HUGO RÖNNESKOG REVIEWS THE EUROPEAN COMMISSION’S PROPOSAL FOR A DIRECTIVE TO PREVENT THE MISUSE OF SHELL COMPANIES FOR TAX PURPOSES
On 22 December 2021, the European Commission presented a key initiative to further contribute to and facilitate the fight against the misuse of legal entities for improper tax purposes by means of so-called ‘shell companies’. This proposal is envisaged to serve as an amendment to the already existing suite of directives on administrative cooperation (DACs), commonly referred to in its draft form as the ‘Unshell proposal’. The proposal aims to ensure that holding companies within the EU that do not meet the minimum substance requirements will no longer benefit from any tax advantages. This will additionally put pressure on jurisdictions with a regulatory framework allowing investors to take advantage of such benefits to amend local legislations, ultimately leading to a more even playing field within the EU. Once adopted by EU Member States, the directive should come into effect
on 1 January 2024. The status of the entities is determined by analysing the two preceding years and, as a result, 2022 is already in scope for potential reporting obligations.
WHY ARE SHELL COMPANIES A PROBLEM?
A shell company is a cross-jurisdictional structure with the objective of allowing its shareholders to pay less tax than they would normally pay through a legal entity domiciled in the same country where the shareholder resides, or shelter assets from taxes due. Such structures unfairly burden the ordinary taxpayer and create an uneven playing field within the European market.
WHAT DETERMINES A SHELL COMPANY?
The proposal sets out a list of criteria to identify whether the legal entity should be deemed a shell company or a ‘reporting entity, as it would then be obliged to regularly report its status as a shell company to the relevant tax authorities. As it stands today, the proposal suggests a three-level filtering system, considered as a minimum substance requirement, where the following criteria must be breached to be deemed a shell company:
Income received: If more than 75 per cent of the company’s overall revenue in the previous two tax years does not derive from the entity’s trading activity, or if more than 75 per cent of its assets are composed of real estate or other private property of high value.
A cross-jurisdictional set-up: If the company receives most of its relevant income through transactions linked to another jurisdiction or passes this relevant income on to other companies situated abroad.
Level of company control: Corporate management and administration services performed are to a large extent outsourced.
Therefore, in a nutshell, a holding company whose shareholders do not reside in the same country as where the entity is domiciled would potentially be at risk.
WHAT HAPPENS IF A COMPANY IS DEEMED TO BE A SHELL COMPANY?
If the minimum substance requirements are not met, the proposed directive will consider the legal entity to be a shell company, which would entail it losing
its tax benefits and being treated as a transparent structure for tax purposes. To facilitate the implementation of these consequences, EU Member States will be obliged to either deny the shell company a tax residence certificate or the certificate will specify that the company is a shell company. Moreover, payments to third countries will not be treated as flowing through the shell entity but will instead be subject to local withholding tax in the source country.
WHAT ARE THE ALTERNATIVES?
Practitioners advising shareholders of holding companies pushing the above thresholds are strongly encouraged to review their current affairs. The alternative of setting up new legal entities lacking substance outside of the EU is widely argued to be an unsustainable solution as it will most likely trigger mandatory disclosure rules to the local tax administration and to similar anti-abuse rules in place globally, such as controlled foreign company rules, the Common Reporting Standard and beneficial ownership register requirements. Taking into consideration past events, one thing is for certain: the world is becoming
more transparent and tax authorities are becoming less forgiving. We have witnessed this numerous times over the past couple of years with the Panama Papers, Pandora Papers and Paradise Papers, to name a few. The widely recognised private placement life insurance (PPLI) solution has, over the years, grown into a solid alternative to corporate structures
for ultra-high-net-worth individuals across the globe, making it an ideal cross-jurisdictional planning tool to help the investor protect, preserve and pass on wealth in a compliant manner. With a wide array of benefits, the PPLI solution provides for investment flexibility, asset protection, confidentiality and estate planning, as well as, depending on the jurisdiction, tax deferral and reduction.
