The European Commission has released its highly anticipated anti-tax-avoidance (ATA) package.
The package, released January 28, 2016, contains proposed rules and recommendations to avoid aggressive tax planning within the European Union. It contains many elements also addressed by the OECD BEPS project. Some of the EC proposals diverge significantly from the OECD BEPS project. Add to that the fact that certain of these rules will be embodied in a directive (and therefore binding on all member states) and the importance of this EC initiative becomes apparent. The EC aims to introduce these new rules as early as 1 January 2017.
There are three key documents in the ATA package:
- A Draft EU Anti-Tax-Avoidance Directive
- Proposed amendments to the EU Administrative Cooperation Directive
- Recommendations to EU member states to re-inforce tax treaties
DRAFT EU ATA DIRECTIVE
Within the EU, directives are legally binding upon all member states requiring member states to adopt legislation that is at minimum in line with the rules as laid out in the respective directive. In order for the ATA directive to be adopted, unanimous consent of all member states is required. The draft ATA directive now issued by the EC is the second draft, following an earlier version from December 2015. The EC has an ambitious goal to have this draft approved in the next 4 to 6 months which would allow the directive to become effective as early as 1 January 2017. Further political debate is expected which could result in further amendments to the directive and/or adoption of the directive in parts.
The ATA directive sets out the following six anti-avoidance measures:
i. Hybrid mismatches
The draft directive aims to tackle tax planning through hybrid instruments and hybrid entities. In short, the anti-hybrid rule requires member states to follow the classification of the instrument or the entity of the source member state (claiming the initial deduction). This would result in an inclusion of the corresponding income at the level of the recipient. An anti-hybrid rule is also part of the OECD BEPS initiative. It is important to note, however, that the proposed EC anti-hybrid rule is contrary to Action 2 of the OECD BEPS plan which provides for a primary rule requiring the source state to disallow a deduction.
ii. Interest deductibility
Mostly in line with Action 4 of the OECD BEPS , the ATA directive also provides for a general interest deductibility rule. The interest deductibility rule would limit interest deductibility to 30% of EBITDA with a minimum of net interest expense exceeding EUR 1 million and an alternative fallback based on a group test.
iii. Controlled Foreign Companies (CFCs)
Under the proposed rules, EU resident companies will be required to include non-distributed income from qualifying CFCs in its taxable income on an annual basis. In brief, a non-EU subsidiary will qualify as a CFC in cases where an EU resident entity has a controlling interest of more than 50% ownership. The income is subject to the CFC rules in case (i) the effective tax rate of the income is less than 40% of the effective tax rate of the EU parent company, and (ii) more than 40% of the income is from so-called passive sources. Within the context of the OECD BEPS initiative, both BEPS Action 4 (interest deductibility) and BEPS Action 3 (CFC’s) are so called ‘recommendations’ as a result of which short term consensus on these items is not expected within the OECD. Adoption of the ATA directive, on the other hand, would subject all EU member states to these binding CFC rules.
iv. Switch-over clause
The switch-over clause touches upon the exemption of tax that many member states apply to dividend income and capital gains realized from qualifying subsidiaries (the so-called participation exemption). The switch-over clause would require EU companies to tax dividend income and capital gains realized from low-taxed subsidiaries (low taxed equals less than 40% of the statutory tax rate of the member state). Introduction of the switch-over clause would have a profound impact on EU companies that (also) act as central holding company for a worldwide multinational.
v. Exit tax
The directive includes a provision that requires all member states to levy an exit tax on unrealized gains in cases where assets are, or the residence of a company is, transferred within the EU including transfer of assets from a head office to a branch.
vi. General Anti-Abuse Rule (GAAR)
The proposed GAAR is aimed to address any gaps that could exist in domestic anti-abuse rules. It allows member states to ignore transactions that are not based on valid business reasons.
PROPOSED AMENDMENTS TO THE EU ADMINISTRATIVE COOPERATION DIRECTIVE
The amendments to the EU Administrative Cooperation Directive basically introduce country-by-country (CbC) reporting within an EU framework. The proposed CbC rules for the greater part follow the OECD BEPS guidelines as laid out in BEPS Action 13 and would become applicable as of 1 January 2016. Although there are some differences of detail between the proposal and that in BEPS Action 13, it is broadly in line with expectations and therefore likely to be adopted as part of an amendment of the existing directive.
RECOMMENDATIONS TO EU MEMBER STATES TO REINFORCE TAX TREATIES
As part of the ATA package, the EC also issued a recommendation stating that member states should introduce a GAAR in their respective tax treaties in the form of a Principal Purpose Test (also in Action 6 of OECD BEPS project).
The ATA package is a fundamental part of the EC strategy to battle aggressive tax avoidance in the EU. As we have seen in other instances, the EC does not hesitate to take positions that diverge from the OECD BEPS initiative. In particular, the ATA directive is an example of proposed rules that attempt to supersede the OECD BEPS initiative. Moreover, adoption of the ATA directive would require all EU member states to introduce appropriate legislation as early as 1 January 2017.
There is little doubt that there will be intense political discussion about the content of the ATA package. Unanimous consent of member states to the ATA package (and ATA directive in particular) is not a foregone conclusion by any means. Also, the increasing pressure from the United States on the OECD BEPS project and especially the EC State Aid investigations will play a role in the political debate within the EU.