On 28 January 2016 the European Commission published an Anti Tax Avoidance Package containing measures to address aggressive tax planning, increase tax transparency and create a level playing field within the EU. With this package the European Commission intends that Member States are able to adopt a coordinated action against tax avoidance and ensure that companies pay tax wherever they make their profits in the EU. The Anti Tax Avoidance Package includes a proposal for an Anti Tax Avoidance Directive. In addition, it includes a recommendation on Tax Treaty Issues, a Proposal for a Directive implementing the OECD Country by Country Reporting rules and a Communication on an External Strategy.
The Anti Tax Avoidance Directive lays down rules against tax avoidance in six specific fields: (i) deductibility of interest, (ii) exit taxation, (iii) exemption of low taxed profits of a subsidiary or permanent establishment (the switch-over clause), (iv) a general anti-abuse rule (GAAR), (v) controlled foreign company (CFC) rules and (vi) a framework to tackle hybrid mismatches.
The proposed rules merely set the minimum required standards: Member States may apply additional or more stringent provisions aimed at BEPS practices.
Although all proposed rules may have a substantial impact, the interest deduction rules and switch-over clause stand out. Based on the interest deduction rules, as a general rule the deduction of net interest expense is limited to the higher of 30% of EBITDA or € 1 mio. This limitation relates to group interest as well as third party interest expense. Currently many Member States have less stringent interest deduction limitation rules, particularly with respect to third party interest expense. Under the switch-over clause, income from low taxed subsidiaries or permanent establishments cannot be exempt. An entity or permanent establishment is regarded low taxed if it is subject to a statutory corporate tax rate lower than 40% of the statutory corporate tax rate of the parent company or head office. At present, many Member States exempt income from (active) subsidiaries and permanent establishments.
The Anti Tax Avoidance Directive is tabled for approval by the European Council on 25 May 2016. It needs to be approved unanimously by all 28 Member States. It is unclear whether this will be feasible.
European Commission publishes Anti Tax Avoidance Package
The Anti Tax Avoidance Package that the European Commission (EC) published today includes the following initiatives:
- Proposal for an Anti Tax Avoidance Directive;
- Recommendation on Tax Treaty Issues;
- Proposal for a Directive implementing the OECD Country by Country Reporting (CbCR); and
- Communication on an External Strategy.
Each of these initiatives will be briefly summarized below.
Proposal for an Anti Tax Avoidance Directive
The Anti Tax Avoidance Directive aims implementing some of the final recommendations of the OECD Base Erosion and Profit Shifting (BEPS) projectinto Member States’ national laws.The Anti Tax Avoidance Directive will apply to all taxpayers which are subject to corporate tax in a Member State, including permanent establishments (PEs) of entities resident in a third (non-EU) country.
The Proposed Anti Tax Avoidance Directive is tabled for approval by the European Council on 25 May 2016. For approval, unanimity is required amongst the 28 Member States. The text adopted may differ from the proposal as it is still subject to negotiations between the Member States. If adopted, all Member States will be required to implement the provisions of the Directive in their national laws. The Directive does not yet contain a date by which this must be done.
It is intended that this Directive will function as a “de minimis rule”, meaning that it merely sets out minimum standards. Member States may apply additional or more stringent provisions.
The Directive lays down rules against tax avoidance in six specific fields: (i) deductibility of interest, (ii) exit taxation, (iii) exemption of low taxed profits of a subsidiary or PE (switch-over clause), (iv) a general anti-abuse rule (GAAR), (v) controlled foreign company (CFC) rules, and (vi) a framework to tackle hybrid mismatches. The following paragraphs contain a brief description of each of these proposed rules.
a) Interest limitation rule
This rule limits the deduction of net interest expense to the higher of 30% of EBITDA or € 1 million. Net interest expense in excess of 30% of EBITDA may be carried forward to subsequent years. To the extent 30% of EBITDA exceeds the amount of the net interest expense in any given year, the difference may also be carried forward to subsequent years.
