The EU Commission continues to pursue the goal of curbing the abusive use of so-called letterbox companies. After the draft directive (Proposal for a Council Directive laying down rules to prevent the misuse of shell entities for tax purposes and amending Directive 2011/16/EU - "ATAD 3-E") to combat such arrangements has already been in place since 22 December 2021, it can be assumed that the new regulations will enter into force as planned on 1 January 2024 - even if no final version of the directive has been published since then and, as a result, there are no signs of German legislation being implemented into national law (which should take place by 30 June 2023 at the latest).
ATAD 3 is a further, complementary module of the general EU strategy to take decisive action against tax avoidance (Anti-Tax Avoidance Directive - ATAD) and is ultimately based on the OECD's BEPS project (Base Erosion and Profit Shifting). As part of this project, several action points have already been implemented as part of ATAD 1 and 2, which have massively changed the framework conditions for international structuring (e.g. exit and de-taxation, add-back taxation, interest barrier). The EU Commission's new proposal for a directive on Debt-Equity-Bias-Reduction-Allowance ("DEBRA"), which could result in an interest deduction restriction that goes beyond the interest barrier. This potentially imminent massive intervention is intended to promote equity capital by means of an allowance (notional tax-deductible interest on equity) and, in return, limit the interest deduction for debt capital to 85%, whereby these regulations, in contrast to the ATAD regulations, would apply to all companies based in the EU regardless of cross-border activity.
ATAD is focussing on 3 companies with weak assets, usually in the form of letterbox companies (shell companies). Although the regulations are not expected to come into force until 2024, it is essential that the concept of ATAD 3 is addressed in good time for all cross-border group and investment structures within the EU (the scope of application extends to all companies based in an EU member state; companies based outside the EU are not covered by ATAD 3, although they are to be regulated separately at a later date). A two-stage test scheme is envisaged, which will be used to determine whether a tax-damaging letterbox company exists:
Test step 1: Gateway test
Three criteria, which must be met cumulatively, are used to determine whether a company is subject to reporting requirements.
- Predominantly passive income (more than 75%)
- Predominantly cross-border activity
- Outsourcing of day-to-day business and important management decisions (e.g. via a Director's Office)
If only one of these characteristics is missing, the test is completed and the company cannot qualify as a letterbox company.
Test step 2: Substance test
Legal consequence if all criteria are met: Such qualified companies are subject to a separate reporting obligation to the competent national tax authority. They must provide additional information in their tax return regarding the required minimum substance (own premises, bank account, management and employee requirements). Exceptions are to apply for certain holding and financial companies, among others. Only if a gateway entity fails the substance test, which is now quite clearly regulated, will the unpleasant legal consequences come into full force. In particular, such companies will no longer be able to utilise double taxation agreements and EU directives. A powerful instrument for this is the refusal or restriction of the certificate of residence for the companies concerned.
ConclusionThe denial of certain tax advantages for companies with weak substance is nothing new, as German tax law has traditionally already been able to counter letterbox companies via Sections 39 to 42 of the German Fiscal Code (AO), but ATAD 3 should simplify the previous questions of interpretation by providing largely clear guidelines for the future EU standardised gateway and substance test. It remains to be seen how German legislation will ultimately transpose ATAD 3 into national law by 30 June 2023. However, affected companies must already provide corresponding evidence for the years 2022 and 2023, as the 2024 substance test partly refers to data from the two previous years. Evasive manoeuvres via letterboxes not set up in the EU do not seem advisable, as these will probably be regulated by similar provisions in the near future; strict restrictions are already in force today for tax havens anyway (see TAXGATE blog from 02.03.2021 https://www.taxgate.com/der-naechste-wurf-im-steuerdschungel-das-steueroasen-abwehrgesetz/)
Your TAXThe GATE team will be happy to support you in reviewing and planning international shareholding and investment structures. This topic will be presented in more detail at the WM Seminar on 14 September 2022 (https://www.wmseminare.de/veranstaltung/1599/agenda/1) with further aspects of ATAD implementation, including the particular impact on transfer pricing, inbound taxation and investment funds, as well as a current report on DAC 7.