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The EU's response to BEPS - are you ATAD-ready?


By Tax-News.com Editorial
February 6, 2019


The European Union's response to the OECD BEPS project, the Anti-Avoidance Directive (ATAD I) has brought about extensive changes to the corporate tax regimes of EU member states effective January 1, 2019, with additional measures coming down the track.

The Base Erosion and Profit Shifting (BEPS) project – a brief introduction

The BEPS project represents the G20's determination to plug holes in the international corporate tax system that has allowed multinational companies to legally reduce their exposure to tax, predominately by shifting profits from high-tax to low-tax jurisdictions. The project is being steered by the OECD and was launched in 2013 with the publication by the Paris-based organization of the BEPS Action Plan. In summary, this discussed how national tax rules should be updated to reflect the increasing digitalization of the global economy, and how these rules should be aligned to prevent multinationals using transfer pricing and other arrangements to separate profits from value creation.

The Action Plan contained 15 specific actions designed to give governments the domestic and international mechanisms to prevent corporations from paying little or no taxes, as follows:

  • Action 1: Address the challenges of the digital economy
  • Action 2: Neutralize the effects of hybrid mismatch arrangements
  • Action 3: Strengthen controlled foreign company rules
  • Action 4: Limit base erosion via interest deductions and other financial payments
  • Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance
  • Action 6: Prevent treaty abuse
  • Action 7: Prevent the artificial avoidance of Permanent Establishment status
  • Action 8: Assure that transfer pricing outcomes are in line with value creation/intangibles
  • Action 9: Assure that transfer pricing outcomes are in line with value creation/risks and capital
  • Action 10: Assure that transfer pricing outcomes are in line with value creation/risks and capital
  • Action 11: Establish methodologies to collect and analyze data on BEPS and the actions to address it
  • Action 12: Require taxpayers to disclose their aggressive tax planning arrangements
  • Action 13: Re-examine transfer pricing documentation
  • Action 14: Make dispute resolution mechanisms more effective
  • Action 15: Develop a multilateral instrument

The BEPS final recommendations were published by the OECD in October 2015 and are now being implemented by jurisdictions across the world, although some national BEPS measures have deviated to varying degrees from the measures included in the BEPS final reports.

The Anti-Tax Avoidance Directive (ATAD I) – background

First presented by the European Commission in January 2016, shortly after the publication of the BEPS final recommendations, Directive ((EU) 2016/1164) lays down rules against tax avoidance practices that are said to directly affect the functioning of the internal market. It was adopted by the Council on June 20, 2016.

On October 25, 2016, the Commission presented its proposal for additional rules targeting hybrid mismatch arrangements between EU and non-EU countries. These are designed to complement anti-hybrid rules in the Anti-Tax Avoidance Directive and provide for a "comprehensive framework of anti-abuse measures." These additional measures have been packaged up into a separate directive known as ATAD II (also discussed in this article).

The Council reached a compromise agreement on ATAD II on February 21, 2017 and generally they must be implemented by member states by December 31, 2019.

Introduction

The Anti-Tax Avoidance Directive contains five legally-binding anti-abuse measures, which all member states are required to apply against common forms of aggressive tax planning. The Directive, says the Commission, "creates a minimum level of protection against corporate tax avoidance throughout the EU, while ensuring a fairer and more stable environment for businesses."

The Directive covers all taxpayers that are subject to corporate tax in EU member states, including subsidiaries of companies based in third countries. Three of the five areas covered by the directive implement OECD recommendations, namely the interest limitation rules, the CFC rules, and the rules on hybrid mismatches. The other two areas include an exit tax, and a general anti-abuse rule.

According to the European Commission, ATAD I "creates a minimum level of protection against corporate tax avoidance throughout the EU, while ensuring a fairer and more stable environment for businesses."

Scope

The Directive applies to all taxpayers that are subject to corporate tax in one or more member states, including permanent establishments in one or more member states of entities resident for tax purposes in a third country.

