ATAD III – identifying EU shell holding companies
EU holding entities that lack substance will no longer benefit from EU directives or double tax treaty benefits. ATAD III sets out the mechanism for assessing substance and identifying EU ’shell companies’. Multinational groups holding subsidiaries through an EU entity that outsources management functions, such as private equity and financial service businesses, should ensure their operations are substantive and sustainable. Denied access to EU directives and double tax treaty benefits could give rise to increased withholding taxes and disputes over taxing rights on disposals.
From 1 January 2024, the European Commission’s directive targeting international tax anti-avoidance (ATAD III), is intended to become domestic law across all EU member states. The directive is aimed at EU resident entities and denies access to tax relieving EU directives and double tax treaty benefits where an EU holding entity lacks sufficient substance.
The directive introduces a rules-based approach to identify shell entities, that is, entities whose perceived purpose is to facilitate access to tax relieving EU directives or double tax treaty clauses and thereby avoid withholding taxes.
What is a shell company?
The directive includes several tests to identify shell companies. An entity is at risk if:
- more than 75% of revenue for the past two years is derived from passive activities;
- more than 60% of revenue is from cross border transactions; and
- management of the company is outsourced rather than performed locally in-house
An entity that meets all three tests is required to report information on its economic substance in its annual tax return. This includes details of the entity’s local premises, bank account and details of its nexus to its country of tax residence, such as local directors and staff.
Some exemptions apply which remove the obligation to report, such as where there is a genuine underlying business in the entity. Should an entity meet the above tests, have insufficient substance, and fall outside the exemptions, it risks being treated as a shell company and subject to anti-abuse measures.
What this means for multinational groups
Multinational groups that rely on treaty benefits or EU directives for repatriation of income and profits should consider the ATAD III rule changes. Groups with EU holding entities should consider whether or not to amend their group structure to better reflect where there is genuine substance.
Next steps and how we can help
While the rules may only apply to a limited number of UK multinational groups that have an EU based company within their international holding structure, the change is a significant expansion of the anti-avoidance targeting multinational groups. International businesses that outsource management functions, such as private equity and financial service businesses, should reassess whether or not these rules could apply and what steps should be taken now to maintain access to double tax treaty and EU directive benefits.
Whether or not your business needs support reviewing the substance of its EU holding entities, or assistance in evaluating the appropriateness of the overall tax structure, our team of experts would be pleased to discuss on an initial call.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. You should always seek appropriate tax advice before making decisions. HMRC Tax Year 2023/24.