On January 28, 2016 the European Commission (EC) published its Anti-Tax-Avoidance Package (ATA Package). The package is part of a wider plan of the European Commission to address tax avoidance by multinational enterprises (MNEs). Anti-avoidance measures proposed earlier include the altering of the EU Parent Subsidiary Directive to address hybrid mismatches and to introduce a general anti-abuse rule (GAAR) with respect to the holding of shares in other entities (effective January 1, 2016) and the mandatory automatic exchange of cross-border rulings (effective January 1, 2017).
This article provides an overview of the proposed measures in Part I and the reactions from a Dutch perspective in Part II, including the perspectives of tax professionals in several Bird & Bird offices on how the ATA Package was received in different EU member states. Since there is no EU common tax system for direct taxes (such as corporate income tax), the respective member states will be affected differently by the ATA Package. The different impact expected to the tax systems of the respective member states is reflected in the political reactions to the ATA Package. This has been covered in the press.1
I. Summary of the ATA Package Features
The package is inspired by the OECD’s project on Base Erosion and Profit Shifting (BEPS), the final reports of which were published in October 2015. With the currently proposed package the EC intends to make sure the BEPS outcome is implemented by the member states in accordance with EU law and that taxes are paid in the member states where the corresponding value is created. The core of the proposed package consists of four documents: an Anti-Tax-Avoidance Directive (ATA Directive); a Recommendation on Tax Treaties; a Revised Administrative Cooperation Directive; and a Communication on External Strategy on Effective Taxation. Key points are discussed in this section.
A. Anti-Tax-Avoidance Directive
The proposed ATA Directive contains six anti-avoidance measures which will be legally binding if adopted by the European Council and European Parliament.
1. Interest limitation rule
This rule stipulates that the deductible net interest is limited to the higher of 30% of the taxpayer’s earnings before interest, tax, depreciation and amortization (EBITDA) or € 1 million. If a taxpayer has interest expenses exceeding 30% of EBITDA, those interest expenses may be carried forward to subsequent years. Moreover, if 30% of EBITDA exceeds the interest expenses in a certain year, the difference may also be carried forward.
The interest limitation rule does not apply if the ratio between equity and total assets of a taxpayer is equal to or higher than the equivalent ratio of the group, where a ratio of up to two percentage points below the group’s will be deemed equivalent to the group’s ratio. The excess interest expense will be deductible, however, only if payments to associated enterprises do not exceed 10% of the group’s total net interest expense.
This rule does not apply to financial undertakings as defined in the Directive.
2. Exit taxation
Based on this rule a tax is levied on the transfer of assets if:
a) Assets are transferred from the taxpayer’s head office to its permanent establishment (PE) in another member state or third country;
b) Assets are transferred from a PE in a member state to the head office or another PE in another member state or in a third country;
c) The tax residence is transferred to another member state or to a third country, but not if the assets remain effectively connected with a PE in the first member state;
d) A PE is transferred out of a member state.
The taxable base is formed by the difference between market value and value for tax purposes at the time of exit of the assets concerned. If assets are transferred to member states, those member states are obliged to allow taxpayers to value the assets at market value. Taxpayers may defer tax claims arising from exit taxation by paying in installments for at least five years. If a taxpayer chooses to defer a tax claim, interest may be charged and securities may be demanded by the member state involved. The deferral ends if the transferred assets are disposed of, the transferred assets are transferred to a third country, the taxpayer’s tax residence or its PE is transferred to a third country or the taxpayer goes bankrupt or is wound up.
3. Switch-over clause
This measure prohibits member states from exempting income (profit distributions and proceeds from the disposal of shares) derived from low-taxed entities or PEs in non-EU states. Entities and PEs are regarded as low-taxed if they are subject to a statutory corporate tax rate lower than 40% of the statutory tax rate in the country of residence. The country of residence will grant an ordinary credit for taxes paid in the low-tax jurisdiction. The prohibition to exempt does not apply to losses incurred by the low-taxed PEs or to losses from the disposal of shares held in the low-taxed entity.
It is suggested in Dutch newspapers that a recent draft of the ATA Directive would apply the switch-over clause only to income that does not arise from active business and only if there is no treaty in place between the state of residence of the parent company and the state of residence of the subsidiary. This has not yet been officially confirmed.
