Anti-Tax Avoidance Directive 3 (ATAD 3), also referred to as the Unshell Directive, is a pivotal proposal by the EU Commission aimed at curbing the misuse of shell entities for tax purposes.

The directive received an amended approval from the European Parliament on 17 January 2023. However, the decision now rests with the European Council, which will determine whether to accept or amend the proposal.

The legislation was slated to come into effect from 1 January 2024, but implementation of the directive could be delayed until January 2026.

It’s worth noting that shell entities located outside the EU, particularly in Switzerland, the UK, Dubai, Singapore and Hong Kong, will be covered under ATAD 4.

In a recent interview, Jelle R Bakker, Kreston Global Regional Tax Group Director, sheds light on the intricacies of the ATAD 3.

The shell company conundrum

Shell companies have long been a cause for concern, often serving as vehicles for aggressive tax planning or tax evasion. The European Commission’s proposal aims to address this issue by ensuring that shell companies within the EU are unable to benefit from tax advantages.

A shell company is a corporation exhibiting little to no economic activity. The EU estimates that 75,000 companies, comprising less than 0.3% of the overall number of active enterprises within the EU, fall within this classification.

The Unshell Directive: A step-by-step guide

Step 1: Gateways

According to Jelle, any entity that is engaged in economic activity, considered a tax resident and eligible to receive a tax residency certificate in a member state falls within the scope of the Unshell Directive.

The entity must meet three cumulative gateways:

  1. Passive income: Over 65% of revenues in the preceding two tax years must qualify as ‘relevant income’ under ATAD 3.
  2. Cross-border activity: At least 55% of relevant income must be earned or paid out via cross-border transactions.
  3. Outsourced administration: The administration of day-to-day operations and decision-making on significant functions have been outsourced to a third party in the last two tax years.

Step 2: Minimum substance indicators

Entities meeting the gateways without carveouts or temporary exemptions are considered ‘at risk.’ Reporting obligations determine if the entity has minimal or no substance, automatically exchanged with other member states.

The entity must declare three cumulative ‘minimum substance indicators’ in its annual tax return:

  1. The entity has its own premises (or exclusive use thereof) in its member state.
  2. The entity owns at least one active bank account or e-money account within the EU.
  3. The entity has either a qualified and authorised director, or the majority of full-time equivalent employees are tax residents in the entity’s member state.

Step 3: Presumption of lack of minimum substance

Entities that do not meet the above minimum substance indicators are presumed to be shell companies. Documentary evidence, including business activities, outsourced activities, resident directors or employees, bank account details, and evidence of bank account activity, must be provided with the tax return.

Step 4: Rebuttal of presumption

An entity can rebut this presumption by providing the following:

● additional supporting evidence of the commercial rationale behind using the entity
● information about employees
● concrete evidence of decision-making in the member state.

The rebuttal, if accepted, may be valid for five years if circumstances remain unchanged.

Step 5: Carve-outs and exemption

The following entities are exempt from reporting requirements under the Unshell Directive:

● specific regulated (financial) entities
● alternative investment fund managers
● listed entities
● entities with shareholders and operational businesses in the same member state
● holding companies with shareholders
● parent entities in the same member state

Step 6: Shell company tax consequences

Entities satisfying the three gateways, deemed not to meet minimum substance indicators and unable to rebut the presumption of being a shell company face several tax consequences.

These include denial of a certificate of tax residence, denial of tax benefits under tax treaties and EU tax directives, treatment as a disregarded entity by member states where shareholders are located, and imposition of withholding taxes on payments to the shell entity.

Step 7: Exchange of info and tax audits

Member states gain automatic access to information on shell entities through the automatic exchange of information under the Unshell Directive. Additionally, member states may request tax audits when there is suspicion of non-compliance.

The Unshell Directive imposes non-compliance penalties, with the European Commission proposing an administrative pecuniary sanction of at least 5% of the entity’s turnover in the relevant tax year.

ATAD 3 – The EU’s approach and recent developments

Jelle provides a critical perspective on the EU’s approach, stating that “the EU is using a sledgehammer to crack a nut.” With only 0.3% of companies falling within the classification of a shell company, Jelle suggests that the EU’s existing anti-abuse rules, including substance concepts and various domestic and treaty provisions, already address tax avoidance concerns.

Recent developments, including a compromise proposal from the EU Council’s Spanish presidency, aim to ensure that the Unshell Directive does not undermine existing member states’ anti-abuse rules. On 5 September 2023, concerns were raised during a meeting of the EU working party on tax questions. Some countries expressed worries that entities not considered shell companies under the Unshell criteria could be deemed legitimate, thus evading national anti-abuse rules.

The compromise proposal emphasises that the Unshell Directive does not introduce new standards but adds value by identifying “manifest” shell entity cases through a risk-based process and presumption.

Entities not considered manifest shell entities won’t be subject to additional obligations and consequences under the Unshell Directive. However, the member state where such an entity is located retains the right to conclude otherwise after an audit under its national rules.

Further clarifications ensure that the administration of another member state could consider such an entity as lacking sufficient economic substance under national provisions, even if not under the directive. The compromise proposal aims to prevent Unshell from undermining national anti-abuse or anti-tax-avoidance rules.

Member states are encouraged not to be precluded from applying further consequences to entities considered shells under Unshell or parties not subject to consequences under Unshell.

The proposal also suggests adjustments to the revenue threshold and book value for entities excluded from the directive’s scope. Governmental entities fully owned by governments of member states or not considered high-risk entities are excluded from Unshell.

Significant update

In conclusion, the Unshell Directive is a step change in the EU’s approach to combatting tax avoidance through shell entities. Businesses must navigate these steps to ensure compliance and strategic tax planning in this evolving European tax landscape.

As the directive undergoes further discussions and potential amendments, staying informed and agile will be crucial for businesses operating within the EU.


Author: Jelle R. Bakker, Partner International Tax at Bentacera, and European Tax Director, Kreston Global Tax Group

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