EU Commission publishes anti-tax avoidance package

The EU Commission has released its “Anti-Tax Avoidance Package”, calling on Member States to take a stronger and more co-ordinated stance against multinational companies (MNEs) that avoid tax and to implement the recently agreed international standards against base erosion and profit shifting (BEPS).

The Package consists of a number of measures, including, most notably:

• draft Anti-Tax Avoidance Directive to provide legally binding measures for Member States to take introduce to tackle avoidance
• a recommendation on the best ways for Member States to prevent tax treaty abuse, in a way compatible with EU law
• proposal to extend the existing Directive on Administrative Co-operation (DAC) to cover Country-by-Country reports by MNEs pursuant to the proposal in the Organisation for Economic Co-operation and Development's (OECD’s) Action 13 of the BEPS Package, and
• a new process to for listing third countries “that refuse to play fair”.

The Package represents a bold move on the part of the EU Commission to take control of the implementation of BEPS measures in the EU. However, the proposals do, in some respects, go wider than existing BEPS commitments and may prove controversial in that respect. Clearly, therefore, there is a risk that, in pushing for more ambitious and legally binding developments in some areas, progress may be held up on less controversial aspects of the Package. It remains to be seen how Member States will react to these aspects.

An Anti-Tax Avoidance Directive

The centre piece of the EU Commission’s proposals is an ambitious (some would say unnecessarily overly ambitious) Directive to bring consistency to the existing policy and provisions in Member States for dealing with a range of BEPS issues. The Directive seeks to put in place legally binding minimum measures which Member States would be expected to apply to prevent tax planning in this context.

The Commission notes that Member States have already committed to implementing the OECD’s recommendations under the BEPS final reports, but is concerned that unilateral implementation by Member States may lead to divergent and fragmentary implementation. This may itself lead to loopholes and other opportunities for avoidance. The Commission argues, therefore, that it is essential for coherent and coordinated implementation for Member States to be set minimum standards in this regard, whilst, at the same time, seeking to strike a balance between uniformity and accommodating the special features of Member States’ tax systems.

More generally, the EU Commission expresses its commitment to re-launch its Common Consolidated Corporate Tax Base (CCCTB) proposals, which it contends would be a “comprehensive solution” to profit shifting in the EU, later in 2016. However, pragmatically, it recognises that the CCCTB is at this stage a long way from being implemented, and more immediate progress should be made through its Anti-Avoidance Directive.

The draft Directive itself contains a number of individual clauses dealing with a range of both BEPS related issues and measures that go beyond the OECD’s BEPS process:

Interest limitation rule: The draft Directive suggests that net borrowing costs should be deductible only up to 30% of EBITDA or up to €1m, whichever is higher. Unused EBITDA can be carried forward to future years. However, the provision allows for derogation where the taxpayer can show that the ratio of its equity to its total assets is equal to or higher than the equivalent ratio of the group.

The draft interest limitation rule would not, however, apply to financial undertakings (at least initially).

Exit taxation: Member States shall apply an exit taxation charge based on the market value of assets where a taxpayer transfers assets out of its head office or branch or where a taxpayer transfers its tax residence or closes a permanent establishment (PE).

The subject of exit taxation has proved problematic in the EU, of course, with a number of ECJ decisions confirming that immediate taxation would be disproportionate in such situations. The Directive, therefore, suggests that a taxpayer should be able to defer taxation by payment in instalments over five years in cases involving transfers within the EU or EEA, with a bank guarantee if there is a demonstrable risk of non-recovery. Immediate payment would be required if the assets are subsequently sold or transferred to a third country.

It should be noted that the Commission’s target here goes beyond simple relocations of businesses and appears to be intended to cover simple transfers of assets (such as IP assets) to low tax jurisdictions. Clearly, however, there is a great degree of overlap with the CFC proposals (as well as transfer pricing rules). Indeed, given that the primary issue with such relocations of IP assets at a pre-income generating stage is the valuation of such assets, the inclusion of the exit taxation proposal is perhaps somewhat surprising.

Switch-over clause: The draft Directive contains a prohibition on exemption for foreign dividends received by a company from an entity in a third country (or from the disposal proceeds of shares in such an entity) where that entity is subject to tax on profits at a statutory rate which is lower than 40% of the statutory tax rate in the Member State of the recipient. In those circumstances, the draft Directive would limit tax relief to the credit method.

This is perhaps the most surprising and controversial of the provisions in the draft Directive, especially given the decision of the ECJ in the UK FII GLO litigation that a credit system for overseas dividends which only allows credit for actual tax paid is inherently discriminatory when compared to a domestic exemption system. Although the measure is limited to third country scenarios, the free movement of capital is relevant in such situations and would, in principle, prevent such discrimination.