4. General anti-abuse rule
This GAAR is similar to the one recently introduced in the EU Parent-Subsidiary Directive implemented in the ‘foreign substantial interest’ provision of the Dutch Corporate Income Tax Act and in the Dividend Tax Act. Although the latter would only tax foreign parents, this proposed GAAR would work throughout all corporate tax acts of member states and target any situation of alleged abuse. The GAAR stipulates that any non-genuine arrangement (i.e. arrangement or series thereof to the extent that they are not put in place for valid commercial reasons which reflect economic reality) carried out for the essential purpose of obtaining a tax advantage that defeats the object or purpose of the otherwise applicable tax provisions is to be ignored for the purposes of calculating the corporate tax liability. The tax liability shall then be calculated by reference to economic substance in accordance with national law. The GAAR does not affect the applicability of specific anti-abuse rules. Its application should be limited to ‘wholly artificial arrangements’: a taxpayer may in principle still choose the most tax-efficient structure.
5. Controlled foreign company legislation
The Controlled Foreign Company (CFC) rule attributes non-distributed income of a foreign company to the domestic parent company. The proposed CFC rule targets taxpayers that (together with associated enterprises) directly or indirectly hold more than 50% of capital or voting rights or are entitled to receive more than 50% of the profits of low-taxed foreign entities. For the purpose of the CFC rule, low-taxed entities are entities that under the general regime in its resident jurisdiction are subject to an effective corporate tax rate lower than 40% of the effective tax rate that would have been charged under the applicable corporate tax system in the parent jurisdiction. The CFC rule only applies if more than 50% of the income accruing to the low-taxed subsidiary falls within one or more categories included in the Directive. Those categories are passive income such as dividends, royalties, and interest. The CFC rule will not apply to financial undertakings as defined in the Directive.
If a subsidiary is located in a member state or third country party to the EEA Agreement, the CFC rule only applies if the establishment of the entity is wholly artificial or to the extent that the entity engages in non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage. Arrangements are deemed non-genuine to the extent that the foreign entity would not have undertaken the risks which generate income if it were not controlled by a company where the significant people’s functions are carried out and are instrumental in generating the controlled company’s income. In that case, the income to be included in the tax base of the controlling company will be limited to the income attributable to those significant people’s functions in accordance with the arm’s-length principle.
The income to be included in the tax base of the controlling company will be calculated in proportion to the entitlement of the profits of the subsidiary. The amount of tax due over that income is calculated in accordance with the corporate tax laws of the controlling company’s jurisdiction. Losses will not be allocated to the controlling company, but the CFC rule provides for a carry-forward to subsequent tax years.
Finally, the CFC rule includes a provision to prevent double taxation when the income is distributed. It does not, however, contain a mechanism to prevent CFC income from being included in the taxable base of multiple entities: it does not provide for a rule that prescribes the order in which income must be attributed to parents and grandparents in member states.
It is suggested in Dutch newspapers that a recent draft of the ATA Directive would provide the member states more flexibility in determining when a company is considered a CFC.
6. Hybrid mismatches
This measure deals with double deductions or deduction/no inclusion situations resulting from different classifications of the same entity by different member states. In such cases, the member state where the payment has its source will follow the legal classification of the member state of the entity receiving the payment. A similar rule applies to cases in which two member states give different classifications to the same payment.
B. Recommendation on Tax Treaty Abuse
The EC advises member states to implement a GAAR based on a principal purpose test in their tax treaties. If the principal purpose of an arrangement or transaction is to obtain treaty benefits, those benefits should be denied under the GAAR, unless it is established that the arrangement or transaction reflects a genuine economic activity or that granting the benefits would be in accordance with the object and purpose of the treaty. Additionally, the EC recommends implementing the outcome of BEPS Action 7 (Preventing the Artificial Avoidance of Permanent Establishment Status). In order to do so, member states should amend Article 5 of their double tax treaties.
C. Proposal for a Directive Implementing Country-by-Country Reporting
This proposal is the EC’s effort to implement BEPS Action 13 in the EU. Based on the proposal, the ultimate parent entity of an MNE with a total consolidated group revenue of at least €750 million is obliged to file a Country-by-Country (CbC) report in its member state of residence. If the parent is located in a non-EU state, a subsidiary must file the report. The report must contain inter alia information about profits, revenue and number of employees about all companies within the group. Tax authorities receiving such a report will be obliged to automatically exchange the report with other member states where a company of the MNE is resident or liable to tax.