Member States can allow taxpayers to deduct net interest expense in excess of 30% of EBITDA if the taxpayer can demonstrate that the ratio of its equity over its total assets is equal or higher than the equivalent ratio of the group in which its accounts of the taxpayer are consolidated under IFRS or US GAAP. This exception is subject to an anti-stuffing rule pursuant to which temporary capital contributions are disregarded and it cannot be used if the group pays more than 10% of its total net interest expense to associated enterprises.
The interest limitation rule shall not apply to financial undertakings, which are defined in the Directive and generally comprise regulated financial institutions such as banks, insurance companies, pension funds and certain investment funds.
b) Exit taxation
The Directive provides for an exit tax to be assessed in the Member State of origin on the difference between the market value of the transferred assets and their tax value. Exit tax shall be triggered in the case of:
- transfer of assets from the head office to a PE located in another Member State or in a third country;
- transfer of assets from a PE in a Member State to its head office or another PE located in another Member State or third country;
- transfer of tax residence to another Member State or third country (except when the assets remain connected with a PE in the Member State of origin); or
- transfer of the business carried out in a PE out of a Member State.
Members States to which assets are transferred must accept the market value of the assets transferred established by the transferor Member State as the starting value for tax purposes (i.e., a step-up).
Member States may allow taxpayers to defer the exit tax payment by paying it in instalments spread out over at least five years when the transfers occur between Member States or states that are party to the European Economic Area Agreement (EEA Agreement; Liechtenstein, Norway and Iceland). Interest may be charged on deferred exit tax and the deferral of payment of exit tax may be subject to security arrangements to ensure proper collection. The deferral of exit tax must be terminated if the transferred assets are disposed of, are transferred to a third country or if the taxpayer transfers its residence for tax purposes or goes bankrupt.
c) Switch-over clause
This provision requires Member States to deny an exemption from corporate tax with respect to distributions of profits and proceeds from the sale of shares in low taxed entities that are resident in, and PEs that are located in, third (non-EU) countries. Presently, many EU Member States exempt such income under a participation exemption system or a regime providing for an exemption of PE profits. An entity or PE is regarded low taxed when that entity or PE is subject to a statutory corporate tax rate lower than 40% of the statutory corporate tax rate that would apply in the Member State of the taxpayer receiving the income. A credit will be available for tax that was paid by the low taxed subsidiary or PE.
The GAAR which is included in the Directive is identical to the general anti-abuse rule of the 2015 amendment to the EU Parent Subsidiary Directive, except that it should now be applied to the entire domestic corporate tax laws of the Member States. Under the GAAR, non-genuine arrangements or series thereof that are put in place for essential purpose of obtaining a tax advantage that defeats the object or purpose of the applicable law should be ignored for the purposes of determining the corporate tax liability. Arrangements or series thereof shall be regarded as non-genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality. If the GAAR applies, the tax liability should be determined by reference to economic substance in accordance with the respective national law.
The preamble to the Directive clarifies that the application of the GAAR should be limited to wholly artificial arrangements in order to ensure that it is in line with the Treaty freedoms and the interpretation adopted by the Court of Justice of the European Union (CJEU).
e) CFC legislation
The Directive prescribes Member States to implement CFC legislation in their national laws. The CFC legislation is to be applied to non-distributed income of entities when the following conditions are met:
- a taxpayer by itself or together with associated enterprises, holds directly or indirectly more than 50% of capital or voting rights or is entitled to receive more than 50% of the profits of an entity;
- profits are subject to an effective tax rate lower than 40% of the effective tax rate that would have been applied in the Member State of the taxpayer; and
- more than 50% of the income accrued to that entity falls within one or more of the categories listed in the Anti Tax Avoidance Directive (i.a., interest, dividends, royalties, income from banking and insurance activities and income from related party services).
The CFC legislation should be applied in general to third country entities. In case of entities that are resident in a Member State or in a third country which is party of the EEA Agreement a different standard applies: in that event the CFC legislation should only be applied in case the establishment of the entity is considered as “wholly artificial” (non-genuine).