This is another area where the EU Commission’s proposal go wider than the BEPS proposals and, as such, may prove somewhat controversial.

General anti-abuse clause: The draft Directive would require each Member State to have in place provisions to ignore “non-genuine arrangements or series thereof carried out for the essential purpose of obtaining a tax advantage that defeats the object or purpose of the otherwise applicable tax provisions”. There may be questions as to whether the UK’s recently adopted anti-abuse clause, designed primarily to strike down only schemes at the egregious end of the avoidance spectrum, and its double negative test would be sufficiently strong to meet this requirement?

CFC legislation: The Directive proposes that each EU Member State implement CFC rules for 50% subsidiaries in third countries where the rate of tax is lower than 40% of the rate in the relevant Member State and where more than 50% of the income of the CFC is, essentially, passive income (income from financial assets, IP, dividends, immovable property etc). The Directive would also apply to CFCs in other Member States and an EEA country, but only where the establishment can be shown to be wholly artificial or engages in non-genuine arrangements designed to gain a tax advantage.

It should be noted that, unlike the OECD’s recommendations on design, the EU Commission’s proposals would create a legal obligation to introduce CFC rules in all Member States.

Hybrid mismatches: The Directive would require Member States to implement anti-hybrid rules dealing with both hybrid entities and hybrid instruments and would require Member States to follow the tax treatment of the jurisdiction where the payment has its source (or the relevant losses/expenses are incurred).

Tax Treaty recommendations

Following on from BEPS Action 6, the Commission has also published guidance which is intended to advise Member States on the recommended method of implementing the anti-treaty shopping rules contained in the OECD’s BEPS final report. It is notable that this Recommendation makes no mention of the Limitation on Benefits clause suggested by the OECD, focussing instead on the inclusion in treaties negotiated by Member States of a general anti-avoidance clause. The recommended wording in the Recommendation is as follows:

"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."

In addition, the Recommendation also encourages Member States to adopt the new form of the Permanent Establishment article agreed by the OECD in its final report on Action 7.

CbC reporting

Following on from the Multilateral Competent Authority Agreement (MCAA) signed at the OECD by 31 jurisdictions on 27 January 2016, the EU Commission has released a proposal for extending the existing Directive on Administrative Co-operation (DAC) to CbC Reports to be produced in accordance with the recommendations of the OECD under Action 13 of the BEPS project.

The amended Directive would require Member States to automatically exchange information received from a parent company resident in their jurisdiction pursuant to a CbC report to other Member States where the group has a presence.

It might be noted that, whilst these amendments and the OECD proposals on CbC reporting are limited to confidential reports to tax authorities, the Commission is separately carrying out a study into the issue of public CbC reporting with a view to presenting an initiative in “early spring”.

Third countries

Following the somewhat controversial (and error strewn) publication by the Commission of Member States’ blacklists in 2015, the Commission intends to follow up on this work. Initially it has produced an updated listing of third countries blacklisted by Member States. However, the longer term goal is to agree common EU criteria for blacklisting third country to encourage good governance and transparency outside the EU. The common EU criteria would be used to produce an EU-wide common blacklist. The aim is to complete this work by the beginning of 2019.

As part of this process, the EU Commission intends to work with third countries to promote standards of good governance in relation to tax. At present, it is unclear what the nature of sanctions for being on the list might be, however.

Comment

Much of the content of the Commission’s package of measures will be uncontroversial, representing a co-ordinated EU-wide response to the recent OECD BEPS process. Such co-ordination, leading to a greater degree of consistency in the measures adopted by Member States, is to be welcomed.

However, the package does go further in some respects that the BEPS process. In particular, mandatory provisions in relation to CFCs, the proposed “switch-over clause” and limitations on interest deductions are likely to be more controversial and may hold up the wider agreement on the package.

Although no deadline is given for implementation of these Directives, the Commission will wish to capitalise on the political momentum behind the BEPS process to push the measures forward. There appears to be no reason in principle why extension of the DAC to CbC reporting should not be implemented very quickly, for example. However, certain measures in the draft Anti-Tax Avoidance Directive may well give some Member States pause for thought and it seems likely that the Commission may have to implement these proposals in stages, with the least controversial taken forward initially, if it wishes to make speedy progress on this aspect.

Update

For details of the approved Anti-Tax Avoidance Directive, see "Anti-Tax Avoidance Directive approved".

For the EU Commission’s latest corporate tax package, including plans for a CCCTB, see “EU Commission’s corporate tax package”.