D. Communication on an External Strategy for Effective Taxation
This communication to the European Parliament and the European Council proposes a framework for a new EU external strategy for effective taxation. The EC intends to “help the EU promote tax good governance globally, tackle external base erosion threats and ensure a level playing field for all businesses.” It aims to accomplish those objectives by increasing tax transparency and endorsing fairer tax competition. For instance, the EC announces that it investigates public CbC reporting requirements for other sectors than those to which the requirements currently apply (i.e. the banking and financial sector and the logging and extracting sector). Moreover, a common list of countries the EU considers to be tax havens will be drafted. Once a state is on that list, all member states are to take measures against that state in order to protect their own tax bases and to incentivise the state concerned to make adjustments to its tax system.
II. Initial Tax Practitioner Reaction to the ATA Package
The proposal is currently under debate in working groups with representatives from the EU member states and can still (partially) change. On April 12, Dutch newspapers announced that the working group seems to be preparing a new draft ATA Directive that is less stringent than the original draft. For instance, as mentioned above, the proposed switch-over clause would only apply to income that does not arise from active business and only if there is no treaty in place between the EU member state in which the parental company resides and the (third) state in which the subsidiary resides. Without the initially proposed switch-over clause there will be much less resistance by the countries involved.
A. The Netherlands
In the Netherlands, most tax practitioners greeted the ATA Package with great scepticism on its effect and aversion for its impact on the Dutch fiscal climate for MNEs. For example, headquarters based in the EU and especially in the Netherlands may be negatively affected by the proposed switch-over clause because of the impact it would have on the long-standing Dutch participation exemption—one of the cornerstones of the Dutch tax system. The participation exemption currently exempts capital gains and distributions from qualifying participations, including those from subsidiaries in low-taxed jurisdictions as long as they are active. Changing this tax exemption arguably may have a significant negative impact on the competitiveness of EU-and Dutch-based MNEs and contradicts the principles of an open economy. The Dutch Association of Tax Lawyers criticized the proposed measures, stating they would target bona fide structures and would end Dutch fiscal sovereignty2 . The Dutch government is yet to formally respond. Considering its current EU presidency, this response will be received with great interest. Most concerns are aimed at the switch-over clause. If this is amended as suggested in some news commentary, less scepticism is to be expected.
Belgian tax practitioners generally view an intervention on the supranational level as necessary in order to implement anti-tax-avoidance legislation in a consistent and coherent way. Nonetheless, some points of the proposed ATA Directive have not been warmly welcomed. In general, the entrepreneurial environment fears that the Union will not be at a level playing field with the rest of the world in terms of fiscal attractiveness. Critics also note the absence of an impact analysis, even though it is generally expected that the effective taxation will surely increase for the majority of businesses. In addition, considerable doubt exists with regard to the additional CbC reporting duties, possibly resulting in an excessive administrative burden for bona fide companies.
Furthermore, three of the specific areas covered by the proposed ATA Directive could have an (in)direct impact on the Belgian tax environment. While Belgium already has exit rules, the nature of the current proposals would probably impose some modifications. Second, the switch-over provision aiming to increase the tax base by neutralizing the numerous tax exemptions for revenues from low-taxed third countries might force the Belgian government to renegotiate certain double tax treaties. Finally, Belgian law does not contain CFC measures and would therefore require rather drastic changes. In addition, implementation of the proposed CFC measures in other countries will seriously affect the Belgian subsidiaries of MNEs, as they envisage changing or eliminating certain preferential tax regimes, such as the excess profit ruling, patent boxes and notional interest deductions.
C. Czech Republic
The ATA Package as recently presented by the EC has the full support of the Czech government and has generally been supported across the Czech political spectrum, including both the socialist/centrist government coalition and the conservative/liberal opposition. The head of the Economic Committee of the Czech Parliament (and a former governor of the Czech National Bank) noted that “despite a relatively low corporate tax level and a relatively narrow tax base under Czech tax legislation, sophisticated tax avoidance structures and transfer of profits abroad are the issues due to which the Czech state budget is deprived of considerable income each year, and therefore hopefully the EU member states would be supportive to the EC’s initiative.” The views of the leading tax professionals on the ATA Package are also generally positive, although they do emphasize that it is the inexperience and inconsistent practice of the tax authorities, rather than missing legislative measures, which help MNEs avoid Czech taxes.
