Introduction
On 21 June 2016, the European Council agreed on a draft directive (“draft”) addressing commonly used tax avoidance practices, as a result of the January 2016 anti-avoidance package of the Commission’s proposals to combat tax avoidance, which incorporates basic elements of the Organisation for Economic Co-operation and Development’s (OECD’s) BEPS project as well as anti-tax avoidance initiatives of the Commission.
The draft covers all taxpayers subject to corporate tax in EU states, as well as European permanent establishments of entities resident for tax purposes in a third country, laying down principle-based rules and leaves the details of their implementation to member states, in a way that best fits their systems.
Areas Covered
The draft focuses on the elimination of tax avoidance in five specific fields:
- Deductibility of interest;
- Controlled foreign company (CFC) rules;
- A framework to tackle hybrid mismatches;
- A General Anti-Abuse Rule (GAAR); and
- Exit taxation.
Three of the five areas covered by the directive implement OECD best practice, namely the interest limitation rules, the CFC rules, and the rules on hybrid mismatches. The two others (i.e., the general anti-abuse rule and the exit taxation rule) are not part of the BEPS initiative.
Compared to the January 2016 anti-avoidance package, provisions for a switch-over clause were not included in the draft. A proposed switch-over clause would represent a broad departure from the exemption system that is widely regarded as efficient and supportive of the capital import neutrality principle, towards a tax credit system. Therefore, it would put an end to the participation exemption principle, a basic feature of existing tax legislation in several EU member states.
Adopted Rules
Deductibility of Interest
Under the new rule, exceeding borrowing costs shall be deductible to the higher of: (i) to 30 % of the EBITDA, or (ii) an amount of EUR 3 million. The draft provides for two alternative worldwide group ratio escape rules: (i) the equity escape rule, or (ii) the earnings-based worldwide group ratio rule. These rules may be optionally implemented by the member states. Carry forward (and back) provision options are also available to ensure a balanced application of the interest deduction limitation rule. Financial institutions may be excluded from the application of the new rules by the respective member states.
CFC Rules
The draft directive effectively introduces CFC rules in the national legislation of the member states. Under the proposed rules, income of low-taxed controlled subsidiaries or permanent establishments (PEs) is reattributed to the parent companies. This applies when the parent company (alone or together with an associated party) holds directly or indirectly 50% of the capital, voting rights, or entitlements to the profit of a low-taxed entity. An entity is characterized as low taxed, if it is subject to an effective tax rate less than 50% of the effective tax rate in the member state of which the shareholder is resident.
Hybrid Mismatches
Hybrid mismatches occur when an entity is characterized differently into two member states, resulting in a double deduction of certain costs or losses (“double deduction”) or a deduction of certain costs without taxation of the corresponding income (“deduction/non-inclusion”). The new rules indicate that in the first case the deduction shall be granted only in the member state where the payment is sourced. In the latter case of deduction/non-inclusion, the member state of the payer shall deny the deduction of such payment. The rules apply only to hybrid mismatches between member states.
GAAR
The proposed GAAR entail that non-genuine arrangements, if carried out for the obtainment of a tax advantage that defeats the object or purpose of the otherwise applicable tax provisions, should be ignored for corporate tax purposes. Arrangements shall be regarded as non-genuine to the extent that they are not put into place for valid commercial reasons, reflecting economic reality.
Exit Taxation
The introduction of exit taxation legislation in the EU countries aims at maintaining the possibility to tax capital gains or other reserves created in their respective jurisdictions in the cases when a transfer of assets or tax residency results in deemed capital gains. Exit taxes may be imposed in the case of:
(i) a transfer of assets between the head office and a permanent establishment (or vice versa) or between permanent establishments in another EU country or third country;
(ii) a transfer of the tax residency to another EU country or third country; and
(iii) a transfer of the permanent establishment itself. Taxation should not occur insofar the assets remain subject to tax in the “transferring” member state.
The “receiving” member state shall accept the fair market value setup by the transferor member state as the starting value for tax purposes. In the case of a transfer to another EU or EEA country (Lichtenstein, Norway, and Iceland), there is the right to defer exit tax payment by settling it in installments over a five-year period. Interest may be charged on deferred exit tax, and the deferral of payment may be subject to security arrangements to ensure its collectability.
Timeline
No timeline is specified. The draft will be submitted to a forthcoming council for adoption.