The European Commission recently made public its draft new directive, known as “ATAD III”. This directive, still in draft form, aims to discourage the use of front companies for tax purposes. This directive constitutes a further step in the establishment of a fair and sustainable European system of corporate taxation, which will thus supplement the mechanisms for the exchange of information organized by the various so-called “DAC” directives, and the “anti- -abuse” set up by the previous “ATAD I” and “ATAD II” directives.

The objective is for the draft, once adopted, to be transposed into the domestic law of the 27 Member States no later than June 30, 2023, for entry into force on January 1 , 2024 with retroactive effect from January 1 , 2022.

The “ATAD III” project aims to settle the fate of entities qualified as “front companies” or “empty shells”, i.e. companies with (too) little substance, whose headquarters are located on the territory of a Member State , and who are involved in cross-border transactions, or whose assets are located in a State other than that of their residence. If certain categories of companies are, as drafted, excluded from the scope of the new measures, and in particular listed companies or regulated entities (not. AIFM Funds or UCITS), or even entities that employ a minimum of 5 people (employees) full-time, such is not the case for holding companies, or financial companies or patrimonial companies, real estate or not, for which the Commission has little taste. Companies that hold intellectual property rights will also be targeted.

To do this, the Directive proposes a 7-step process:

Identification of companies requiring reporting due to a higher risk of lack of substance.

Are thus considered at risk, and will therefore be subject to a specific reporting obligation, companies that cumulatively present several characteristics generally associated with entities with little or no substance:

  • passive activity : income from more than 75% of passive or similar income (financial products, royalties or remuneration of intellectual property or intangible assets, dividends, capital gains from the sale of shares, real estate income or income from assets for use private sector with a book value of more than €1 million, income from insurance, banking or other financial activities or provision of services subcontracted to associated entities) during the two previous financial years;
  • international activity : income from more than 60% of cross-border transactions, or a balance sheet made up of more than 60% of real estate assets or assets for private use with a value of more than €1m located abroad. In the event that the securities of companies, or real estate or property for private use exceed 75% of the balance sheet value, the condition relating to income is not required;
  • use of outsourcing : over the past two years, outsourcing of activities related to the day-to-day management of the company or decision-making for the most important functions.

However, certain entities presumed to have limited risk are exempt from additional reporting obligations, whether they carry out regulated financial activities or are already subject to reinforced transparency obligations due to their status (listed companies, financial institutions, SICAVs, insurance companies or reinsurance within the meaning of Directive 2009/138/EC , etc., or whether they are holding companies whose main activity is the holding of operational activities in the same Member State as well as their beneficial owners, or they employ at least five full-time equivalents dedicated to activities generating the entity’s revenues.

Specific reporting obligations for presumed shell companies

The companies identified at the end of the first stage will have to include a certain amount of information in their annual declaration of income in order to allow the Member State where they are established to test their minimum substance level.

The following indicators must therefore be mentioned:

  • local : ownership or exclusive use of offices in the Member State in question;
  • bank account : the existence of at least one active bank account in the European Union and mainly in the country where the company’s registered office is located;
  • directors or salaried staff: alternatively:
    • at least one non-salaried director or director residing in the same Member State as that in which the company is established, or having a residence close enough to exercise his functions there, endowed with decision-making powers relating to the passive activity of the company company, having a certain autonomy to use them on a regular basis and moreover not employed by a third-party company and not performing a similar function for other unrelated companies;
    • a majority of full-time equivalent employees residing in the same Member State as that in which the company is established, or having a residence close enough to carry out their duties there, and endowed with the skills necessary for the performance of these same duties.

The statement must also be accompanied by documentation to corroborate the answers provided (including at least the address of the premises, the amount of the entity’s income and expenses by nature, the identification of the non-salaried directors or directors or salaried staff with their place of residence and professional qualifications, subcontracted activities, details of bank accounts, powers of attorney and proof of activity).

Establishment of a simple presumption of minimum substance or absence of minimum substance

Depending on the information provided in the tax return, the tax administration of the Member State concerned may establish either the presumption of a minimum substance (criteria fully met), or the company will be presumed to lack sufficient substance and qualified as a company. screen.

This is a simple presumption, which can be overturned in both cases by the tax authorities or the taxpayer respectively.

Reversal of the presumption of absence of sufficient substance

Insofar as substantive tests are only based on indicators, taxpayers have the possibility of reversing the presumption established following the previous step, by providing additional elements of assessment relating to:

  • the commercial reasons for establishing the alleged front company;
  • the profile of the employees and in particular their level of experience, their role, position and decision-making powers within the organization chart, their skills and the duration of their contract;
  • the local nature of decision-making relating to the activity of the alleged front company;
  • any element making it possible to establish that the company permanently has control of the operations that generated the passive income and has borne the risks.

At the end of the financial year for which the presumption has been reversed, the tax administration of the Member State will have the option of extending the benefit of this reversal for a period of 5 years, provided that there is no no change in the facts and circumstances relating to the company.

Safeguard clause

Member States will have the option of exempting from the special reporting obligations certain taxpayers who have not passed the minimum substance test at the end of the first stage, when they are able to demonstrate that the interposition of the company screen in the organizational chart did not allow a tax benefit to be obtained for its beneficial owners or the group as a whole.

The proof of the absence of a tax advantage must include a comparison of the overall tax burden that would have been due without the intervention of the company in question.

This exemption from reporting obligations will be valid for a period of 1 year, if necessary extended for a total period of 5 years, subject to the absence of change in the facts and circumstances specific to the organization.

Tax implications for businesses qualifying as front companies

In the Member State where the shell company is established

The local tax administration may choose not to issue a certificate of tax residence, or issue a certificate specifying that the entity cannot benefit from the provisions of tax treaties aimed at avoiding double taxation or any other international treaty of equivalent scope.

On the other hand, there would be no consequences for the local taxation of the shell company, which would remain subject to the existing tax legislation of its Member State of establishment.

In other Member States

The other Member States will be able to exclude the application of the provisions of the conventions aimed at avoiding double taxation and tax the income of the shell company as if it had been directly apprehended by its shareholders. More specificly :

  • the Member State of the source of the income paid to the shell company may apply the deductions at source under common law, or apply the withholding provided for in the agreement concluded, where applicable, with the State of residence of the shareholders of the shell company;
  • the Member State of residence of the shareholders of the shell company may tax the income of the latter, after deduction of the local corporate tax paid and withholding taxes borne, where applicable, on incoming flows (at the rate of the agreement concluded on where applicable with the State of the source of income).

However, third countries are not affected by the Directive and will continue to apply their provisions of domestic law, it being specified that in the absence of the issuance of a certificate of residence, they may themselves be required to apply the deductions. common law on flows to the shell company.

Automatic exchange of information between Member States

The entities qualified as shell companies at the end of the previous stages will be subject to an automatic exchange of information through a centralized directory accessible in real time to the tax authorities of the 27 Member States.

Control and sanctions

The Directive does not provide for specific procedures for checking declarations, but provides two important clarifications:

  • on the one hand, the tax authorities of a Member State will be able to call on their counterparts in the event of a suspicion of default or irregularity in the declaration of an entity likely to be qualified as a front company, in order to trigger a check on the situation of this entity;
  • on the other hand, in the event of infringement of the provisions of the Directive, the defaulting companies may be subject to penalties left at this stage to the discretion of the national legislators, but including an administrative pecuniary penalty equal to at least 5% income of the company concerned.

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