Tax Notes logo

EU to Consider Making Unshell Substance Test a Minimum Standard

Posted on Nov. 21, 2023

A note prepared by the EU Council’s Spanish presidency suggests pursuing the European Commission’s idea to maintain the tax consequences of its proposal to tackle the misuse of shell entities.

The Spanish presidency's latest compromise proposal would implement the commission's idea and avoid the two-step approach discussed during an October 4 meeting.

The October 4 meeting of the high-level working party on taxation tested Germany's idea for a two-step approach to the Unshell, under which the directive would require only exchange of information on entities considered to be shell entities as a first step. If appropriate, a second potential step would be amending the directive to include tax consequences.

This approach was generally supported by member states, the presidency said in a note prepared for the November 23 working party meeting. It adds, however, that some member states raised concerns about the administrative burden that would remain. Others said reaching agreement would still be difficult because the new approach "would pose the same problems that had been identified during the nearly two years of discussions." The two-step approach came about because Germany feared that Unshell would undermine its stricter national substance criteria.

The commission defended the inclusion of tax consequences in the directive and proposed a new approach, the presidency’s note says. This approach would safeguard member states' ability to define stricter criteria and apply tax consequences in addition to the exchange of information requirement.

The new approach would make the substance criteria a minimum standard, the presidency said. That means member states would be able to apply additional criteria "for the identification of shell entities resident therein." The directive's criteria would be applicable in all member states. Therefore, entities that would have been considered shells under the previous compromise proposal would still be caught under the minimum standard approach.

“The novelty would be that entities resident in a member state that has established more stringent criteria would now also be considered shell entities if they fail to fulfill these additional criteria," the presidency said.

This approach would no longer contain a rebuttal provision, but instead would have a declaration of the presumed shell entity (including under stricter national rules) stating that it has not been established for the purpose of obtaining a tax advantage, with supporting documentary evidence. The exchange of information between member states would include this documentary evidence.

A tax advantage would be defined as a situation in which the tax due from the shareholder or the group as a whole on income flowing into or from the entity or its assets is lower than half of the amount of tax that would be due if the entity did not exist.

As for tax consequences, the presidency proposes the establishment of a "toolbox" of consequences that member states could adopt. These range from requiring detailed reporting of any transactions with shell entities to applying a withholding tax without the possibility of reduction or exemption. Other consequences in the toolbox include denial of deduction of costs and payments to the entity and denial of any participation exemption for dividends or other profits received from the entity.

These consequences would be applied by a member state other than an entity’s state of residence when the entity is considered a shell under the criteria of its member state of residence. In the member state of residence, the only tax consequence that would apply under the directive is that the tax residency certificate would say the entity is considered a shell.

Tax consequences would apply to entities considered shells that have not made a declaration stating that they have not been established to obtain a tax advantage.

The criteria of the proposal’s substance test remain wholly unchanged.

Copy RID