EU Council adopts Anti-Tax Avoidance Directive

The EU Council has adopted the Anti-Tax Avoidance Directive, which was put forward by the EU Commission as part of its package of proposals to strengthen rules against corporate tax avoidance.

The Directive seeks to ensure that Member States give effect to base erosion and profit shifting (BEPS) measures in a consistent and co-ordinated way. Some aspects of the Commission’s original proposal, which went beyond the scope of BEPS and proved controversial, have been removed. Most notably, the Directive has dropped the controversial “switch-over clause” included in the original draft, which was designed to limit tax exemption on dividends from low tax jurisdictions. In addition, the Directive now takes a more helpful approach on issues such as grandfathering than early adopting Member States, such as the UK, have proposed.

Background

In January 2015, the EU Commission put forward an “Anti-Tax Avoidance Package”, calling on Member States to take a stronger and more coordinated stance against multinational companies (MNEs) that avoid tax and to implement international standards against BEPS.

The Package, largely representing an attempt to ensure that Member States implement BEPS measures consistently in the EU, consisted of a number of measures, but, most notably, a draft Anti-Tax Avoidance Directive designed to provide legally binding measures for Member States to tackle avoidance. The proposed Directive did, in a number of key respects, go wider than BEPS commitments and proved controversial in that respect.

A compromise version of the Directive was put forward at the Economic and Financial Affairs Council (ECOFIN) meeting on 17 June 2016 and was agreed, subject to a “silence procedure”, which expired, without any objections being submitted, at midnight on 20 June. The Directive was formally adopted on 12 July 2016.

The anti-tax avoidance directive

The main aspect of the EU Commission’s proposals was a draft Directive to bring consistency to the existing policy and provisions in Member States for dealing with a range of BEPS issues. The draft Directive sought to put in place legally binding minimum measures which Member States would be expected to apply to prevent tax planning in this context, after apparent concerns as to the appetite of certain Member States to adopt the full package of BEPS measures. However, the original draft proposed by the Commission went beyond the scope of the BEPS proposals in a number of ways and the version put to the ECOFIN meeting was a compromise version containing a number of important changes and removing the controversial switch-over clause. That version has now been adopted.

The adopted Directive contains amended clauses dealing with a range of measures dealing largely with implementation of the OECD’s BEPS proposals:

Interest limitation rule: The compromise Directive proposes that net borrowing costs should be deductible only up to 30% of Earnings before interest, tax, depreciation and amortisation (EBITDA). However, the clause allows for a number of derogations from this basic rule, including:

• net borrowing costs up to €3m may be deductible
• the restriction will not affect a “standalone entity”
• the group’s actual external borrowing ratio may be used instead where that is higher OR 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
• Member States may exclude interest on loans concluded before 17 June 2016, and
• Member States may exclude financial undertakings from the interest limitation rules.

The compromise Directive provides that Member States may allow excess borrowing costs to be carried forward to future years or carried back three years. In addition, unused capacity may be carried forward for up to five years.

In addition, the Directive recognises that Member States may have other targeted rules for preventing BEPS through interest expenses and will allow such Member States to continue to apply such rules until at least 2024 if they are “equally effective” to the interest limitation rule.

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.

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 compromise Directive, therefore, provides that a taxpayer should be able to defer taxation by payment in instalments (with interest) 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, for example, the assets are subsequently sold or transferred to a third country.

General anti abuse clause: The compromise Directive requires, in language closely matching that of many UK targeted anti avoidance provisions (although not the UK’s general anti abuse rule), each Member State to have in place provisions to ignore “an arrangement or series of arrangements which, having been put into place 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, are not genuine having regard to all relevant facts and circumstances”.

CFC legislation: The Directive proposes that each EU Member State implement controlled foreign companies (CFC) rules for 50% subsidiaries where the tax paid is less than 50% of the tax that would have been paid in the relevant Member State. Where the CFC rules apply, a Member State should include in its tax base the passive income of the CFC (income from financial assets, IP, dividends, immovable property etc). The rules provide that the CFC provisions shall not apply if the CFC carries on a substantive economic activity supported by staff, equipment, assets and premises, however. In addition, a Member State may opt not to treat an entity as a CFC if one third or less of its income is not passive income. Equally, a Member State may opt not to treat a financial undertaking as a CFC where one third or less of its passive income comes from transactions with associated enterprises. The compromise Directive also includes a de minimis provision for excluding entities with accounting profits of no more than €750,000 and non-trading income of no more than €75,000 or where its accounting profits amount to no more than 10% of its operating costs.

It should be noted that, unlike the Organisation for Economic Cooperation and Development (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 will require Member States to implement anti hybrid rules dealing with both hybrid entities and hybrid instruments. The compromise text is much lighter on the detail of the approach to be adopted than in the original proposal.

Comparison of the Directive v OECD BEPS measures

Comment

Much of the content of the Directive merely represents a coordinated EU-wide response to the recent OECD BEPS process. As such, the decision to drop the switch-over clause is both welcome and pragmatic. However, whilst co-ordination, leading to a greater degree of consistency in the measures adopted by Member States, is desirable, the derogations included in the Directive and the options available to Member States for different approaches on specific aspects of, for example, the interest restriction and CFC measures, will ensure that the actual measures adopted by individual Member States may, in practice, differ significantly. Despite the harmonisation objective behind the Directive, therefore, the opportunity for arbitrage may still arise, in part influenced by the approach of relevant Member States to the issues posed by BEPS and the circumstances of those Member States, for example as common holding company jurisdictions.

The Directive, which was formally adopted on 12 July 2016, requires Member States to adopt measures to implement it by 31 December 2018 for a 01 January 2019 implementation date. However, the implementation date for the exit tax provisions is one year later.