We are currently seeing an international push for the harmonisation of corporate taxation and to prevent tax avoidance. At times, it might be hard to draw a line between illegal tax avoidance and legal tax planning. Step over that line, and not only will you face potential tax consequences, but you will be certain to attract media attention. It is not only corporations that need to be awake, it is important for investors, too, to understand what kind of changes international legislation will bring in the long term.
International guidelines for preventing aggressive tax planning are already being drawn up in the OECD’s BEPS (Base Erosion and Profit Shifting) project. However, the project is proving slow to reach the finish line, which has led the European Commission to draft the Anti-Tax Avoidance Directive in record time, and a political understanding was reached on the new directive in June.
The Commission’s original goal for the directive was to weed out tax avoidance with strict statutes. The end result, however, is lighter than planned, and the directive has already been criticised as a compromise. The criticism is, in my view at least, premature. The implementation of the directive has only just started in Member States, and it is impossible to know how tight the various national requirements will end up being.
Taxation Situations Targeted by the Directive
National measures to implement the directive have begun in Finland, and new legislation is being drafted. The Commission’s directive deals with five issues generally associated with tax avoidance:
- The key Finnish point of interest with respect to corporate finance is the intention of the directive to intervene in the deductibility of interest payments as a means of tax planning. There are already provisions in force in Finland limiting the deductibility of interest, but they only apply to intra-group loans, among other things. The directive brings two changes to this:
- The directive extends the restrictions to also apply to 1) group-external loans, such as from banks, and 2) companies taxed under the Income Tax Act, such as real estate companies.
- However, the directive also contains numerous exceptions to the applicability of interest limitations, such as the opportunity to deduct net interest expenses up to three million euros. The proposed limit is six times the one currently in force in Finland.
- The second change concerns the taxation of holding companies. The directive includes a general anti-abuse provision that enables tax authorities to deny a certain tax benefit, such as a lower tax rate, if a holding company that receives a payment and is domiciled in a different country does not have sufficient independent financial operations.
- The controlled foreign company provision is intended to prevent companies from channelling profits into a subsidiary or branch established in a low-tax country. For example, it would prevent the income of a subsidiary established in the Cayman Islands from being taxed separately from the profits of its parent company. Finland already has legislation concerning controlled foreign companies, so it remains to be seen what changes the directive will require.
- The hybrid provision intervenes in situations where a company can avoid taxes by exploiting differences in the national provisions of different Member States. The provision applies to situations in which a company makes the same deduction in two different countries or makes a deduction in one country without being taxed in another. This provision could lead to, for example, complex fund structures losing their tax efficiency.
- The exit tax is applied when a taxpayer transfers assets between fixed places of business or between a fixed place of business and its head office. This tax will lead to, for example, the financial value of a patent being taxed at the time of transfer, even if the potential profit has not been realised at the time of exit.
Faster Results through State Aid Regulations?
The directive sets a minimum level of regulation, which means that it is possible to enact even stricter national provisions. The goal of the Member States is on the one hand to secure their tax accrual while on the other hand remaining attractive destinations for investors. It will be interesting to see just how different Member States implement the directive.
Rather than rely on the directive, it seems to be easier for the Commission to intervene in aggressive tax planning via state aid regulations. The Commission has taken a heavy-handed approach in state aid cases involving multinational corporations. A recent example of this is the 13 billion euro back tax imposed by the Commission against Apple in Ireland. The amounts to be collected can be large when companies have acted in accordance with agreements made with or legislation enacted in individual Member States.