Interest limitation rule

Under the Directive, "exceeding borrowing costs" shall be deductible in the tax period in which they are incurred only up to 30 percent of the taxpayer's earnings before interest, tax, depreciation and amortization (EBITDA). Borrowing costs and the EBITDA may be calculated at the level of the group and comprise the results of all its members.

"Exceeding borrowing costs" is defined by the Directive as the amount by which the deductible borrowing costs of a taxpayer exceed taxable interest revenues and other economically equivalent taxable revenues that the taxpayer receives according to national law.

Under the directive, a taxpayer may be given the right to deduct exceeding borrowing costs up to EUR3m (USD3.4m) for the entire group. A "standalone entity" may fully deduct exceeding borrowing costs. A standalone entity is a taxpayer that is not part of a consolidated group for financial accounting purposes and has no associated enterprise or permanent establishment.

Where the taxpayer is a member of a consolidated group for financial accounting purposes, the taxpayer may be given the right to either fully deduct its exceeding borrowing costs at an amount in excess of what it would be entitled to deduct under the 30 percent rule, subject to certain conditions.

The Directive allows member states to provide rules for the carrying forwards or backwards of unused deductions, subject to certain limitations.

Exit tax

Under the Directive, a taxpayer shall be subject to tax at an amount equal to the market value of the transferred assets, at the time of exit of the assets, less their value for tax purposes, in any of the following circumstances:

  • a taxpayer transfers assets from its head office to its permanent establishment in another member state or in a third country in so far as the member state of the head office no longer has the right to tax the transferred assets due to the transfer;
  • a taxpayer transfers assets from its permanent establishment in a member state to its head office or another permanent establishment in another member state or in a third country in so far as the member state of the permanent establishment no longer has the right to tax the transferred assets due to the transfer;
  • a taxpayer transfers its tax residence to another member state or to a third country, except for those assets which remain effectively connected with a permanent establishment in the first member state;
  • a taxpayer transfers the business carried on by its permanent establishment from a member state to another member state or to a third country in so far as the member state of the permanent establishment no longer has the right to tax the transferred assets due to the transfer.

A taxpayer satisfying certain conditions may defer the payment of an exit tax by paying it in installments over five years.

General anti-abuse rule

Under the Directive, an arrangement or a series of arrangements put into place for the main purpose or one of the main purposes of obtaining a tax advantage shall be ignored by a member state. Such arrangements shall be regarded as non-genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality. Where such arrangements are ignored by a member state, the tax liability shall be calculated in accordance with national law.

Controlled foreign company rule

Under the Directive, the member state of a taxpayer shall treat an entity, or a permanent establishment of which the profits are not subject to tax or are exempt from tax in that member state, as a controlled foreign company where the following conditions are met:

  • in the case of an entity, the taxpayer by itself, or together with its associated enterprises holds a direct or indirect participation of more than 50 percent of the voting rights, or owns directly or indirectly more than 50 percent of capital or is entitled to receive more than 50 percent of the profits of that entity; and
  • the actual corporate tax paid on its profits by the entity or permanent establishment is lower than the difference between the corporate tax that would have been charged on the entity or permanent establishment under the applicable corporate tax system in the member state of the taxpayer and the actual corporate tax paid on its profits by the entity or permanent establishment.

Where an entity or permanent establishment is treated as a controlled foreign company, the member state of the taxpayer shall include in the tax base:

  • the non-distributed income of the entity or the income of the permanent establishment which is derived from the following categories:
    • interest or any other income generated by financial assets;
    • royalties or any other income generated from intellectual property;
    • dividends and income from the disposal of shares;
    • income from financial leasing;
    • income from insurance, banking and other financial activities;
    • income from invoicing companies that earn sales and services income from goods and services purchased from and sold to associated enterprises, and add no or little economic value; or
  • the non-distributed income of the entity or permanent establishment arising from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage.

Member states may opt not to treat an entity or permanent establishment as a controlled foreign company under certain circumstances, including when one third or less of its income is derived from the categories of income in the first point above.

