The Unshell Directive – The next big thing?

In early 2023, the European Parliament approved the European Commission’s draft directive to prevent the misuse of shell entities for tax purposes (known as ATAD 3 or the Unshell Directive).

ATAD 3 introduces indicators of minimum substance to assess whether an entity has no or minimal economic activity, which would result in a refusal of certain tax benefits based on treaties or EU directives, such as the withholding tax exemption on dividends, interests, or royalties.

Unlike Pillar 2, ATAD 3 is not limited to international or domestic groups with global revenues exceeding EUR 750 million. It will, therefore, affect many small and medium-sized enterprises with an EU presence and will increase the administrative burden.

If and when adopted, ATAD 3 will have a substantial impact on European holding structures.

Entities concerned

ATAD 3 aims to target passive undertakings that are tax resident in an EU Member State and that do not conduct any economic activity because they are deemed not to have minimum substance.

The first step is to determine wheter if an undertaking crosses all three gateways below and, consequently, it is considered a risk:

1. Passive income – More than 65% of an entity's overall revenue in the preceding two tax years is ‘relevant income’.‘Relevant income’ broadly covers passive income such as interest, including any other income generated from financial assets, such as crypto assets, royalties, dividends, income from immovable property, income from certain movable property with a book value exceeding EUR 1 million or income from services that have been outsourced to other associated enterprises.
2. Cross-border activities – Over the course of the preceding two tax years, at least 55% of the entity’s relevant income is earned through or paid out via cross-border transactions. Alternatively, more than 55% of the book value of certain assets (mainly immovable property or movable property with a book value exceeding EUR 1 million) is located outside the Member State of the entity.
3. Outsourced management and administration – The entity concerned has outsourced the administration of day-to-day operations and the decision-making on significant functions in the preceding two tax years.

 If an entity lacks substance under the three gateways it becomes subject to the reporting of certain information on its annual tax return (i.e., information on its premises, bank accounts, directors, and employees). In case it fails to provide sufficient evidence, including supporting documents, of its substance and business rationale, it is presumed to be a shell entity.

However, an entity has the right to rebut this presumption, as further explained below.

Certain domestic holding companies will still benefit from a carve-out and will be exempt from reporting obligations if:

• their main activity is holding shares in operational businesses in the same Member State while their beneficial owners are also resident for tax purposes in the same Member State; or
• they are resident for tax purposes in the same Member State as the entity’s shareholder(s) or the ultimate parent entity. In addition, some regulated funds are also expected to benefit from a carve-out.

In addition, certain listed companies, certain regulated financial companies, and certain holding companies are also expected to benefit from some type of carve-out.

The rebuttal of the shell presumption

Member States should take measures to enable entities that are considered a shell entity to provide rebuttal evidence demonstrating that there is a commercial rationale for the existence of the entity concerned and that it is not misused for tax purposes.

To this end, entities should provide some additional evidence:

• a document allowing to ascertain the business rationale behind the establishment of the entity in the Member State where the activity is performed; or
• information on the profiles of full-time, part-time, and freelance employees.

The Member State should consider a request for the rebuttal of the presumption within a period of nine months after the introduction of the request and it should be deemed accepted in the absence of an answer from the Member State after the expiry of that nine-month period.

A successful rebuttal may remain valid up to 5 years from the time the decision is issued assuming the relevant factual and legal circumstances do not change

If the entity cannot rebut this presumption, it will not receive a certificate of tax residence from its EU Member State of residence. This means that the entity will be disallowed any tax advantage gained through bilateral tax treaties of the entity’s resident jurisdiction or through EU Directives (e.g. Parent-Subsidiary Directive and the Interest and Royalties Directive).

Pathway for approval and entry into force

There is an absence of consensus at the level of the EU Member States on some of the key provisions of the Unshell Directive and continued uncertainty regarding the final version of the compromise text, which has not been published yet. Although this absence of consensus is likely to lead to further amendments to the proposal, at of the date of this publication, there has been no official change to the proposed 1 January 2025 effective date. One should also consider that, upon the adoption of the Directive, each Member-State might have its own timing when transposing it internally, leading to a fragmented application. 

In this regard, it is worth noting that, at the recent European Region conference of the International Fiscal Association, held in Amsterdam, there were renewed levels of optimism about the Unshell Directive, with a representative of the current Spanish Presidency indicating that reaching an agreement is a priority for them and their aim is to reach political alignment on this by the ECOFIN meeting in November 2023.

Despite the uncertainties, what is sure is that, if approved, ATAD 3 will have an impact on the burden of proof. Indeed, when applying the current general or specific anti-abuse provisions, it is up to the tax authorities to prove that the entity is a shell. Under ATAD 3, it is the taxpayer, however, who will have to demonstrate that it is not a shell entity based on the criteria of ATAD 3.

And what to expect next? Is ATAD 4 on the way?

In addition to ATAD 3, the European Commission is also working on a new taxation package intended to further restrain the use of shell entities and aggressive tax planning.

This includes the Securing the Activity Framework of Enablers initiative, the so-called SAFE initiative (as a supplement to the ATAD 3 by targeting enablers setting up structures using non-EU shell entities).

There is also the so-called FASTER proposal, which aims to introduce a new EU-wide system for withholding tax to prevent tax abuse in the field of withholding taxes. The European Commission aims to adopt a directive proposal for a more efficient withholding tax relief procedure in the EU in the coming months.

Our take

We encourage the entities that might be affected (either in Madeira, Portugal or Malta) to assess whether there is a potential reporting obligation under the ATAD 3 - in this regard, it is worth noting that structures put in place before the entry in force of ATAD 3 will be impacted.

Further to this evaluation, and in order to avoid unnecessary risks for the investors, companies might need to reconsider or simplify potentially redundant corporate structures through restructurings involving mergers, share-for-share transactions or the liquidation of entities.

At NEWCO, we have experience in monitoring the degree of compliance with substance requirements of companies incorporated in Madeira, Portugal, and Malta.

In particular, one interesting feature of the Unshell Directive is that it provides several substance indicators that are already within our recommendations for companies operating in the Madeira International Business Centre, such as:

• Having its own premises;
• Having at least one own and active bank account or e-money account in the Union through which the relevant income is received;
• Having directors qualified and authorised to take decisions in relation to the activities that generate relevant income for the entity or in relation to the entity’s assets;
• The majority of the full-time equivalent employees of the entity having their habitual residence in the Member State of the entity.

Although companies within the Madeira International Business Centre are expected to already comply with some of the Unshell Directive requirements, a case-by-case assessment is recommended, and hence, we can assist you with the following:

• Assessing the current structure and substance indicators of your entity;
• Suggesting possible solutions to overcome any substance issues;
• Any other services you may need regarding the proposed directive.