One year ago (in December, 2021), the European Commission proposed the introduction of an “unshell” directive in order to combat shell entities’ misuse for tax purposes, whereby “unshell” refers to preventing shell companies from misusing their structure for tax purposes. The EC proposes adoption of a ‘filtering’ system for EU company entities obliged to pass numerous gateways, so as to ensure there is sufficient ‘substance’ to the entity. For the time being, only companies based in the EU (in-shore) will be affected by the directive. However, the EU Commission is still expected present a proposal on the treatment of shell companies domiciled outside the EU.
How is it determined if a company is a shell company?
A company qualifies as “shell” company on the grounds of three cumulative criteria (“gateways”) covering the preceding two tax years, as follows:
- passive criterium (more than 75% of the company’s revenue);
- cross-border criterium; and
- outsourcing criterium.
“Shell company” risk is encountered only if all three gateways are at hand, resulting in reporting obligations. In such cases, the shell company should perform a “substance” test on its tax return, including reporting information on its own premises, its active EU bank account(s), and its director(s) or full-time employees.
What are the consequences of classification as a shell company?
The taxation of the company in the state of residence itself remains unchanged. However, if a company is classified as a shell company:
- No certificate of tax residency would be granted by local tax authorities (or it would be granted with a specific warning) – As a result, the tax exemptions provided for in double taxation agreements (DTAs).
- The entity would not have access to the EU parent-subsidiary and interest-royalty directives or income tax treaties – In particular, this means that the shell company will be no longer granted relief from withholding tax on dividend, interest or royalty payments.
- The tax authorities of EU member states would exchange information on the company – Data on shell companies and those for which there is a presumption of lack of substance based on the gateway test, will be exchanged among EU states.
- Fines of at least 5% of the companies’ annual turnover – Member states may provide and impose fines on shell companies if the latter do not comply with the provisions of the directive.
Unlike the proposed pillar two directive outlining a global minimum tax, there would be no minimum revenue threshold for the application of these rules. However, an undertaking could be exempt in the absence of tax benefits for itself or its group, and it could also rebut the presumption that it is a shell.
Stage of the Directive Proposal
The draft directive still needs to be unanimously agreed by all EU member states. If approved, the directive’s provisions would likely be transposed into each EU local legislation by June 30 2023, and its provisions would be effective as of January 1st, 2024.
