The European Commission has on the 22nd December 2021 proposed a directive, the main aim of which is to increase scrutiny for EU undertakings with no or minimal substantial presence and real economic activity (referred to as ‘shell companies’) to prevent them from being used for tax evasion and avoidance.
The provisions of the proposed directive will be applicable to any entity that is considered to be a tax resident in an EU member state, without any distinction being made to size and type of legal entity. The proposed Directive establishes a ‘substance ‘test’ of three cumulative conditions to determine whether or not the undertaking is at risk to be considered as a shell company. The test is to be assessed on the basis of the two previous tax years.
The cumulative conditions are:
- The undertaking predominantly derives passive income;
- The undertaking is mainly engaged in cross border activities; and
- The undertaking has outsourced core management activities since it owns no or inadequate resources
Undertakings at risk should declare information related to their substance in their tax return and self-assessment in terms of premises, existence of an active bank account in the EU as well as place of residence and qualification of the directors and / or employees). Undertakings failing to meet one of the substance indicators will be presumed to be shell companies. The onus of proof to prove that it an undertaking is not a shell company is on the undertaking itself.
Undertakings deemed as shell will have the possibility to rebut such a presumption, by providing concrete evidence and information including the non-tax or commercial reasons for setting up and maintaining such an undertaking, the resources it owns as well as the nexus that exists between the undertaking and the MS where it claims to be tax resident for tax purposes. If this is done to the satisfaction of the tax authorities, they will certify such a rebuttal for the relevant tax year which will be extended for another five years, provided the legal and factual circumstances do not change.
Undertakings which do not meet a certain level of substance required by the Directive but carry out genuine business activities without creating tax benefits for its beneficial owners or the group they form part of may request an exemption from their reporting obligations. The undertakings will have to produce the necessary evidence to proof that their interposition does not lead to any tax benefits to the group or to their beneficial owners. If the tax authorities are satisfied with the evidence produced, they will grant the exemption for the relevant year which will be extended for another five years, provided the legal and factual circumstances do not change.
If an undertaking is considered to be a shell, it will not be able to benefit from the EU tax directives namely the Parent Subsidiary and the Interest and Royalties Directives as well as any other benefits available under the treaty network which that EU member state has with other countries. Tax authorities will also be compelled not to issue tax residence certificates for such undertakings or issue them with a warning.
All EU member states will have access, at any time to all the information related to shell entities as the information will be exchanged automatically. Member states will be free to impose penalties in case an undertaking fails to comply with its reporting obligations. Such penalties should be effective, proportionate and dissuasive and should include an administrative pecuniary sanction of at least 5% of the undertaking’s turnover.
If adopted, member states will be required to implement the Directive by the 30th June 2023 and to apply it as from 1st January 2024.
Maltese companies which might be impacted with this new directive, if adopted, will do well to anticipate its impact. Since indicators as to whether or not an undertaking is considered to be at risk will be assessed based on available information in the preceding two years, undertakings should start evaluating their structures as early as 2022.
ACT will be able to advise and assist undertakings to evaluate their existing structures in particular the criterion related to the administration of the day-to-day operations which should be monitored carefully and properly documented.