News and developments
The Third Anti-Tax Avoidance Directive (ATAD 3) The tombstone of shell entities
A. INTRODUCTION
The European Commission on the 22nd of December 2021 published a legislative proposal for a Directive to be issued, the Third Anti-Tax Avoidance Directive, known as “ATAD 3”, which sets forth rules to prevent the misuse of shell companies for tax purposes. The Directive should be adopted early 2022 by the Council and be implemented by Member States by 30 June 2023 at the latest. The provisions should subsequently be effective in all Member States from 1 January 2024. The Directive lays down a uniform test that will help Member States to identify undertakings that are engaged in an economic activity, but which do not have minimal substance and are misused for the purpose of obtaining tax advantages. Once these minimum substance requirements are not met, the undertaking will be classified as “shell entity” and will sustain certain adverse tax consequences. The methodology followed by the proposed Directive to identify shell entities There are 7 steps to be followed:- Identification of undertakings being at risk to be classified as shell companies;
- Substance reporting requirements;
- Exempted undertakings from reporting;
- Presumption of being classified as a shell entity or not, for tax purposes;
- Rebuttal of the presumption of being classified as shell entity - Exemption;
- Tax Consequences of not meeting the substance requirements;
- Exchange of information, tax audits and Penalties.
B. SUMMARY OF THE PROVISIONS OF THE PROPOSED DIRECTIVE
The proposed Directive will be applied following the above identified methodology, step by step. At first, undertakings, tax residents of member states which are engaged in economic activity, will be examined whether they meet cumulatively the following three conditions:- Whether the undertaking has passive income more than 75% of its revenues, such as interest, dividends and royalties; and
- Whether it is engaged in cross border activity; and
- Whether it outsources its management and administration to third parties.
- Whether the undertaking has an office space, (owned or rented), through which it exercises its activities;
- Whether the undertaking has an active EU bank account; and
- Whether at least one of its directors is an in-house director properly qualified to handle the business of the undertaking or the majority of its full - time employees reside in the same country as the undertaking.
THE PROVISIONS OF THE PROPOSED DIRECTIVE IN DETAIL
Definitions - Interpretation For the purposes of this Directive the following definitions shall apply: “Undertaking” means any entity engaged in an economic activity, regardless of its legal form, that is a tax resident in a Member State1; “Member State of the undertaking” means the Member State where the undertaking is resident for tax purposes2; In effect, any type of a legal body engaged in economic activity, being tax resident in a Member State, is subject to the provisions of the Directive. Cyprus Local or International Trusts, not being a legal person, and not liable as such to taxation in Cyprus, do not fall within the provisions of the Directive. Their subsidiary companies being tax residents of Cyprus might be caught by the provisions of the Directive unless exempted. “Relevant income” shall mean income falling under any of the following categories:- interest or any other income generated from financial assets, including crypto assets,
- royalties or any other income generated from intellectual or intangible property or tradable permits;
- dividends and income from the disposal of shares;
- income from financial leasing;
- income from immovable property;
- income from movable property, other than cash, shares or securities, held for private purposes and with a book value of more than one million euro;
- income from insurance, banking and other financial activities;
- income from services which the undertaking has outsourced to other associated enterprises3.
- more than 75% of the revenues accruing to the undertaking in the preceding two tax years is relevant income as relevant income is above identified;
- the undertaking is engaged in cross-border activity on any of the following grounds:
- more than 60% of the book value of the undertaking’s assets that fall within the scope of points (e) and (f) above, was located outside the Member State of the undertaking in the preceding two tax years;
- at least 60% of the undertaking’s relevant income is earned or paid out via cross-border transactions;
- in the preceding two tax years, the undertaking outsourced the administration of day-to-day operations and the decision-making on significant functions4.
- the undertaking has own premises in the Member State, or premises for its exclusive use;
- the undertaking has at least one own and active bank account in the Union;
- the undertaking meets one of the following two indicators:
- One or more directors of the undertaking:
- are resident for tax purposes in the Member State of the undertaking, or at no greater distance from that Member State insofar as such distance is compatible with the proper performance of their duties; and,
- are qualified and authorised to take decisions in relation to the activities that generate relevant income for the undertaking or in relation to the undertaking’s assets; and,
- actively and independently use the authorisation referred to in point (2) on a regular basis; and,
- are not employees of an enterprise that is not an associated enterprise and do not perform the function of director or equivalent of other enterprises that are not associated enterprises;
- The majority of the full-time equivalent employees of the undertaking are resident for tax purposes in the Member State of the undertaking, or at no greater distance from that Member States insofar as such distance is compatible with the proper performance of their duties, and such employees are qualified to carry out the activities that generate relevant income for the undertaking5.
- One or more directors of the undertaking:
- address and type of premises;
- amount of gross revenue and type thereof;
- amount of business expenses and type thereof;
- type of business activities performed to generate the relevant income;
- the number of directors, their qualifications, authorisations and place of residence for tax purposes or the number of full-time equivalent employees performing the business activities that generate the relevant income and their qualifications, their place of residence for tax purposes;
- outsourced business activities;
- bank account number, any mandates granted to access the bank account and to use or issue payment instructions and evidence of the account’s activity6.
