As far as Pillar One is concerned, Member States will have to provide a contribution proportional to the taxable reallocated profits. These new own resources will be introduced gradually as of 1 January 2023. The revenues will be used for both the financing of the Social Climate Fund and the repayment of NextGenerationEU.

Furthermore, the European Commission intends to propose a second basket of new own resources by the end of 2023, building on the 'Business in Europe: Framework for Income Taxation proposal. This basket could include a Financial Transaction Tax and an own resource linked to the corporate sector.