The pressure on holding companies, trust and investment structures, any other vehicle with little economic substance, as well as on family offices has been steadily increasing over the last years with the introduction of several anti-avoidance measures such as the general anti-abuse measure, CFC rules, principal purpose test under the MLI, and case law developments such as the Danish cases of the ECJ. Recently, the European Commission issued a proposal for a new Directive ("Proposal") specifically aimed at curtailing the use of legal entities in the EU with no or minimal substance and no real economic activity (so-called "shell" entities). The Proposal includes an annual reporting requirement for entities at risk of being considered a shell, and determines adverse tax consequences in case an entity is effectively considered to be a shell.

The EU Commission has announced in a press release that it will present a similar initiative this year to respond to the challenges linked to non-EU shell entities.

Although the Proposal is targeted at the use of shell entities for tax evasion and avoidance purposes, it goes beyond the improper tax use of shell entities so that vehicles (including companies, partnerships, trusts) with little substance may enter into scope even if set up with valid holding and/or investment purposes. The relevant criteria of the Proposal to determine whether a vehicle is at risk of being considered a shell include the receipt of passive income (broadly determined), the outsourcing of administrative activities and the cross-border nature of the activity. It is hence clear that a private client’s holding and trust structures and family offices should be held against the light of the Proposal to determine the consequences and consider how the structures can be made more robust, especially considering that the current proposal provides for a lookback period of two years.

Which entities are in scope?

The Proposal targets any legal entity (irrespective of its legal form, including companies, partnerships, trusts…) that is a tax resident in an EU member state and that is at a risk of qualifying as a shell.

Three cumulative ‘gateways’ determine whether an entity is at risk of being considered a shell: (i) more than 75% of the entity’s income is passive income (broadly defined, e.g., interest or other income from financial assets (including crypto assets), royalties, dividend income, capital gains, income from real estate, income derived from intragroup administration services); (ii) the entity is engaged in cross-border activity; and (iii) the entity outsources the administration of day-today operations and the decision-making on significant functions. The latter, under the current text of the Proposal, probably also includes the situation where some directors are “professional directors” provided by trust or administration services companies.

A long list of entities that are out of scope is provided in the Proposal, which includes, amongst others (i) regulated and supervised entities (such as credit institutions, pension funds, (re)insurance undertakings, regulated investment funds such as UCITS, AIFS, AIFMS, securitisation vehicles if they meet certain conditions, etc.); (ii) companies with listed securities, (iii) holding companies with shareholders in the same EU member state; and (iv) companies with at least five own FTEs or members of staff exclusively carrying out the activities generating the relevant income.

Annual reporting requirement

If all gateways are met, the entity is at risk of being considered a shell and will need to comply with an annual reporting obligation in its member state of residence through which it should demonstrate, with documentary evidence, that all indicators of minimum substance are met in order not to be qualified as a shell. The reported information will be automatically exchanged between member states through the Common Communication Network (CCN).

These indicators of minimum substance are (i) the availability of premises in the EU member state for exclusive use; (ii) the availability of at least one active bank account in the Union; (iii) qualifying directors or personnel.

Today, all these indicators still raise questions (e.g., what qualifies as exclusive use of premises, when is a bank account considered active), but the main question will be whether the entity has qualifying directors or personnel available. In this context, the Proposal requires at least one director who (i) is tax resident in the member state of the entity or at a distance that is “compatible with the proper performance of his/her duties”; (ii) is qualified and authorised to take decisions; (iii) is actively and independently using such authorization; and (iv) is not performing a function as director or employee in a nonassociated enterprise (i.e., not a “professional director”). Alternatively, the Proposal requires that the majority of the entity’s FTEs are (i) tax resident in the member state of the undertaking or at a distance compatible with the performance of their duties; and (ii) is qualified to carry out the activities.

Note that the entity can request its member state of residence to be exempt from the reporting obligation if it is able to demonstrate that the interposition of the structure does not lead to a tax benefit for its beneficial owner(s) or of the group as a whole. Such exemption may be granted for one year with a possible extension for five years.

Qualification as a shell and adverse tax consequences

The entity that does not meet all of the above-mentioned indicators will be presumed to be a shell. Such presumption can only be rebutted by providing additional supporting evidence demonstrating that the entity has performed, had control over, and bore the risk of the business activities by providing evidence regarding (i) the commercial rationale behind the undertaking’s establishment; (ii) information about employee profiles; (iii) evidence that decision-making is taking place in the entity’s member state of residence. If such additional supporting evidence is not provided, the finding of the entity being considered a shell will lead to the following adverse tax consequences:

(i) The source country may apply (higher) withholding tax, as the benefits under the Parent-subsidiary Directive and the Interest and Royalty Directive, as well as under the tax treaties between EU member states, are no longer available;

(ii) The entity will no longer receive a certificate of tax residence from its member state of residence or will obtain a certificate that states that it is no longer entitled to the benefits of the EU Directives and the tax treaties with other EU member states.

(iii) The shell’s shareholder’s country may tax the relevant income as if it had accrued directly to the shareholder (in other words, apply a look-through approach) and deduct the tax paid on such income at the level of the shell.

Many questions arise on the exact tax consequences and implications of a shell finding, both in EU situations and in situations involving a third country. As mentioned, the Proposal currently suggests the application of a lookthrough approach, but is unclear how this will be applied in practice. For example it is unclear, in an EU situation, whether the source country may take into account the EU Directives and/or tax treaties with the member state of the shell’s shareholder when determining the applicable withholding tax rate.


The Proposal determines that the member states will lay down rules on penalties, which are effective, proportionate and dissuasive. This wording is quite standard and gives member states some discretion on determining the appropriate level penalties (that can lead to some considerable differences between member states, as we have seen with DAC 6, for example). However, the Proposal also states that the penalties should include an administrative pecuniary sanction of at least 5% of the undertaking’s turnover in the relevant year in case of nonor late compliance with the reporting obligation.

Concluding remarks

A consultation period is currently open with the EU Commission until March 16, and it is expected that many parties will submit comments as the current Proposal triggers many question marks (such as its compatibility with primary EU law). In addition to the many uncertainties that remain in terms of application of the rules under the Proposal, it is also currently unclear if and when the Proposal will actually make it into law.

The negotiations have started at the level of the EU Council, where the unanimous consent of all EU member states will be required to adopt the Proposal. The EU member states then need to implement the Directive into their domestic law. The current envisaged time line indicates that the Directive should be implemented by 30 June 2023 and take effect as of 1 January 2024. Even if this seems like an ambitious time line, it is nevertheless time to act, considering that the Proposal provides for a lookback period of two years to determine whether an entity is at risk of being a shell. Indeed, under the Proposal’s current time line, this would mean that the assessment of whether an entity is at risk of being a shell will be based on the facts and figures of 2022 and 2023.

Mindful of DAC 6, where a lookback period was also introduced, action should hence be taken as soon as possible with respect to EU holding, investment and trust structures and family offices, amongst others, to determine whether entities in the structure are at risk of being considered a shell. Relevant actions include holding the client’s trust, holding and investment structures against the light of the Proposal, determining how one will establish and demonstrate towards the tax authorities (with documentary evidence) that the relevant entities are not shells at risk of tax abuse, by establishing the adverse tax consequences in case this cannot be demonstrated, as well as appropriate restructuring in the latter case.