The EU’s proposal on shell companies introduces a multiple-step filtering procedure to help Member States identify undertakings located in the EU that are engaged in an economic activity, but which do not have minimal substance and are misused for the purpose of obtaining tax advantages. To ensure equal treatment, the directive does not introduce a threshold based on company turnover and applies to all shell entities, regardless of whether they are owned by an SME or a multinational.
At first, a ‘gateway test’ is set up: EU entities would need to check via three gateways whether they are ‘at risk’ of lacking substance and being misused for tax purposes. Some types of shell entities, particularly in the area of financial services, would be exempted from the proposal and would thus not need to apply the gateway test, as the Commission argues they are ‘commonly used for good commercial reasons’. The three gateways are:
- more than 75 % of an entity’s income is ‘relevant income’, which broadly covers passive income (interest, dividends, royalties),
- more than 60 % of the book value of the entity’s assets has been located outside the undertaking’s Member State for at least two years, or more than 60 % of the entity’s relevant income is earned through cross-border transactions,
- the entity has outsourced the administration of its day-to-day operations and decision-making.
If the entity passes all three gateways, it will be obliged to report, through its annual tax return to its tax authority, information regarding the entity’s level of substance concerning:
- the premises of the company,
- whether it has its own, active bank account in the EU,
- the tax residency of its director(s) and the majority of its full-time employees.
All declarations will need to be accompanied by supporting evidence.
If an entity lacks substance in one of these indicators, it is presumed to be ‘a shell’ for the purposes of the directive. A company has the right to rebut this presumption, and it can do so by providing at least additional evidence on the commercial rationale of the undertaking, information about their employees (such as their level of experience, their decision-making power and role in the overall organisation, or their employment contract), and evidence showing that decision making on the activity generating the relevant income takes place in the Member State where the undertaking is located. Additional information which the entity believes to be crucial can be provided. If the tax authority accepts the taxpayer’s rebuttal, the rebuttal is valid for the tax year and may remain valid for an additional five years, if the factual and legal circumstances of the company do not change.
Once an undertaking is presumed to be a shell for the purposes of the directive, and the undertaking does not rebut such a presumption, or when the Member State’s tax authority does not accept the rebuttal, the directive will aim to disallow any tax advantage for the entity, in particular any tax advantage gained through bilateral tax treaties of the undertaking’s resident jurisdiction or through EU directives such as the EU Parent/Subsidiary Directive (90/435/EEC) and the EU Interest/Royalty Directive (2003/49/EC). As a tax consequence, the Member State of the tax residence of the shell company will not issue a tax residence certificate at all, or will issue a certificate with a warning statement, to inform the source country that it should not grant the benefits of its tax treaty with the Member State of the shell (or applicable EU directives) for payments towards the shell, making them subject to higher withholding taxes. Moreover, the relevant income of the shell company will be taxed in the Member State where the shareholders of the shell entity are residing, as if that income had directly accrued to them.
Information on EU shells will be exchanged automatically through an EU-wide central directory. The directory will also include information on when a tax authority has accepted an entity’s rebuttal or exempted a company from the scope of the directive. Member States will also be able to request another Member State to launch a tax audit if they have reason to believe that an entity might be lacking minimal substance.
The directive would apply from 1 January 2024.