On December 22, 2021, the European Commission presented its proposal for a Directive (COM(2021) 565 final) to tackle the misuse of shell companies, which are increasingly being used for the purposes of aggressive tax planning or to evade the tax authorities.
The Commission itself estimates that in the EU tax avoidance linked to the misuse of shell companies amounts to around 23 billion euros: a very important figure that the Commission seeks to recover with the introduction of these new provisions, which should be adopted by Member States by June 30, 2023 and come into force on January 1, 2024.
The “brake” that the Commission is trying to give to those who intend to set up and use companies of this type is linked to the passing of the “substance test“, which has the objective of helping member states to identify companies that carry out an economic activity but have no minimum substance and are misused to obtain tax advantages. This test follows a logical sequence characterized by two key steps:
- the first is aimed at identifying those companies at real risk of lack of substance and tax abuse through a screening to be carried out with certain criteria, which we will set out below.
- The second requires the company to indicate in its annual tax return, for each tax period and attaching documentary evidence, that it meets the “minimum substance indicators“.
Let us therefore see in detail what these two steps that identify the so-called shell company consist of.
The first phase consists in applying a “filtering” system in order to identify those companies at real risk of lack of substance and tax abuse. In particular, those companies that positively meet the following criteria (“gateways”) are to be considered at risk:
- more than 75% of the income accrued by the company in the previous two tax periods is passive income (e.g., dividends, interest, etc.) or, alternatively, the book value of the equity investments it holds or of its movable and immovable property with a book value in excess of €1 million is more than 75% of the total book value of the assets;
- the company is predominantly engaged in cross-border business, consisting of the fact that:
- more than 60% of the book value of its movable and immovable property with a book value in excess of €1 million was located outside the member state of the company in the previous two tax years; or
- at least 60% of the firm’s passive income is related to cross-border transactions;
- the firm has outsourced the day-to-day administration and decision-making on significant functions in the two preceding tax periods.
Companies that meet all three criteria are required to disclose in their annual tax return, for each tax period and attaching documentary evidence, the following “minimum substance indicators“:
- the business has its own premises or premises for exclusive use in the Member State of residence;
- the business has at least one own and active bank account in the Union;
- at least one of the following indicators:
- residence and activities carried out for the company by the directors (by way of example, decision-making powers over assets and their constant exercise, their independence with respect to other companies in the group, etc.);
- residence and activities carried out by employees (existing contracts, duties performed, responsibilities, etc.).
The proposal for the Directive does, however, provide for the possibility of requesting an exemption from reporting obligations, granted if the company itself is able to demonstrate, by providing sufficient and objective evidence, that its existence is not capable of reducing the tax burden of its beneficial owner(s) or of the group, as a whole, of which the company is part.
What happens if you fail the substance test?
If the substance test is positive (i.e. all three parameters of the first phase are met), it is assumed that the company is not a shell company.
On the contrary, if even only one parameter is not met, it is presumed that the company has been set up for reasons of tax avoidance and is therefore a shell company.
The consequences of this outcome are quite important from a tax point of view:
- -Firstly, the other member states (other than the one where the shell company is established) disallow any benefit provided by both the Double Tax Conventions and the withholding exemption regimes provided by the Parent-Subsidiary Directive for dividends and the Interest&Royalties Directive.
- The shareholders of shell companies resident in the same Member State as the company are taxed on a transparent basis (i.e. the income of the shell company is attributed to them, as if the company did not exist).
- For these shell companies, certificates of fiscal residence, valid for access to any tax benefit, will no longer be issued.
It has to be underlined that the Directive does, however, allow the company which does not pass the substance test the right to provide proof to the contrary, i.e. to demonstrate the economic substance of the company which, according to objective parameters, would be a shell company.
Conclusions and future prospects
The proposal for a Directive on shell companies is one of the numerous measures that Europe is adopting, and will adopt in the future, in the fight against tax abuses. Together with the actions of monitoring and exchange of information that are increasingly present in the European context, it represents a very important step forward in favor of greater transparency of companies and protection of the economic environment of equality and economic growth, which is proper to the European Union.
This Directive could also represent a boost for the reform of the Italian discipline on shell companies. In fact, the motivations behind the introduction of the Directive are similar to those inspiring the Italian national regulations (art. 30 of Law 724/94), aimed at identifying “shell companies” which do not carry out an effective economic activity, but the effects and consequences are different: in the domestic regulations a minimum taxable income is attributed, with the application of a higher tax rate, while in the European regulations there is a denial of the benefits of the Conventions and Directives on withholding taxes. A future modification of the Italian regime is also expected, which in time will have to adapt to the European indications provided on this subject.