Following the OECD’s BEPS initiative, the EU Commission has published a package of measures to prevent tax avoidance in the EU, including a draft of the Anti-Avoidance Directive, a proposal to amend the tax cooperation Directive, as well as recommendations to Member States.
Following the initiative of the Organisation for the Economic Cooperation and Development (OECD) against base erosion and profit shifting (BEPS) started with the BEPS Action Plan, the European Commission published on 28th of January 2016 a package of measures to prevent tax avoidance in the EU internal market (the “Anti-Tax Avoidance Package“).
The Anti-Tax Avoidance Package proposes measures to allow Member States to tackle BEPS in order to preserve corporate fairness taxation in the EU, ensuring that companies pay taxes where they effectively obtain their profits. In addition, this Package seeks to achieve a coordinated response for all the Member States to implement coherently in their respective legislations some of the principal recommendations set out in the BEPS Action Plan.
The EU Commission Anti-Tax Avoidance Package consists of the following key elements:
- Anti-Avoidance Directive draft;
- A Recommendation on Tax Treaties;
- A proposal of amendment to Directive 2011/16/EU, introducing the Country-by-Country (CbC) reporting of information between tax authorities of the Member States; and
- A communication on an External Strategy for Effective Taxation.
1. Anti-Avoidance Directive
The EU Council has drafted a proposal Directive containing a serie of rules to prevent BEPS, which are briefly explained below. The Anti Avoidance Directive would be applicable to taxpayers that are subject to corporate tax in any Member State, including, amongst others, both permanent establishments (PE’s) of entities resident in Member States and PE’s of entities resident for tax purposes in third countries (meaning outside EU).
As the European Commission has stated, rules proposed in the Directive have as an objective to provide a minimum level of protection for national corporate tax systems in the UE, leaving to Member States the implementation of the specific measures and details that fit best their respective tax systems.
Limitations to the tax deductibility of interests
The EU Council proposes that financial net expenses shall be deductible up to 30% of the taxpayer’s earnings before interest, tax, depreciation and amortisation (EBITDA) or up to €1 million, whichever is higher. This limitation may not be applied if the taxpayer can prove that the ratio of its equity over its total assets is equal to or higher than the equivalent ratio of the group. In such case the relevant borrowing costs will be deductible. However, the mentioned exception shall be subject to the compliance of certain requirements.
Either the EBITDA which is not fully absorbed by the financial net expenses, or the exceeding financial net expenses which could not be deducted in the current year, may be carried forward to use or deduct respectively in subsequent years.
The interest limitation rule will not apply for financial undertakings (e.g. credit institutions, insurance and reinsurance, etc.), although this exclusion may be temporary.
The exit tax pretends to ensure that a Member State will have the chance to assess taxes for the underlying profits of assets located in its territory that are transferred to another state (including third countries), or when a company moves its tax residency to another State (including third countries). For this purposes, the amount subject to taxation will be calculated by the difference of the market value of the assets at the exit date and its value for fiscal basis.
It must be noted that this provision may be considered as a limitation to the EU fundamental freedoms (i.e. free movement). This may be solved by the Directive providing that under certain circumstances the taxpayers would be able to defer the payment of the exit tax by paying it in instalments over at least 5 years. Generally, the deferment would apply in cases where the assets or tax residence are transferred to other Member States or countries that are parties of the European Economic Area’ (EEA) agreement.
The exit tax shall not be applicable to temporary transfers of assets, when the involving assets are intended to come back to Member State of the transferor.
The switch-over clause pretends to ensure that a minimum taxation will be assessed to certain income distributions (i.e. profit distribution, proceeds from the disposal of shares; income distribution from PE’s) received by taxpayers which are originated in third low taxation countries.
Specifically, the Directive proposes that Member States shall not exempt the mentioned distributed income in cases where this income has not been taxed or it has been taxed at a statutory corporate tax rate lower than 40% of the statutory tax rate that would have been charged under the applicable corporate tax system in the Member State of the taxpayer.
However, the EU Commission proposes that Member States applying this clause should give a deduction of the tax paid in the third country in order to prevent double taxation.
This clause may affect profit participation exemption rules contained in local corporate tax systems of the Member States.
General anti-abuse rule (GAAR)
The GAAR is designed to cover gaps that may exist in a country’s specific anti-abuse rules against tax avoidance. According to this, the GAAR should apply in cases where other specific provisions have not been able to prevent tax practices deemed abusive.
The GAAR contained in the Directive provides that non-genuine agreements carried out for the essential objective to obtain a tax advantage that defeats the object of applicable tax provisions should be ignored to calculate the corporate tax liability. In those cases, the tax liability should be calculated by reference to the economic substance according to the national law.