Additionally, member states may exclude an entity or permanent establishment from the scope of the second point if its accounting profits do not exceed EUR750,000 and its non-trading income does not exceed EUR75,000; or when its accounting profits amount to no more than 10 percent of its operating costs for the tax period.

Hybrid mismatches

Hybrid mismatches can result in either double deductions for the same expense, or deductions for an expense without the corresponding receipt being fully taxed. Hybrid mismatch outcomes can arise from hybrid financial instruments (both equity and debt) and hybrid entities, and from arrangements involving permanent establishments. They can also arise from hybrid transfers and dual resident companies.

The Directive states that when hybrid mismatches result in a double deduction, the deduction shall be given only in the member state where such payment has its source. When a hybrid mismatch results in a deduction without inclusion, the member state of the payer shall deny the deduction of such payment.

ATAD 2 addresses hybrid mismatches with regard to non-EU countries. It is therefore intended to ensure that hybrid mismatches of all types cannot be used to avoid tax in the EU, even where the arrangements involve third countries.

ATAD 2 – Hybrid mismatches with non-EU countries

ATAD 2 addresses hybrid mismatches with regard to non-EU countries. It is therefore intended to ensure that hybrid mismatches of all types cannot be used to avoid tax in the EU, even where the arrangements involve third countries.

ATAD 2 follows the approach taken by the OECD in its final report on Action 2 and applies to all taxpayers which are subject to corporate tax in a member state. The aim is to capture all hybrid mismatch arrangements where at least one of the parties involved is a corporate taxpayer in a member state.

Under the directive member states will have the obligation to deny the deduction of a payment by a taxpayer or to require the taxpayer to include a payment or a profit in its taxable income, as the case may be.

The proposal addresses hybrid mismatch arrangements that were not covered by ATAD I, including:

  • a hybrid entity mismatch involving a third country leading to a double deduction;
  • a hybrid entity mismatch involving a third country leading to a deduction without an inclusion;
  • a hybrid financial instrument mismatch involving a third country leading to a deduction without an inclusion;
  • a hybrid permanent establishment mismatch, both between member states and between a member state and a third country, leading to a double deduction;
  • a hybrid permanent establishment mismatch, both between member states and between a member state and a third country, leading to a deduction without an inclusion;
  • a hybrid permanent establishment mismatch, both between member states and between a member state and a third country, leading to non-taxation without inclusion;
  • a hybrid transfer, both between member states and between a member state and a third country, where the return on a financial instrument is regarded as derived simultaneously by two jurisdictions, leading to a deduction without an inclusion;
  • a hybrid transfer, both between member states and between a member state and a third country, where the return on a financial instrument is regarded as derived simultaneously by two jurisdictions, leading to a double tax credit;
  • an imported mismatch where a double deduction is imported by a member state through a non-hybrid instrument;
  • an imported mismatch where a deduction without an inclusion is imported by a member state through a non-hybrid instrument;
  • a dual resident mismatch between a member state and a third country leading to a double deduction.

Impact

Many member states already have extensive anti-avoidance legislation in place including such measures as controlled foreign company, interest limitation, and general anti-avoidance rules. Therefore, in some EU countries, the ATAD has only required relatively minor tweaks to existing tax law.

However, this is certainly not the case across the whole of the EU, and several member states have had to legislate extensively to ensure alignment with the requirements of the directive. As such, the corporate tax landscape has changed considerably in many parts of the EU. Therefore, it will be crucial for multinational companies with operations in the EU, including those based in third countries, to factor these extensive changes into their forward tax planning.

Given the widespread changes to national tax laws and regulations taking place at a global level as a consequence of the BEPS project and increasing public and governmental focus on tax avoidance, this is likely to add to an already challenging tax compliance environment for multinational firms.

 

Tags: tax | BEPS | interest | transfer pricing | tax avoidance | accounting | law | environment | business | Europe | Tax | tax planning | European Commission | exit tax | services | dividends | intellectual property | royalties | G20 | banking | compliance

 

 

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