- companies which have a transferable security admitted to trading or listed on a regulated market or multilateral trading facility;
- regulated financial undertakings;
- undertakings that have the main activity of holding shares in operational businesses in the same Member State while their beneficial owners are also resident for tax purposes in the same Member State;
- undertakings with holding activities that are resident for tax purposes in the sameMember State as the undertaking’s shareholder(s) or the ultimate parent entity;
- undertakings with at least five own full-time equivalent employees or members of staff exclusively carrying out the activities generating the relevant income7.
- Other Member States will disregard application of tax treaties and disregard the application of the Parent-Subsidiary and Interest and Royalties Directives in relation to transactions with the reporting entity. The relevant Member State may nonetheless allow benefits under domestic law or tax treaties to apply in relation to the shareholder of the reporting company (i.e., look-through treatment)
- If the reporting entity has an EU shareholder, the EU jurisdiction of the shareholder will tax the relevant income of the reporting company as if it had accrued to them directly, according to its national rules, with a credit for taxes paid at the level of the reporting company, and
- The reporting entity will, in principle, no longer receive a certificate of tax residency, or the respective tax authority will issue an amended tax residency certificate indicating that the reporting company is no longer entitled to benefits of treaty or relevant EU Directives.
THE PROCESS OF THE PROPOSED DIRECTIVE IN A DIAGRAM
The methodology of the proposed Directive in order to identify shell entities proceeds as follows:![](https://www.legal500.com/developments/wp-content/uploads/sites/19/2022/03/questions-259x300.png)
E. OUR OBSERVATIONS
Tax residency of Cyprus Companies and substance requirements under ATAD 3 The proposed Directive is applicable only to tax resident undertakings having economic activity. As per art. 2 of the Income Tax Law No. 118(I)/2002 as amended, a company, anywhere registered, is tax resident of Cyprus only if its management and control is exercised in Cyprus. In addition, as from 31/12/2022 Cyprus registered companies, which are managed and controlled from abroad, will be automatically considered as tax residents of Cyprus by registration, unless they are tax residents of any other foreign country. Relevant analysis of this concept has been given in our publication, “The Management and Control Test – Taxation of Cyprus and Foreign Companies” published, January 2022, which can be found at https://www.kinanis.com/Publications The Income Tax Law above, does not specify the meaning of management and control, neither the Commissioner of Income Tax has given any guidance as to the interpretation of this principle, so as to identify which companies are managed and controlled from Cyprus and consequently to be tax residents of Cyprus. In this respect, in order to interpret and apply this notion, we refer to UK court cases as we have pointed out in detail in our above-mentioned publication. As per the interpretation given to the principle of management and control, if the directors of the company meet and decide independently the business issues of the company in Cyprus, the company is considered as having its management and control in Cyprus and consequently the entity is a tax resident of Cyprus. Important role to identify whether the board of directors meets and decides in Cyprus, is the substance issue of the company and especially if the company maintains an office in Cyprus where the board of directors meets and decides the company issues accordingly. Also, important issue is the residency of the directors and whether the company employs personnel stationed in Cyprus to undertake the business of the company from Cyprus. These were crucial factors in identifying whether the management and control of the Cyprus company is exercised in Cyprus but were not officially framed so far. ATAD 3 with its requirement as to particular substance conditions so that the characterization of the company as a shell company is avoided, officially gives a way out to the substance issue which should have been present in identifying the management and control of a company. In effect, once the substance requirements of ATAD 3 are met, in the case where the in- house qualified director has been appointed, and is indeed managing the affairs of the company from Cyprus, the management and control test identifying the tax residency of a company is strengthen and supports the allegation that such a company is managed and controlled from Cyprus and therefore is a tax resident of Cyprus. The substance requirement as per ATAD 3 is also met if the majority of the full-time employees are resident for tax purposes in the Member State of the undertaking. This condition though, cannot be connected with the management and control of the company which is a notion related to the directors’ powers. If the substance requirement as per ATAD 3 is met only with the majority of the employees stationed in Cyprus in the absence of the directors’ involvement and capacity residing and deciding from Cyprus, then such a company might not be managed and controlled form Cyprus and in this respect, it might not be a tax resident of Cyprus and the Directive will not be applicable to it. The below diagram clarifies the particular situation under discussion.![](https://www.legal500.com/developments/wp-content/uploads/sites/19/2022/03/Table-300x297.png)
F. HOW KINANIS LLC CAN HELP YOU
We shall be glad to assist you to assess the impact of this Directive on your structure and examine the steps that need to be taken in case of final implementation. The Directive seems to have serious impact on holding companies and some requirements to meet the tests and parameters employed, have retrospective effect as from 2022. In this respect, planning as from now seems imperative.G. DISCLAIMER
This publication has been prepared as a general guide and for information purposes only. It is not a substitution for professional advice. One must not rely on it without receiving independent advice based on the particular facts of his/her own case. No responsibility can be accepted by the authors or the publishers for any loss occasioned by acting or refraining from acting on the basis of this publication.1 Article 3(1) of the proposed Directive. 2 Article 3(4) of the proposed Directive. 3 Article 4 of the proposed Directive. 4 Article 6(1) of the proposed Directive. 5 Article 7(1) of the proposed Directive. 6 Article 7(2) of the proposed Directive. 7 Article 6(2) of the proposed Directive. 8 Article 8 of the proposed Directive. 9 Article 9 of the proposed Directive. 10 Article 10 of the proposed Directive.