What is ATAD III?
ATAD III - also known as the ‘Unshell Directive’ - is the latest Anti-Tax Avoidance Directive proposed by the European Commission as part of its strategy on direct corporation taxation. Propelled by the Panama Papers and Luxleak scandals, ATAD III is designed to target ‘shell companies’, legal entities with no or minimal substance and economic activity which can be used (in the European Commission’s terms) for ‘improper tax purposes’.
EU Member States already have an arsenal of legislative tools to tackle aggressive tax planning schemes - including the misuse of shell companies - in the form of general anti-abuse rules (‘GAARs’), the multilateral instrument (‘MLI’) and European Court of Justice case law. However, where these require the active involvement of the tax authorities, ATAD III shifts the burden to the taxpayers by automatically denying treaty and directive benefits where minimum substance requirements are not met.
How does ATAD III work?
ATAD III introduces a filtering system consisting of three ‘gateways’. Respectively these look at:
- the activity of an entity based on the income it receives;
- whether the income derives from cross-border transactions; and
- whether management or administration of the entity is outsourced.
If an entity crosses all three gateways, it is considered to be ‘at risk’ and must report details of its premises, bank accounts and the residency of its directors and employees to the tax authorities as ‘substance indicators’. Failing any one of the substance indicators will result in a rebuttable presumption that the entity is a ‘shell’, with the result that:
- It will not be able to access the tax benefits of EU directives and tax treaties. Member States will deny the entity a tax residence certificate, or can provide a certificate indicating that the entity is a shell and not entitled to double tax relief.
- Payments to third countries will not be treated as flowing through the entity and will be subject to withholding tax at the level of the payor. Inbound payments will be taxed in the state of the entity’s shareholder.
- In addition, ATAD III allows the Member States to apply penalties, including a fine of at least 5% of the entity’s turnover.
Entities which do not meet all substance indicators will still have the opportunity to rebut the presumption of being a shell, by providing concrete evidence of the economic activities they performs and by proving a genuine commercial justification for their existence.
Certain undertakings are excluded from the proposal, including companies listed on regulated markets, regulated financial undertakings and undertakings with at least five of their own full-time employees or members of staff carrying out income-generating activities. Member States will automatically exchange information on all undertakings which are in the scope of the Directive - regardless of whether these are shell entities or not. Member States are to implement penalties where an entity does not comply with the substance reporting requirements or provides inaccurate information.
When does ATAD III come into force?
The Member States must unanimously agree to adopt ATAD III. This will entail a period of negotiation. Whilst historically EU Directives have been passed with few changes, ATAD III has attracted criticism and some Member States may push back on certain aspects of the proposal – particularly those which have cultivated an industry of corporate service providers. Therefore we could see changes to ATAD III before it is adopted.
If, as the European Commission intends, ATAD III is adopted by 30 June 2023, then the new provisions are expected to take effect from 1 January 2024. However, it is important to be aware that the gateways look at the income and activities of the entity within the preceding two years. This means that an entity’s position from 1 January 2022 could impact its treatment from 1 January 2024. This presents a dilemma for taxpayers, who will be disinclined to go to the expense of restructuring or of adding substance to holding companies until the final form of ATAD III is known.
Impact outside of the EU
Non-EU entities (including UK companies) are not within the scope of ATAD III and therefore will not be subject to the rules.
However, non-EU entities should still pay heed to ATAD III, for the following reasons:
- Many company groups include a EU entity. This may be an operating company which is not at risk of being a shell. However, many corporate structures include holding companies located in jurisdictions with access to treaty networks and EU Directives, or with favourable tax regimes relating to intellectual property. ATAD III will be a concern for the Netherlands, Luxembourg, Cyprus, Malta and Ireland in particular.
- A shell designation could have negative implications for entities beyond those prescribed in ATAD III. For example, it could act as a ‘red flag’ to financial institutions, who may be reluctant to deal with the entity in question.
- It is also not out of the question that, once ATAD III is in force, the European Commission and the European Court of Justice could start applying it more broadly. It is also likely that some Member States will implement the Directive more strictly than others and potentially go further than the European Commission originally envisaged.
- Shortly after ATAD III was proposed, the European Commission announced the intention to follow up with an initiative aimed at non-EU entitles. A consultation for a new Directive was launched earlier this month - more on this below.
New European Commission Consultation
On 6 July 2022 the European Commission launched a consultation for a new Directive targeting ‘enablers who design, market and/or assist in the creation of tax arrangements or schemes in non-EU countries that lead to tax evasion or aggressive tax planning for the EU Member States.’
The consultation puts forwards three options:
- Option 1 is to require all enablers to carry out dedicated due diligence procedures, to check whether the arrangement or scheme they are facilitating leads to tax evasion or aggressive tax planning.
- Option 2 combines the due diligence procedures of Option 1 with a registration requirement for enablers who provide advice or services of a tax nature to EU taxpayers or residents.
- Option 3 is to require all enablers to follow a code of conduct obliging them to ensure that they do not facilitate tax evasion or aggressive tax planning.
- In addition, the European commission proposes that EU taxpayers be required to declare any 25% interest in a non-listed company located outside the EU in their annual tax returns.
The options are reminiscent of DAC 6, which requires intermediaries to report certain cross-border arrangements. However, the European Commission notes that the audits and tax consequences of DAC 6 are in principle addressed to the taxpayer and not the enabler involved in the reportable cross-border arrangement. By targeting enablers, the new Directive seeks to attack the problem from a new angle.
The call for evidence closes on 12 October 2022 and the European Commission is ambitiously seeking adoption in the first part of 2023. Therefore we are likely to have more details in late 2022.