The European Commission yesterday published an “Anti-Tax Avoidance Package”. Key documents in this package include:
- a draft Anti-Tax Avoidance Directive (also referred to as the anti-BEPS Directive) (the draft Directive);
- a proposed revision to the Administrative Cooperation Directive, which will introduce country-by-country reporting (CBCR) between tax authorities on key tax-related information;
- a Recommendation on tax treaties; and
- a proposal for a new EU external strategy for effective taxation.
Draft Anti-Tax Avoidance Directive
The draft Directive seeks to implement a number of the final BEPS recommendations in a harmonised way at an EU level. Whilst most Member States have committed to implement the measures contained in the BEPS final reports (and some Member States have already implemented a number of measures), the Commission takes the view that unilateral and possibly divergent implementation of the BEPS recommendations by Member States could in practice result in national policy clashes, distortions and tax obstacles for businesses in the EU. The Commission also considers this could create new loopholes and mismatches that could be exploited by companies seeking to avoid taxation, thereby ultimately undermining the key objectives of implementing the BEPS recommendations.
On this basis, the Commission has concluded it is essential for Member States to transpose the OECD BEPS measures into their national systems in a coherent and coordinated manner. The Commission’s proposal to achieve this is the draft Directive which provides common minimum standards for implementation of the final BEPS recommendations and seeks to achieve a balance between the need for a certain degree of uniformity in implementing the BEPS recommendations across the EU versus the need of Member States to accommodate the special features of their tax systems within these new rules. To allow for this, the draft Directive sets out principle-based rules but leaves the details of implementation to Member States.
It is worth noting that the draft Directive also includes a number of provisions which were originally proposed as part of the EU Common Consolidated Corporate Tax Base (CCCTB) project and have been split out from that project. This means that in a number of areas the draft Directive goes further than the recommendations set out in the final BEPS reports, including, for example, provisions on exit taxation and a switch-over clause (considered in further detail below).
The draft Directive will apply to all taxpayers that are subject to corporate tax in one or more Member State(s), including permanent establishments in one or more Member State(s) of entities resident for tax purposes in a third country.
The proposal sets out certain minimum standards that Member States must adhere to, but it is made clear that Member States are not prevented from going beyond the proposed minimum standards. The main areas covered by the draft Directive are summarised below:
- Interest limitation rule – this rule provides for a limit on borrowing costs of 30% of taxable earnings before interest, tax, depreciation and amortisation (EBITDA) or €1 million if higher. The current drafting allows Member States to introduce group ratio carve out rules by derogation from the general interest cap rule, although it is interesting to note that the group ratio rule included in the draft Directive uses an assets based ratio of equity/total assets rather than the group interest to EBITDA ratio test which is the preferred option in the final report on BEPS Action 4.
- The explanatory memorandum to the draft Directive confirms that discussions on how the interest limitation rule will apply to the financial and insurance sectors are ongoing at both an international and EU level. Consequently, the application of the interest limitation rule to these sectors remains under review.
- In Germany, an interest limitation rule has been in existence since 2008 (so-called Interest Barrier Rule, Sec. 4h German Income Tax Act). The concept of the German Interest Barrier Rule was copied by several other countries. The BEPS report mentioned it as a ‘best practise example’. The existing German rules should largely be in line with the standard of the draft Directive, so that further significant changes seem unlikely. There is one exception – the draft Directive provides for a de-minimis exception of just € 1 million, whereas current German law has a threshold of € 3 million which is designed to bring smaller businesses out of the reach of the Interest Barrier Rule. Should the current threshold be lowered, this could mean that many more businesses become subject to the Interest Barrier Rules which will be problematic.
- Controlled foreign companies (CFC) - the draft Directive includes measures to deal with the diversion of profits to low taxed jurisdictions using some of the “building blocks” highlighted in the final report on BEPS Action 3. It provides for a charge on undistributed profits of controlled entities that are subject to an effective corporate tax rate lower than 40% of the effective tax rate in the Member State of the relevant taxpayer where the majority of the income accruing to the controlled entity falls within a number of categories, including royalties, income from banking and financial activities and dividends and income from share disposals. There are exceptions to this charge where the controlled entity is tax resident in a Member State (or a country that is party to the EEA agreement).
- In Germany, rather tight CFC rules have been in existence since 1972 (Sec. 7 – 14 German Foreign Tax Act) . They are in some aspects (much) stricter than the EU proposal. This calls for a reform, especially regarding the definition of low taxation (which under current German rules is set at a very high “below 25%” threshold) and the definition of passive income. That restrictive approach is largely seen as putting German businesses with activities abroad at a competitive disadvantage. According to rumours, the Federal Ministry of Finance is working on a reform of the German CFC rules which hopefully addresses these issues.
- Hybrid mismatches - the proposal prescribes that the legal characterisation given to a hybrid instrument or entity by the Member State where a payment, expense or loss (as the case may be) originates should be followed in the counter-party Member State. Surprisingly, this provision does not appear expressly to reflect the primary rule and secondary/defensive rule structure set out in the final report on BEPS Action 2. It is also currently restricted to hybrid mismatches between Member States although it is acknowledged that similar rules will be required for hybrid mismatches between Member States and third countries.
