These measures will need to be ratified by the 28 Member States. Some of the measures are not completely aligned with the OECD’s proposals, and there are some additional proposals too. Given that many Members of the EU are also OECD member countries, it is not clear why the EC has chosen to plough a different furrow in some areas, notably on how the anti-hybrid measures would operate. The EC is also taking the opportunity to revive proposals for a Common Consolidated Corporate Tax Base (CCCTB). Whilst we can expect some changes to be made to the proposals, EU based groups need to be aware of the proposals as they stand.
Key aspects of the proposals are:
- A draft anti-tax avoidance directive;
- Automatic exchange of CbC reports;
- Draft anti-treaty shopping rules;
- External strategy regarding non-Member State countries
The objective of this draft directive is the implementation of various anti-avoidance measures in common form across the 28 Member States. The directive will cover all taxpayers subject to corporate tax in EU Member States, as well as permanent establishments of other companies located in the EU.
There are six specific areas covered by the draft, as detailed below.
1. The deductibility of interest
To discourage erosion of the tax base through ‘inflated’ interest charges, the proposal is for a limitation to be placed on the amount of interest which will be tax deductible in a given year. Net interest will only be deductible up to a fixed ratio based on gross operating profit (proposed as the greater of 30% of EBITDA or €1 million). However, the taxpayer would be able to have a full deduction if they were able to demonstrate that the ratio of its equity over its total assets is within 2% of being as high as the equivalent ratio of the group. Interest costs which are not deductible one year can be relieved in a future year provided the 30% EBITDA limit is not exceeded. These rules will not apply to the financial sector.
2. Exit taxation
The provisions here are aimed at taxpayers aiming to reduce their tax liabilities by either moving their tax residence and/or assets to a low tax jurisdiction. An exit charge will apply based on the market value of the assets transferred. The EC is clearly mindful of previous litigation at the CJEU in respect of exit charges, so within the EU or EEA, the taxpayer will be able to defer payment of the tax by payment in instalments over five years. This is an area which was not covered by the OECD-G20 BEPS proposals.
3. Switch over clause
This is another proposal not covered by the OECD-G20 BEPS action plan. This would result in a move away from the exemption of low taxed income and gains and instead to taxation with credit for overseas tax paid. ‘Low tax’ for this purpose is defined as a rate lower than 40% of the tax rate in the recipient. Given that the FII GLO litigation held that it was discriminatory to have a credit system for overseas dividends but an exemption system for domestic dividends, this is a surprising proposal.
4. General anti-abuse rule
The UK has already been there and got the tee shirt. The EC proposal is slightly differently framed and would apply to ‘Non-genuine arrangements carried out for the essential purpose of obtaining a tax advantage that defeats the object or purpose of the otherwise applicable tax provisions shall be ignored for the purposes of calculating the corporate tax liability… An arrangement or series thereof shall be regarded as non-genuine to the extent that they are nor put into place for valid commercial reasons which reflect economic reality.' If the EC GAAR applies, the tax liability would be calculated by reference to the economic substance.
The UK GAAR applies to many taxes, and not just corporate tax, and the emphasis is on whether the arrangements would reasonably be regarded as abusive. It is not clear what taxpayer safeguards might apply (such as the Advisory Panel in the UK).
5. Controlled foreign company legislation
Unlike the UK, not all Member States currently have CFC rules. The draft directive proposes to change this, with the introduction of a CFC regime for 50% subsidiaries based in non-Member States with a tax rate less than 40% of the tax rate in the parent company’s territory. This would be targeted at companies with at least 50% of their income coming from passive sources. Furthermore, the CFC’s profits would only be apportioned if the CFC did not have significant people functions to manage its business (in similar fashion to the UK CFC rules).
In view of the Cadbury Schweppes litigation, there is a carve out for EU/EEA subsidiaries – these would only be within the ambit of CFC rules if they were wholly artificial or engaged in arrangements with a main purpose of obtaining a tax advantage.
6. Hybrid Mismatches
This would apply where two Member States give different legal characterisation of the same taxpayer (hybrid entity) or to the same payment (hybrid instrument). However, in these proposals, the treatment adopted in the state in which deduction is first claimed would then need to be followed in the second state.
The UK has already published draft legislation in Finance Bill 2016, although the way it works is slightly different to what is proposed by the EC.
There is also a draft CbC reporting directive, which would require multinational enterprises with turnover exceeding €750 million to file detailed information as set out by the OECD-G20 requirements starting with accounting periods beginning on or after 1 January 2016. Member States would then have to share information to other Member States where the MNE has a presence within 15 months of the accounting period.
Where Member States, in tax treaties which they conclude among themselves or with third countries, include a principal purpose test based general anti-avoidance rule in application of the template provided for in the OECD Model Tax Convention, Member States are encouraged to insert in them the following modification:
"Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that it reflects a genuine economic activity or that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention."
This is different to the limitation on benefits proposed by the OECD-G20.
Finally, the EU is seeking to encourage good governance and transparency outside the EU, with the end goal of blacklisting territories that do not meet these criteria.