The provisions on CFC legislation in the Directive provide rules with respect to the computation of the income to be included under the CFC rules (calculated in accordance with the rules of the Member State where the taxpayer resides) and the amount of income to be included under the CFC rules (proportion of entitlement to profits of the entity). The provisions also provide rules for relief of juridical double taxation (previously taxed undistributed CFC income is not taxed again when received or realized). However, there is no provision for a credit for underlying tax.
f) Hybrid mismatches
With respect to the treatment of hybrid mismatches created by entities or instruments between two Member States that may give rise to double deduction or deduction/no-inclusion situations, the Directive prescribes that the legal characterization given to the hybrid entity or hybrid instrument by the Member State in which the payment has its source, should be followed by the other Member State. For example, if taxpayer X that is a resident of Member State A makes a tax deductible payment to entity Y that is treated as transparent in Member State A and that is owned by Z, a resident of Member State B, Member State B should tax that payment notwithstanding that Y is treated as non-transparent for Member State B tax purposes.
The scope of this rule is limited to hybrid mismatches between Member States as situations involving Member States and third countries still need to be further examined. If, in the example above, Z would be resident in a third (non-EU) country, the hybrid mismatch provision would not apply.
- Recommendation on Tax Treaty issues
This recommendation by the EC to the Member States addresses the implementation by the Member States of measures against tax treaty abuse taking into account the final recommendations of the OECD BEPS project on Actions 6 (Preventing the granting of treaty benefits in inappropriate circumstances) and 7 (Preventing the artificial avoidance of PEs).
In this context, the EC considers that the inclusion of Limitation on Benefit rules in tax treaties may be in breach of EU law. As regards the inclusion of a general anti-avoidance rule based on the Principal Purposes Test, the EC suggests that Member States may adopt it with a modified wording in order to be EU law compliant:
“Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that it reflects a genuine economic activity or that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.”
The recommendation encourages Member States to implement the proposed new provisions to Article 5 of the OECD Model Tax Convention regarding PE status as drawn up in the OECD BEPS Action 7 final report when they (re-)negotiate tax treaties.
- Proposal for a Directive implementing CbCR
This proposal is aimed at the EU wide implementation of the CbCR obligation as developed in the OECD BEPS project in Action 13. It introduces (i) the CbCR obligation, and (ii) mandatory automatic exchange of information on CbC reports between Member States.
The rules governing the obligation to file a CbC report in a Member State, as well as the information to be reported, are in line with BEPS Action 13. So, the CbCR obligation will in principle rest on those resident entities of a Member State which are the ultimate parent entity (or an appointed subsidiary) of a multinational enterprises (MNE) with a total consolidated group revenue of at least EUR 750 million. If the ultimate parent company is based outside the EU and the third country fails to provide a CbC report to all relevant Member States, the (appointed) EU subsidiary will become obliged to file the CbC report of the MNE group. The proposal does not contain rules on master file or local file as this is already covered under the EU code of conduct on transfer pricing documentation.
The information to be reported must include the revenues, profits, taxes paid and accrued, capital, accumulated earnings, number of employees and certain tangible assets of each group company. CbC reports will need to be filed annually in the relevant Member State within 12 months after the end of the fiscal year to which the report relates. The first reporting relates to fiscal years beginning on or after 1 January 2016.
Under the proposed rules, Member States receiving a CbC report will be required to automatically exchange information on the report within 15 months after the end of the fiscal year to which the CbC report relates by using a standard form. The first exchange relates to fiscal years beginning on or after 1 January 2016. A Member State is only required to share information on CbC reports with other Member States in which an entity of the MNE group is resident or liable to tax.
If approved, the proposed rules will amend the Directive on administrative cooperation between Member States (Directive 2011/16/EU) and come into effect on 1 January 2017.
- Communication on an External Strategy
In its Communication to the European Parliament and the European Council “on an External Strategy for Effective Taxation”, the EC makes reference that additional measures to the ones provided in the Anti Tax Avoidance Directive may be adopted as regards third countries that are included in the EU common list (EU Tax Haven list). This list will include jurisdictions that do not meet the EU standards on tax good governance: transparency, information exchange and fair tax competition. Possible measures could include the levy of withholding taxes on and non-deductibility of payments made to entities resident in those tax haven jurisdictions.