- German tax laws already provide for a number of rules targeting hybrid mismatch situations, but these are designed for specific situations. Hence, it is expected that there will be a proposal for a rule with a broad(er) scope of application, which may even be implemented in German law before the draft Directive (which needs unanimous consent of all Member States, see below) has been finally adopted. It is not unlikely that the German Anti-BEPS Bill may follow the OECD proposal quite closely; that would i.a. mean that the denial of a tax deduction would only apply in a related party scenario or a structured arrangement, but not (as foreseen in a draft bill launched by German federal states in 2015 but not adopted) on any third-party transaction.
- General anti-abuse rule (GAAR) - The draft Directive includes a very broad GAAR which allows tax authorities to ignore non-genuine arrangements carried out for the essential purpose of obtaining a tax advantage that defeats the object or purpose of the otherwise applicable tax provisions. “Non- genuine arrangements” are defined as arrangements not put into place for valid commercial reasons which reflect economic reality. The GAAR should be strictly limited to these non-genuine arrangements as taxpayers are still at liberty to choose the most tax-efficient structure for their commercial affairs, but it remains to be seen how this will be applied by Member States in practice.
- In Germany, the General Tax Act provides already for a general anti-abuse rule. Many court cases have dealt with that anti-abuse rule, and hence, a number of guiding principles have been developed by the tax courts as regards the application of that general anti-abuse rule to individual circumstances. Therefore, it would likely not make the tax law application easier and better foreseeable if new and different rules would be enacted.
- Exit taxation - the draft Directive includes exit taxation rules which seek to address tax base erosion where taxpayers reduce their tax bill by moving their tax residence and/or assets to a low tax jurisdiction. The proposed exit tax rules are aimed at allowing a Member State to tax the economic value of any capital gain created in its territory where a taxpayer moves assets or its tax residence out of the tax jurisdiction of that Member State, even if the gain has not yet been realised and even if the transfer is to another Member State. These rules do not apply to assets transfers of a temporary nature where the assets are intended to revert to the Member State of the transferor.
- In order to comply with EU law and jurisprudence, this proposal provides that taxpayers should, in certain circumstances, have the option of deferring the payment of the amount of tax over a number of years and settling payment through staggered payments. The Member State of origin, however, may charge interest in accordance with its national legislation applicable to deferred payments of tax claims. In addition, the taxpayer may be required to provide a guarantee if there is an actual risk of non-recovery.
- German tax law contains several exit taxation rules. They are broadly in line with the draft Directive, so that major changes seem unlikely.
- Switch-over clause – this provides that certain income entering the EU should be taxed in the recipient Member State with credit for any foreign tax suffered rather than being exempt from tax. It is proposed that the switch-over clause will apply to distributions, capital gains on shares and branch profits relating to an entity or permanent establishment outside the EU where the entity or permanent establishment is subject to tax at a statutory corporate rate lower than 40% of the rate that would have been charged by the recipient Member State.
- Germany has already a domestic switch-over clause (Sec. 50 d par. 9 German Income Tax Act). However, that provision is tailored to specific situations and not as broad as the draft Directive.
- Permanent establishments – it is worth noting that an earlier version of the draft Directive included provisions dealing with artificial avoidance of permanent establishment status, but these provisions have not been included in the latest draft. This issue is instead addressed in the Commission's "Recommendation on Tax Treaties" document (see further below)
The draft Directive will now be considered by the Member States. As the legal base for the draft Directive is Article 115 of the Treaty on the Functioning of the EU, the draft Directive would require unanimous agreement from all Member States. It unclear at this stage whether such agreement will be possible, particularly as the provisions in the draft Directive go beyond the recommendations set out in the final reports of the OECD’s BEPS project.
As Germany has proven to be a driver of the BEPS process in general, and as many current existing German rules cover the draft Directive points already or go even beyond, it can be expected that Germany will strongly support the draft with the aim that also the other Member States will tighten their rules.
Proposal to require multinational groups to share country-by-country reports
CBCR was recommended as a minimum standard in the OECD's final report BEPS Action 13 with the first CBCR due to be delivered to tax authorities by January 2017. To implement this at an EU-wide level, the Commission has published a draft Directive (the CBCR Directive) amending Directive 2011/16 as regards mandatory exchange of information in the field of taxation (the Administrative Cooperation Directive), aiming to establish the automatic exchange of information provided under the CBCR procedure between Member States. The CBCR Directive builds on the Administrative Cooperation Directive published last December which broadened the scope of the automatic exchange of information between Member States to include tax rulings and advance pricing agreements.
The Commission has concluded that multinational enterprise groups (MNEs) are in a position that renders them capable of exploiting loopholes in domestic and international laws to move profits to low-tax jurisdictions and which significantly contributes to tax base erosion. In order to be in a position to combat such tax planning, tax authorities need comprehensive information on MNEs structures, transfer pricing policies and internal transactions with related parties of MNE groups.