At first glance, the proposal would not appear to have a major impact on the Finnish tax system. Finnish legislation already corresponds fairly closely to the proposed changes and in some aspects imposes even stricter requirements than the proposals in the ATA package. For example, the CFC legislation is already wider in the Finnish legislation than in the EC proposal.
The Finnish business community does have concerns, however, regarding the additional administrative burden and costs that the proposed package may create for taxpayers. It is also considered important that investors still find Finland an interesting and functional destination in which to operate. The proposed changes should not reduce the certainty of treatment under the Finnish tax system. Furthermore, it would be worrisome if tax law becomes more complex and if multiple regulatory levels (a national-and EU-level) make codification of the proposed measures cumbersome.
To summarize, the main goals of the proposals have been seen as mostly positive, but enforcing the ATA Package on the legislative level of each member state may be a rather challenging task.
With the recent introduction of the new anti-abuse clause for parent-subsidiary distributions (provided in the Council directive EU 2015/121 (January 27, 2015)), France’s legislation already generally corresponds to the ATA Package. The exit tax, hybrid mismatches and thin capitalization rules are already implemented within French tax law. For many years now, France has been modifying its tax legislation in this direction.
The EU package has not generated significant criticism in Germany to date. The German government has supported the OECD and EU BEPS process from the beginning, so it can be expected that Germany will also be supportive of this EC initiative. Nonetheless, the German Minister of Finance said the EU should exercise restraint in implementing the OECD BEPS reports into EU hard law.
Many of the recommended regulations included in the proposed EC package already exist under German legislation. In particular, German tax rules include similar interest limitation rules as well as strict CFC and exit taxation rules. Hybrid mismatch situations for certain cases are also covered by current German tax laws. Nevertheless, there are rumors that the Federal Ministry of Finance is working on a BEPS bill that could be finalized in the first half of this year. It is expected that this bill will tighten rules in order to adopt the EU initiative.
Hungary already has general anti-abuse rules similar to the one proposed in the ATA Directive. Other parts of the proposed ATA Package—CFC rules, hybrid mismatches and the interest limitation rule—are also addressed in Hungarian tax law. Nevertheless, tax practitioners generally agree that the introduction of the ATA Package would have considerable impact on Hungary’s position in international tax planning. It would likely require significant modification of Hungarian tax law. This could partly be done by amending existing rules and partly (e.g., for the proposed exit taxation rule and the switch-over clause) by introducing new ones.
The Hungarian government stated it supports the fight against tax avoidance and in that respect supports the idea of the ATA Package. Nonetheless, the Hungarian Minister of Finance raised concerns regarding the details of the package. He stated that the EU has to take into account that member states have legal obligations resulting from bilateral tax treaties and that thorough studies are required in order to predict the impact of the proposed package.
If implemented, the proposed measures would negatively affect the relatively simple and favourable tax environment for MNEs in Hungary.
The ATA Package has received support from the Polish government. According to an official statement, “Poland supports all efforts to eliminate tax base erosion and profit shifting and, therefore, the initiative of the European Commission in this regard.”
In Poland, a discussion on taxation of holding groups has been ongoing for several years now. Poland does not have particular provisions which would attract foreign holdings to register in Poland, yet there are many foreign companies already present there (mainly due to attractive employment costs and the large amount of EU funds Poland has received). Thus, the consequences of international tax avoidance practice are particularly negative for Poland as it loses potential profits from income tax. Therefore, prevention of tax optimization is one of the priorities for the Polish government. Recently, a draft amendment to the Polish Tax Ordinance was revealed which, inter alia, introduces a general tax avoidance clause. Moreover, Poland has always followed the EU’s directions and implemented its directives. One would expect that Poland will also support and follow the ATA Package.
With respect to holding companies, practitioners have identified the need for Polish law which would provide clear rules for such companies to operate in Poland. Although Polish provisions concerning tax capital groups do exist, those are not up-to-date and are insufficient to address tax avoidance if international holding companies are involved. A law aiming to address those problems has been drafted, and the market is expecting an update on further progress.
