The draft Anti-Tax Avoidance Directive (“ATAD”) issued by the European Commission (the “Commission”) on 28 January 2016 has been progressing rapidly through the EU legislative process. On 17 June 2016, the finance ministers of EU Member States are expected to vote on the adoption of the ATAD. It seems increasingly possible that the ATAD will be adopted in some form at that meeting.
The ATAD is further evidence of the greater role the Commission is seeking to play in the area of direct taxation (about which we recently wrote). According to the European Treaties, direct tax remains a matter of national competence for EU Member States. Pierre Moscovici, European Commissioner for Taxation, recently restated that “we respect tax sovereignty”. However, the ATAD would be a surrender in part of national competence in direct tax matters. It is not clear whether Member States are fully prepared for the consequences of this surrender and the legal effect it will have on the operation of the national tax system of each Member State. Once any concession is made in this area, it is difficult to imagine a reallocation of competence back to Member States.
The ATAD includes six separate proposals, one of which is a general anti-abuse rule (“GAAR”) designed to counter aggressive tax planning structures. For the purpose of this update, we focus only on the GAAR, however, many of the points outlined below would apply equally to other aspects of the ATAD.
Many EU Member States (including Ireland) already have domestic GAARs in their existing legislation. On that basis, the GAAR proposal might appear at first glance to be of limited significance. However, in practical terms, the introduction of an EU GAAR could fundamentally impact the operation of the tax systems of EU Member States.
What does the EU GAAR say?
The ATAD requires Member States to ignore “an arrangement or series of arrangements which having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the otherwise applicable tax provisions, are not genuine”. An arrangement is treated as “non-genuine” to the extent that it is “not put in place for valid commercial reasons which reflect economic reality.” Where the GAAR applies, the ATAD requires the arrangements to be ignored and for tax to be calculated “in accordance with national law.”
European Directives do not apply in the same way as European Regulations and domestic legislation. Directives set out results that all EU Member States must achieve but each EU Member State determines how the Directive should be implemented domestically to meet the prescribed result. As a result, the language of European Directives tends to be vague. This is certainly true of the draft GAAR. Save for the brief explanation of “non-genuine arrangements”, none of the terminology used (“arrangements”, “tax advantage”, “tax”, “valid commercial reasons”, “economic reality”) is defined.
The terminology used in the draft GAAR appears to be derived from decisions of the Court of Justice of the European Union (“CJEU”), notably, the Halifax decision on VAT, Cadbury Schweppes and CFC GLO on the application of CFC rules, and Lankhorst-Hohorst which considered the application of German thin capitalisation rules. It is unclear whether Member States are expected to have regard to those decisions when implementing and applying the EU GAAR.
Applying the EU GAAR in practice
Given that each EU Member State has the freedom to implement the EU GAAR in the way it considers appropriate, different forms of the rule will be adopted by different Member States. Some Member States may seek to define some of the terminology used (whether those definitions are based on existing domestic law, the previous decisions of the CJEU or otherwise) and others may not. This will result in a varied range of EU GAARs with some EU tax authorities granted a wider discretion than others. The application of the EU GAAR is similarly likely to give rise to different approaches from one tax authority to the other.
It is inevitable that, following implementation by Member States, questions on the application of the EU GAAR will ultimately be referred to the CJEU. This prospect raises a number of novel issues:
- first, although the EU GAAR is an EU law construct, its application will require consideration of the purpose of domestic tax provisions by those seeking to apply it (including the CJEU as ultimate arbiter) – the EU GAAR can only apply where the purpose or object of domestic tax provisions is defeated. Depending on the CJEU to determine the object or purpose of a domestic tax provision quite obviously erodes the notion of EU Member States retaining sovereignty on direct tax matters.
- second, although the decisions of the CJEU are binding only on the parties to each case, any decisions on the EU GAAR will have to be considered by every EU tax authority. This, of itself, raises a number of difficult questions. Can the decisions of the CJEU on the EU GAAR be relied on by every EU taxpayer and every EU tax authority even where implemented differently in different Member States? If the CJEU decides that the object of a German tax provision was defeated by a taxpayer’s planning and invokes the EU GAAR, can the French tax authority rely on that decision when invoking the EU GAAR against a French taxpayer? Or, is it only relevant to taxpayers seeking to defeat the object of the German taxing provision that was considered in the case? Or can it apply in respect of a French tax provision drafted in similar terms?
- finally, under an EU GAAR the direct tax system of every EU Member State is open to ultimate review by the CJEU and the Commission. Quite apart from the implications this has for Member States’ tax sovereignty, it adds an additional layer of unnecessary complexity and uncertainty for all taxpayers operating in the EU (and for every national tax authority). The Commission may take infringement proceedings against Member States who fail to implement and apply the EU GAAR correctly. It also seems possible that if the Commission considers that the EU GAAR was applied (or, more likely, not applied) to taxpayers on a selective basis, it could bring retrospective State aid type actions against that Member State and seek recovery of the tax forgone. The ability of the Commission, not only to influence the design of the tax rules to be applied but also to oversee implementation and enforcement brings an entirely new dimension to the tax system of every Member State. Given recent involvement by the Commission in the tax affairs of multinationals, this oversight may be viewed as creating even more uncertainty for taxpayers.
Although many Member States already have domestic GAARs, the proposal to introduce an EU GAAR has much broader consequences for the tax systems of all EU Member States. It opens the direct tax systems of all Member States to review by the CJEU and extends the Commission’s reach into domestic tax systems. In some cases, the EU GAAR will permit the CJEU to determine the object or purpose of domestic tax provisions. Despite concerns about tax sovereignty, politically, it can be difficult for any Member State to be seen to oppose the introduction of an anti-abuse provision in the current environment (or indeed to stand in the way of the successful adoption of the ATAD which has gathered significant political momentum over the past few months).
The other proposals in the ATAD are the introduction of EU-wide restrictions on the deductibility of interest, the imposition of an exit tax on the transfer of a business from a Member State (whether to another Member State or otherwise), a so-called ‘switch-over’ clause which would prevent the application of participation exemptions where the underlying income is taxed below a particular rate, controlled foreign company rules and anti-hybrid provisions. Many of the observations above on the EU GAAR (in particular the incremental ceding of tax sovereignty) would be equally relevant to those proposals. The operation of the EU GAAR in practical terms and, more broadly, the impact of the ATAD on the legal framework of each Member State’s national tax system (and tax sovereignty) should merit thorough consideration by every Member State before it is adopted.