The EU is about to take the next big step in its fight against corporate tax avoidance with the publication of the anti-BEPS (base erosion and profit shifting) proposals. The objectives of these proposals appear to be twofold. First, they aim to accelerate implementation of some of the final BEPS proposals published by the OECD in October 2015. Second, they aim to secure the implementation of a minimum level of anti-BEPS measures within the EU in a coordinated fashion. The proposals contain anti-tax avoidance rules in six specific fields: a limitation on interest deduction, a switch over rule, controlled foreign companies’ legislation, anti-hybrid rules, a general anti-abuse rule, and exit taxation rules. The proposals are scheduled for the ECOFIN meeting on 25 May 2016 and need to be unanimously approved by all 28 EU member states. It remains to be seen if the proposals will be adopted in the current form and, if so, what the implementation deadline will be.
Limitations on interest deduction
An earnings-stripping rule proposes to limit the deduction of net interest expenses to 30% of the taxpayer’s earnings before interest, taxes, depreciation and amortisation (EBITDA). EBITDA must be calculated based on the taxable profits of the taxpayer rather than its commercial accounting profits. Profits from qualifying domestic or foreign subsidiaries which are exempt under participation exemption regimes will therefore not increase the capacity to deduct interest. The proposal provides for a group ratio escape. This escape allows member states to fully deduct interest if the taxpayer can demonstrate that its stand-alone debt-equity ratio is lower than the equivalent consolidated ratio of its group. The EBITDA of a fiscal year which is not absorbed by the interest expenses incurred by a taxpayer in that year may be carried forward to future years. Interest which cannot be deducted in the current fiscal year may be carried forward to future years as well. The limitation on interest deduction will not apply to a wide range of financial undertakings. However, the EU has expressed the intention to introduce a rule that also applies to financial undertakings at a later stage.
Under the proposed switch-over rule, member states may not exempt profits derived by an EU taxpayer from non-EU subsidiaries or permanent establishments if the statutory tax rate in the relevant third country is lower than 40% of the statutory rate in the relevant EU Member State. Instead, the taxpayer must be granted a tax credit for taxes paid in the country of the subsidiary or permanent establishment. The proposal does not require member states to issue a credit for underlying taxes paid by, for instance, a subsidiary of the participation. From a Dutch perspective, the number of jurisdictions affected by this rule will be limited and would in practice capture primarily the typical offshore jurisdictions (for example, Bermuda, Cayman, and BVI) and certain jurisdictions in the Middle East.
Controlled Foreign Companies legislation
Under the CFC rule, EU taxpayers will immediately be taxed on all income of a qualifying CFC, not only passive, non-distributed income. An entity qualifies as CFC if:
- the taxpayer alone or together with associated enterprises holds a direct or indirect equity participation of more than 50% of in the entity;
- the effective corporate tax rate in the country of the CFC is lower than 40% of the effective tax rate that would have been charged in the taxpayer’s member state, and
- more than 50% of the CFC’s income qualifies as tainted income.
The proposal sets out a rather extensive list of tainted profits, including interest, royalty and dividend income and capital gains on shares. The rules provide for carve-outs for CFCs located in EU or EEA jurisdictions and for financial undertakings. On this basis, we expect that many Dutch taxpayers will fall outside the scope of these rules when it comes to their EU CFCs.
The proposal also sets out rules tackling hybrid mismatches within the EU. No rules have been proposed yet in relation to hybrids involving non-EU jurisdictions. The proposed rules address structures resulting in multiple deductions or deductions without inclusion created through:
- hybrid entities, meaning entities treated as opaque by one EU Member State while another EU Member State treats the entity as tax transparent; and
- hybrid instruments, meaning instruments that give rise to tax exempt income in one EU Member States while the instrument gives rise to a tax deduction in another EU Member State.
These new rules will apply in addition to the existing hybrid mismatch provision in the parent-subsidiary directive.
General anti-abuse rule
The proposed GAAR requires EU Member States to ignore non-genuine arrangements or series of those arrangements if they are essentially carried out to obtain a tax advantage that defeats the objectives of otherwise applicable tax provisions. Whether an arrangement qualifies as a non-genuine arrangement depends on the extent to which the arrangement is not put in place for valid commercial reasons that reflect economic reality. For the purpose of the tax calculations, the ignored arrangements must be substituted by arrangements that reflect the economic substance. The proposed GAAR appears to largely resemble the existing Dutch anti abuse doctrine (fraus legis).
The proposed rules on exit taxation apply to cross-border corporate migrations and cross-border transfers of assets. The taxpayer must be subject to exit taxation on built-in gains existing at the time of the exit. The Netherlands has already implemented comprehensive exit taxation rules. The main change will be that the Netherlands must in principle levy exit taxation on the transfer of assets from the head office of a Dutch taxpayer to a foreign permanent establishment. Currently, taxation in this respect is deferred. For migrations and transfers within the EU/EEA, the deferral of exit tax payment must be granted subject to strict conditions.