ATAD 3: the writing on the wall for EU holding companies?

15 June 2021

The European Commission (EC) set out its ambitions for a 21st century tax system in May 2021. Since then, it has published a consultation around the use of shell companies in tax avoidance with a view to bringing in legislative requirements by the end of 2021 (via ATAD 3). 

This is a story of rapid and numerous developments. The agenda mirrors action previously taken by the EU to introduce rules regarding economic substance in a number of offshore jurisdictions but also comes closely off the heels of the OECD BEPS Action 6 workstream to introduce a principal purpose test (PPT), and more recently the decisions in the so-called Danmark cases on beneficial ownership (although the EC cite the journalist investigations into arrangements in Luxembourg for bringing this agenda to their attention). As a result there has been increasing focus on the appropriate levels of employees, premises, functions performed and risks undertaken to understand whether there is real economic activity in a jurisdiction.

The EC is focused on situations where the ultimate objective is to minimise overall tax via the use of legal entities with no or minimum substance and no real economic activities. No examples are provided in the consultation or accompanying documents but holding companies with passive income appear to be the main target. The impact that these proposals will have on the industry hinges on whether it materially shifts the definition of what is an acceptable level of substance.

The EU brought in rules regarding economic substance requirements for its list of non-cooperative tax jurisdictions, and as a result of which, a number of offshore jurisdictions have introduced substance requirements for certain financial and service activities. This means some offshore entities must demonstrate that they are directed and managed in the jurisdiction of tax residence; undertake core income generating activities in the jurisdiction of tax residence; and have adequate people, premises and expenditure in the jurisdiction of tax residence. There is overlap between this definition and the indicators listed in the consultation, but at this stage of the consultation it is not clear how the EC will proceed with defining economic substance.

The consultation seeks views on what measures should be taken if the economic substance test is not met. These include:

  • denial of double tax relief, application of treaty benefits, or deductibility of costs, both for the entity and the wider group;
  • increased audit risk;
  • public disclosure of information about the shell entity; and
  • monetary sanctions on the entity, directors, and or beneficiaries.

What does this all mean? Clearly it is too early to tell if this is the writing on the wall for EU holding companies. Groups will want to take a critical eye of their structure to ensure there is real economic substance, as the direction of travel appears to be heading one way. Greater comfort might be taken from ensuring that the holding company undertakes a wider range of functions and activities (and with that more employees and/or premises), or even consideration of using a non-EU jurisdiction to perform the same function. The UK’s asset holding company regime might become a more attractive proposition in light of these developments.

"legal entities and arrangements with no – or only minimal – business presence and economic activity continue to pose a risk"