Investment funds hot topics

The End of Shell Entities in Europe?

The End of Shell Entities in Europe ?  Nikada

The End of Shell Entities in Europe ? Nikada

As part of the fight against base erosion and profit shifting, the European Commission has launched an action plan to curb the use of shell companies within the European Union, which could affect financial activities in some EU countries including Luxembourg.

On 18 May 2021, the European Commission (“EC”) published a communication about “Business Taxation for the 21st Century” introducing a set of actions to ensure fair and effective taxation. Two days after, a consultation strategy was released on the upcoming initiative to fight the use of shell entities, which are meant to be companies with no or minimal substantial presence and real economic activity, for tax purposes within the European Union (“EU”).

According to the EC, shell entities continue to create a risk of being used for improper purposes, such as aggressive tax planning, tax evasion or money laundering notwithstanding the different measures taken at the international and EU level. There is still a lack of EU legislative measures defining substance requirements for tax purposes to be met by entities within the EU.

The Inception Impact Assessment

As an initial step, the EC published an Inception Impact Assessment which outlines their understanding of the issue and provides the objectives pursued and a preliminary assessment of the expected impacts. According to it, the overall objectives of this initiative are:  

·       To preserve the integrity of the internal market by defining common tax related substance requirements;

·       To combat tax abuse and aggressive tax planning more effectively by equipping tax administrations with new targeted instruments to prevent, identify and penalize abusive practices of shell entities; 

·       To preserve fair competition in the internal market by denying tax benefits to legal entities and arrangements which do not meet the tax related substance requirements;

·       To ensure fair and effective taxation to support productive investment and entrepreneurship.

The EC will focus on situations where the ultimate objective is to minimize the overall taxation of a group or of a given structure. As it reminded, in order to ensure that companies pay their fair share of tax, it will continue to use all tools, including the enforcement of State Aid rules.

In this regard, an initiative was taken to explore the most suitable options to ensure that legal entities and legal structures in the EU without a substantial business presence will not benefit from tax advantages.

The EC’s questionnaire revealing its direction

The EC has decided to launch a public consultation designed to gather stakeholders’ views on the possible improvements to the EU legal framework in this field from 4 June 2021 to 27 August 2021. An online questionnaire has been issued in order to collect those views on the use of shell entities and arrangements in the EU for tax purposes. The questions are drafted in a way that can give an idea about where the EC seems to go.   

Indeed, question 3.7 deals with the elements that could characterize a shell entity. Among them, we can find company services providers, the lack of own premises, passive income as main source of income, outsourcing of income generating activity and mostly foreign sourced turnover. Most of those elements are characterizing a lot of companies located in countries like the Netherlands, Ireland or Luxembourg.

Moreover, questions 3.8 and 3.9 are about the commercial rationales that justify the establishment and operation of shell entities and the business activities most likely to be performed by shell entities for tax purposes. Holding and managing equity or real estate, headquarters services and investment fund management are among the activities listed.

Some countries like Luxembourg, the Netherlands and Ireland are obviously targeted by the EC and they might be economically impacted in the future. Those countries are launch pads for worldwide investments and those new rules could have a significant impact on financial activity within those countries.

The EC is already in the process of drafting a new directive that will be ready for the first quarter of 2022. In the meantime, the latest G7 discussions seem to lead to a 15% minimum corporate tax rate and Pillar 1 and Pillar 2 at the OECD level should lead to international agreements in the short term. The forthcoming discussions at the international and EU level will have to be followed carefully in order to apprehend a potential change in legislation and to try to avoid negative financial consequences.