So far, there has not been a specific reaction of the Slovakian authorities to the ATA Package. However, the Slovakian government has put long and continuous emphasis on the fight against tax avoidance (especially concerning VAT), and we expect the Slovakian government to positively respond to the ATA Package.
Although no official announcement has been made yet by the Spanish tax authorities on the envisaged implementation of the ATA Package, no significant changes are expected. It may be decided that many of the measures in the proposed ATA Directive have already been implemented in Spanish tax regulations, either because they were inspired by the OECD BEPS-project or because Spain has already enacted recommendations/tax practices generally followed in other jurisdictions with the introduction of new tax regulations in connection with the 2015 Corporate Income Tax Law. Moreover, the CbC reporting obligations will only require the Spanish tax authorities to process the information in a different format. Spanish taxpayers already produce the appropriate information under the current regulations, duly aligned with OECD guidelines.
The recommendation on tax treaty abuse should be a measure with little impact in the short term, as such recommendations are likely inserted in the format of treaty clauses when new tax treaties are reached or when the old ones are amended. As Spain has an extensive network of recently renewed tax treaties, it is not expected to implement the treaty recommendations immediately.
Finally, with regard to the Communication on the External Strategy, there is concern that it lacks strong commitments to reach shared goals such as a common consolidated corporate tax base, specific regulations which envisage transfer pricing requirements for related party transactions or other measures to ensure fair tax competition in areas other than direct taxes.
Bird & Bird colleagues in Sweden report that one of the most frequently heard concerns from representatives of the Swedish business community are the growing difficulties the industry faces in being able to accurately predict their future tax positions. These concerns have grown significantly with the introduction of the OECD BEPS project and are likely to grow even more with the introduction of the EC’s extensive ATA Package. Along with domestic anti-avoidance rules, tax practitioners will now have three sets of avoidance norms (domestic, OECD/BEPS and EU) to consider. This is a problem not to be taken lightly.
Generally speaking, the UK has highly sophisticated anti-avoidance laws which likely cover most of the items within the ATA Directive. Nonetheless, the details of the ATA Directive present a number of areas where UK law will need to change to satisfy the proposals. In particular:
The interest limitation rule is likely to be unattractive in many sectors—in particular the real estate sector—where debt-equity ratios have been high historically;
(i) The exit taxation provisions which apply to transfers to and from PEs are broader than existing UK exit rules;
(ii) The switch-over clause is likely to be controversial, particularly in respect of capital gains arising on disposals of subsidiaries.
(iii) There are also areas where the Directive is less stringent than existing UK avoidance rules.
Tax practitioners generally view the introduction of an additional layer of anti-avoidance rules as a further complication of the tax system. Given that the BEPS proposals are fairly prescriptive, it is not entirely clear why the EU considers that this additional level of complexity is required. It may be that, as stated in the proposal, the EU is again pushing for an EU corporate tax base (the so-called Common Consolidated Corporate Tax Base), so perhaps this is seen as a useful stepping stone in that direction. Given the current political mood in the UK and talk of a ‘Brexit’, it will be interesting to see whether the UK Government will accept all the proposals and, going forward, what kind of appetite the UK has for being party to a Common Consolidated Corporate Tax Base.
The ATA Package must still receive the approval of the European Parliament and the European Council. On May 25th, 2016 the ATA Directive was tabled for (unanimous) approval by the European Council. The European Council adopted that day two texts for: (i) a directive on European CbC reporting rules for multinationals and (ii) conclusions on external taxation strategy (EU-blacklist) and measures against tax treaty abuse.
The Council failed to reach definitive agreement on the ATA Directive. According to a letter of the Dutch Secretary of Finance dated May 13th, the Council generally agrees on the rule on exit taxation, the GAAR and the measure addressing hybrid mismatches. The debate is mostly on the switch-over clause and the CFC rule. A new compromise will be tabled for the upcoming European Council meeting on June 17th, 2016. Clearly, interested parties in each of the countries—and MNEs from outside the EU—will be following these developments closely to understand the impact on their businesses. ■
2 For the underlying report (in Dutch only), please follow this link: http://www.nob.net/sites/default/files/content/article/uploads/nob_commentaar_anti-beps_richtlijn.pdf