For the purposes of the application of the GAAR, non-genuine agreements are those that are not performed for valid commercial reasons which reflect the economic reality.
Controlled Foreign Company (CFC) rules
CFC rules allow Member States, under certain conditions, to assign non-distributed income of controlled companies to its controlling company in order for this income to be taxed in the country of the controlling company.
Notwithstanding, exceptions to the application of CFC rules are foreseen when the controlled is an entity or financial undertaking resident in a Member State or in a country which is party in the EEA agreement; or PE’s situated in a Member State; as long as they are not wholly artificial or perform non-genuine activities.
The Directive deems as a foreign controlled company those in which the taxpayer by itself, or together with its associated enterprises, holds a direct or indirect participation of more than 50% of the voting rights, owns more than 50% of capital or is entitled to receive more than 50% of the profits of that company.
The attribution of the non-distributed income of the controlled company to its controlling company is subject to certain requirements, being the following the most relevant:
- in the country of the controlled entity profits must be subject to an effective corporate tax rate lower than 40 percent of the effective tax rate that would have been applicable in the State of the controlling company;
- more than 50% of the undistributed income shall fall into specific categories (i.e. royalties; interests; dividends and income from the disposal of shares; income from services rendered to the taxpayer or its associated enterprises, etc.)
Hybrid mismatches occur when two legal systems of the Member States characterize payments or entities in different manners so that double deduction or a deduction of the income is obtained in the State where payment has its source without inclusion in the tax base of the other State.
To avoid these mismatches, the Anti-Tax Avoidance Directive proposes that the legal characterisation given to the hybrid instrument or entity by the Member State in which the payment has its source shall be followed by the other Member State.
2. Recommendations on Tax Treaties
The EU Commission suggests a minimum amendment in the wording of the GAAR rule contained in OECD Model Tax Convention, which is based on “principal purpose test” of transactions. The principal purpose test aims to determine when the main purpose of arrangements or transactions is to obtain the tax treaty benefits. This recommendation relates to Action 6 (“preventing the granting of treaty benefits in inappropriate circumstances“) of the BEPS Action Plan.
Highlighted below is the wording proposed by the European Commission:
“Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that it reflects a genuine economic activity or that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.“
Moreover, when negotiating tax treaties, the EU Commission suggests Member States to adopt the new provision relating to the PE of the OECD Model Tax Convention, proposed in the final report of the Action 7 (“preventing the artificial avoidance of permanent establishment status“) of the BEPS Action Plan.
3. CbC reporting of information
In line with the recommendations set out on Action 13 (“re-examine transfer pricing documentation“) of the BEPS Action Plan, the EU Commission has proposed an amendment on Directive 2011/16/EU regarding mandatory automatic exchange of information in the field of taxation in order to implement the automatic exchange of the Country-by-Country report.
The CbC report consists on the obligation by certain Multinational Enterprises (MNEs) Groups -as defined in the Directive- resident for tax purposes in a Member State, to provide tax authorities in an annual basis with specific information of the Group for each jurisdiction in which it operates. Concretely, the information to be included in CbC report relates to (i) revenue; (ii) profit before income tax; (iii) income tax paid and accrued; (iv) stated capital; (v) accumulated earnings; (vi) number of employees and (vii) other tangible assets; with regard to each jurisdiction where the MNE operates. The report shall also (viii) identify the constituent entities (as defined in the Directive) of the Group, (ix) their tax residence, (x) the jurisdiction under the laws in which is organised and (xi) the nature of their main business activity.
The CbC report would be required to MNE Groups whose total consolidated revenue is equal or higher than €750 million. In a general basis, the Member State shall require the CbC report to the ultimate parent company -as defined in the Directive- of an MNE Group that is resident for tax purposes in its territory.
If the amendments to the Directive are approved, the first CbC report shall be communicated for the fiscal year commencing on or after 1st of January 2016.
Under the proposed Directive amendment the competent authority would communicate the CbC report by means of automatic exchange to any other Member State in which, on the basis of the information in the CbC report, one or more constituent entities of the MNE Group of the reporting entity are either resident for tax purposes, or are subject to tax with respect to the business carried out through a permanent establishment.
Some countries are already implementing this obligation on local regulations. For example, the Spanish government has already introduced the obligation to fulfil the CbC report on the amendment to its Corporate Income Tax Regulation (Royal Decree 634/2015 from 10th of July 2015).
4. Communication on an External Strategy for Effective Taxation
The EU Commission has also published a Communication on an External Strategy that identifies some measures that can help the EU to promote tax good governance globally and the cooperation on tax good governance matters with third countries.
The EU Commission will adopt other measures to ensure fair tax competition with its international partners (i.e. to include state aid provisions in negotiating proposals for agreements with third countries; the elaboration of a common EU approach to listing third countries; etc.).