On this basis, the CBCR Directive imposes transparency requirements on MNE groups to provide annually, and for each tax jurisdiction in which they do business, a defined set of basic information that will be accessible by Member States based on the information to be provided under the CBCR procedure. The Commission considers that this information will enable tax authorities to make the necessary changes in domestic legislation and/or carry out adequate tax audits to combat aggressive tax planning whilst giving an incentive to MNE groups to pay their fair share of tax in the country where profits are made.
The revised Administrative Cooperation Directive will apply to MNE groups with a total consolidated group revenue equal or higher than €750 million. Such MNE groups will be required to file their CBCR documents with the tax authorities of the Member State where the ultimate parent entity of the MNE group is tax resident.
Once the relevant Member State has received the CBCR information from MNE groups, it shall, on an automatic basis, share the CBCR information with any other Member State in which, pursuant to the information in the report, companies of the MNE group are either resident for tax purposes or are subject to tax as a result of business carried on through a permanent establishment..
In case of non-compliance with these provisions, MNE groups will be subject to penalties. Member States shall establish the relevant penalties, which should be “effective, proportionate and dissuasive”, by the end of this year.
The CBCR Directive will now be considered by the Member States. This measure will also require unanimous agreement from all Member States. It is envisaged that Member States should adopt the laws, regulations and administrative provisions necessary to comply with the CBCR Directive by 31 December 2016 and Member States shall apply the new measure with effect from 1 January 2017.
31 countries, including Germany, have signed an agreement on 27 January 2016 to enable automatic sharing of country-by-country reports amongst the relevant tax authorities. Irrespective of whether the Member States are able to agree on the CBCR Directive, the automatic sharing of country-by-country reports is likely to be initiated soon.
Recommendation on Tax Treaties
Issues in relation to treaty abuse have not been addressed in the draft Directive, instead the Commission has presented a Recommendation on the implementation of measures against tax treaty abuse. The Recommendation encourages Member States to adopt the OECD’s proposed revisions to Article 5 of the OECD Model Tax Convention to address artificial avoidance of permanent establishment status. In addition, the Recommendation suggests that if Member States decide to include a general anti-avoidance rule with a principal purpose test based on the OECD recommendations, this should be modified to ensure this is EU-law compliant. The Commission favours the principal purpose test over a limitation of benefits clause as it considers the latter could discourage cross border investment and would therefore be detrimental to the Single Market.
Germany seems eager to implement this policy: The new double tax treaty between Germany and Japan which representatives of both countries signed on 17 December 2015 and which awaits ratification now contains an extensive limitation of benefits rule and a principal purpose test which goes beyond recent German treaty policy.
Proposals for a new EU external strategy for effective taxation
While there is a focus by the EU on a co-ordinated approach to reforming the corporate tax rules within the EU, there is also increasing pressure to also consider and address external challenges to the tax base of Member States. To this end, the Commission has set out proposals in respect of a common EU external strategy for effective taxation which provides recommendations for a coordinated EU approach against external risks of tax avoidance and to promote international tax good governance. These include:
- Updating the EU’s tax good governance criteria and tax good governance clauses to be included in relevant agreements between the EU and third countries;
- Including state aid provisions in trade and association agreements with third parties;
- Continuing to support developing countries in reaching higher levels of tax good governance; and
- A common EU approach to “listing” third countries for tax purposes- this includes:
- Transparency as to when third countries are listed by Member States for tax purposes and are consequently subject to sanctions and/or defensive measures; and
- Establishing an EU-wide approach to listing third countries which is fair and objective and includes measures to incentivise transparency and fair taxation in listed jurisdictions.
Next steps for the proposed Anti-Tax Avoidance measures
The draft Directive and the CBCR Directive will now be submitted to the European Parliament for consultation and to the Member States in the Council for adoption. As the legal base for these Directives is Article 115 of the Treaty on the Functioning of the EU, they would require unanimous agreement from all Member States and MEPs are restricted to providing a non-binding opinion.
The Council and the Parliament should also endorse the Tax Treaties Recommendation and Member States should follow its proposals when revising their double tax treaties. Member States should also formally agree on the new External Strategy for effective taxation.
As mentioned above, it is unclear at this stage whether unanimous agreement on the Directives as currently proposed will be possible, particularly in the case of the draft Directive, which includes provisions that go beyond the recommendations set out in the final reports of the OECD’s BEPS project. However, Member States may still be able to agree on a slimmed down version that removes some of the more controversial aspects.
It is envisaged that the CBCR Directive will be transposed into national law by Member States by 31 December 2016 and Member States should apply the new measures with effect from 1 January 2017. It is worth being aware that the Commission is also considering a proposal to allow information provided under the CBCR procedure to be made publicly available. However, EU Tax Commissioner Pierre Moscovici has publically stressed that this will only be proposed if it does not impact on EU competitiveness.
It is expected that the European Parliament will provide its (non-binding) opinion on the proposals, and it is anticipated this will result in a very public debate on the controversial aspects, including in its ‘Special Committee’ on corporate taxation.
We expect decision-making on these proposals to take at least the remainder of the year and having these initiatives in the legislative procedure now will ensure that the issue of corporate taxation will continue to be in the headlines.