Since the beginning of the OECD BEPS project, there has been unrelenting media and tax administration focus on the ways in which multinational companies (MNCs) arrange their tax affairs. Such tax issues are no longer just a talking point for the finance team but have become a major C-suite issue, as they can have a significant impact on the way in which companies are viewed by their customers and consequently on shareholder value.
In this article, we focus on the hardening attitude of EU tax administrations to perceived cross-border anti-avoidance and the recent measures taken to combat it.
What has changed?
Following the completion of the OECD BEPS project, MNCs need to have a heightened sensitivity in relation to their cross-border structures, both as regards to the impact of the EU anti-tax avoidance directives ("ATAD I and II"), and the adoption of the OECD's Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting (the "MLI"), which currently has over 100 signatories.
ATAD I and II
Many EU Member States have implemented ATAD I into their national law with effect (for the most part) from 1 January 2019. The ATAD I provisions implement key anti-avoidance measures to counter-act some of the most common types of aggressive tax planning, as identified in the OECD BEPS project and include:
- an interest restriction under which the deductibility of borrowing costs is restricted to 30% of a taxpayer's EBITDA – subject to a de minimis exemption of €3 million (per tax year) net interest expense;
- a general anti-abuse rule to counter-act aggressive tax planning when other rules do not apply;
- a tightening of the Controlled Foreign Company rules to deter profit-shifting to no or low tax countries; and
- changes to exit taxation rules to prevent companies from avoiding tax when relocating assets (from 1 January 2020).
ATAD II, which aims to prevent hybrid mismatches between EU Member States and between EU Member States and third country situations, will come into force from 1 January 2020.
Member States have significant flexibility as to how they implement ATAD into national law and MNCs will need to review how ATAD I (and in due course ATAD II) will affect operations in the countries in which they operate. We highlight below how the UK, the Netherlands, Spain and France have approached the implementation of ATAD.
The UK has implemented or amended various pieces of legislation to bring ATAD 1 into effect where its rules fell short of minimum standards imposed by ATAD. These include changes to its UK controlled foreign company rules, the exit taxation rules and the hybrid mismatch rules.
The UK has also implemented rules dealing with interest restrictions. In relation to the de minimis exemption for the interest restriction, the UK's de minimis threshold is £2 million (rather than €3m). The de minimis exemption is also applied across the consolidated group.
The Netherlands, like several other EU Member States, has opted for a broad ATAD. In the Netherlands the interest limitation provision limits the deduction of net interest expenses (whether on related party or external debt) to a maximum of the higher of (i) €1 million or (ii) 30% of EBITDA. Excess interest expense can indefinitely be carried forward.
The Netherlands has opted not to make use of the option to increase the threshold to €3 million; not to apply the grandfathering rules; and not to apply group exceptions.
In Spain, the general view has been that the measures proposed were already part of the Spanish tax system and that the domestic measures were compliant with a broad view of ATAD I. As an example, with respect to interest deduction limitations, Spain adopts a position very similar to that of the Netherlands: the net interest expense is limited to 30% of EBITDA, although expenses of less than €1 million (or the proportional part for tax periods of less than one year) would be deductible in any case. Similarly, Spain does not apply group exceptions nor the grandfathering rules.
In Germany, the implementation of ATAD is not expected to bring significant changes, with the exception of amendments to the controlled foreign company rules and additions to the rules governing hybrid mismatches. This is because Germany already has strict rules in place which aim to prevent any circumvention of tax and to ensure the protection of the German tax base.
Germany introduced interest deduction limitation rules based on a 30% EBITDA limitation in 2008 and the ATAD rules generally reflect the existing German rules, including a de minimis threshold of €3 million, an asset-based group ratio calculation, some options for interest and potential EBITDA carry forwards.
The French Finance Act 2019 includes corporate tax measures that transpose ATAD I into French law with respect to interest limitations and general anti-abuse rules.
Regarding interest limitations, the 25% non-deductibility rebate, which limits the deductibility of net financial expenses to 75% of their amount, and the thin-capitalization rules were repealed and replaced by a limitation based on the EBITDA of the company. The new rule limits the tax deductibility of net financial expenses to the higher of 30% of the EBITDA of the company or €3 million, per fiscal year.
The French Finance Act 2019 also introduced a corporate income tax general anti-abuse clause which enables the French tax administration to disregard operations performed by the taxpayer if two conditions are met:
- the arrangement (or series of arrangements) is set up for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law; and
- the arrangement (or series of arrangements) is not regarded as genuine.
In regard to ATAD II, France is waiting for the future transposition of the directive which must come by the end of 2019.
Tax treaties and the MLI
As part of the adoption by countries of the MLI, a principal purpose test has effectively been included in many tax treaties to deny treaty benefits (such as reduced withholding tax rate on interest) if it is reasonable to conclude that obtaining the relevant benefit was one of the principal purposes of the arrangements.
MNCs will need to assess the impact of any treaty changes resulting from the MLI and ask themselves questions such as: what was the business or commercial driver of the transactions? and what were the decisions behind the choice of location of the parties?
Those MNCs with financing structures that lack substance may find themselves at particular risk of attack under the principal purpose test. However, all MNCs that have local subsidiaries which seek to take advantage of tax treaties to pay interest or dividends need to consider the impact of the principal purpose test on their structures.
What does this mean for businesses?
MNCs need to be aware of the developments in this area and consider how this heightened scrutiny on cross-border transactions and arrangements could impact their group structures and their business. Whilst welcoming efforts to minimise tax avoidance, businesses will also be faced with additional complexity from the compliance angle, increasing the costs associated with conducting cross-border trade.