ATAD 3 and its implications for businesses in the EU

Following the BEPS (Base Erosion and Profit Shifting) project launched a few years ago by the Organisation for Economic Cooperation and Development (OECD), EU member states have implemented a series of actions against tax avoidance in their local tax laws. Among these actions, the ATAD 1 and ATAD 2 measures already exist in the local tax law of the Members State.

ATAD 1 and 2 targeted several anti-abuse rules such as the interest limitation, exit taxation, controlled foreign companies, hybrid mismatches and GAAR.

Now, the aim of ATAD 3 is to prevent the misuse of “shell entities” and ensure that Tax Resident companies within the EU have the minimum economic substance by introducing substance requirements and are not used for tax avoidance purposes.

The draft law for ATAD 3 draft law was published on 22 December 2021, by the European Commission. In January 2023, the EU Parliament adopted several amendments proposed by the Committee on Economic and Monetary affairs (“ECON”). While  the European Parliament has already approved the European Commission’s draft directive to prevent misuse of shell entities for tax purposes, the European Council must grant unanimous voting, and there’s the possibility of introducing further amendments to the  Draft Directive.

Originally, this directive was scheduled to come into force as of January 1, 2024, with member states required to incorporate  these new rules in their local law by June 30, 2023. However, the possibility exists that  the entry into force will be postponed, thereby providing  taxpayers with more time to ensure compliance with these new regulations.

Certain regulated entities like UCITS, AIF, AIFM, and those entities with transferable securities listed on a regulated market, along with domestic holding companies, fall outside the scope of ATAD 3, however, this exclusion does not automatically  apply to entities owned by these regulated entities. A holding company owned by a regulated entity is not inherently exempt from ATAD 3’s reach.

In addition, there remains a possibility to be exempt if the entity can prove that its existence does not give rise to a tax benefit for the ultimate beneficiaries or for the group.

In the absence of an exemption, an assessment for ATAD 3 must be done in several steps:

Gateway Test: the entity must pass a gateways test to determine if it is at risk. An entity is deemed to be “at risk” if it meets the three cumulative conditions of the gateways test:

• Over 65% of the entity’s overall revenue during the last two years consist in passive income.  Passive income includes interest, royalties, dividends, income from immovable property, crypto assets.
• Over the last two years, more than 55% of entity income earned or paid out via cross-border transactions.
• Administration of day to-to operations and the decision-making on significant functions was outsourced to “a third party” during the two preceding years.

Reporting obligations: if the three conditions are met, the entity will have reporting obligation through its own tax return. The following indicators should also be met.

• Premises – the entity must have its own premises, or premises for its own use. The share used of business premises by entities of the same group is allowed.
• Bank account –  the entity must have one active bank account in the European Union.
• Directors and employees – at least one of the following two requirements must be met

1)  one or more directors:

• are locally resident in the EU Member State in which the entity is resident, or reside at a distance that it is compatible with the proper performance of their duties;
• are authorised to make decisions in relation to activities that generate relevant income, or the assets of the entity concerned.

2) the majority of the full-time equivalent employees of the entity concerned:

• are locally in the Member State of the entity concerned, or are resident or reside at a distance that it is compatible with the proper performance of their duties; and
• are qualified to carry out the activities that generate relevant income for the entity concerned.

Entities fulfilling these indicators are presumed to have the minimum substance.  On the other hand, if one of these three indicators are not met, then there is a presumption that the company does not reach the minimum level of substance.

An entity still has the possibility to rebut the presumption of not having the minimum level of substance by providing accurate documentation such as: economic reasons for setting up the entity, employee profiles, evidence that the decision making is taken from the Member State.

While the draft directive can still be amended until its entry into force, it is crucial for entity in the scope of ATAD 3, to assess their substance and take actions as it is expected that the assessment of an entity at risk will be done retroactively applied for the two-preceding years. Originally slated for enforcement on January 1, 2014, the substance assessment should already have been carried out for the years 2022 and 2023.

Tax resident of Member states must already deal with a lot of new regulations (ATAD 1, ATAD 2, DAC 6) for few years and this new directive will oblige to comply with even more new tax compliance obligations which represent heavy administrative burden for taxpayers who had already experienced difficulties during the Covid pandemic.

Furthermore, Tax Authorities, will have to deal with an increase of administrative workload to verify the information related to entities. According to  the draft Directive, Tax Authorities of a Member state must perform tax audit upon a request from tax authorities of another member state when doubt arise about an entity’s substance.

Primarily, failure to comply with the reporting obligation triggers a penalty of at least 2% of the entity’s revenue.

However, the most important consequence of this Directive lies in entities qualifying as shell. Access to tax residence certificate will be denied. Additionally, shell entities will be not entitled to benefit from EU Tax treaties.

As a result, entities qualifying as “Shell entities” will lose withholding tax exemption or reduction on dividends, interest or royalties.

Moreover, in the case the shareholder is tax resident in another EU Member, the other Member States will disregard the shell entity and will tax its income as if it had been received directly by the shareholder of the “shell company”.

Given the potentially significant impact of not getting ATAD 3 compliance right, it is extremely important to work with experts to navigate through your requirements.  Altum are well placed and happy to help so please do get in touch with any ATAD III queries.