The EU Ecofin Council reached unanimous agreement on 12 July 2016 on the ATAD. The ATAD is part of the Anti-Tax Avoidance Package published by the European Commission in early 2016 (see our In context article of February 2016.) The ATAD constitutes the EU implementation of some of the recommendations by the OECD regarding Base Erosion and Profit Shifting (BEPS) and also introduces a few additional measures. The ATAD aims to set a minimum standard on anti-abuse rules in five areas: interest deduction, exit taxation, GAAR, controlled foreign companies and hybrid mismatches.
The ATAD limits the deduction of exceeding borrowing costs to the higher of 30% of the taxpayer’s EBITDA and an amount of EUR 3 million. EBITDA is calculated excluding any tax-exempt income, such as income derived from participations qualifying under the Dutch participation exemption. Member States can choose to apply the rule at the level of a local tax group, such as the Dutch fiscal unity. Exceeding borrowing costs are defined as the amount by which a taxpayer’s interest costs (and economically equivalent costs) exceed that taxpayer’s interest income (and economically equivalent income). The limitation applies to third party and related party debts alike.
The ATAD provides two group ratio escapes that Member States may implement. The first is a balance sheet test which allows a taxpayer to fully deduct its exceeding borrowing costs if its equity to total assets ratio is no more than two percentage points lower than the equivalent group ratio. The second escape is an EBITDA test which allows a taxpayer to deduct its exceeding borrowing costs in accordance with the group ratio of exceeding borrowing costs over EBITDA.
Members States may exclude financial undertakings from application of the limitation. The ATAD’s definition of financial undertakings includes regulated financial institutions such as banks, insurance companies, pension funds, central counterparty clearinghouses and certain investment funds. In addition, Member States:
- may choose not to apply the limitation to stand-alone entities (i.e. entities that are not part of an international or national group),
- are not required to apply the rule to loans used to fund long-term EU public infrastructure projects,
- may grant taxpayers carry forward and carry back with regard to non-deductible interest costs and unused interest capacity,
- may choose, under the ATAD’s grandfathering clause, not to apply the limitation to loans concluded before 17 June 2016 (not including later modifications of these loans), and
- may defer implementation of the limitation, when they already have anti-base erosion rules in place that are equally effective, until the end of the first full fiscal year after publication of a minimum standard agreed under OECD BEPS Action 4, but no later than 1 January 2024.
The ATAD provides an exit taxation rule that applies to cross-border corporate migrations and cross-border transfers of assets, if this migration or transfer prevents future taxation by the Member State of origin. If the exit taxation rule applies, a taxpayer will be taxed on the difference between the fair market value of the assets at the time of transfer and the tax book value of those assets at that time.
If the migration or transfer is to another Member State or to a state party to the European Economic Area Agreement (EEA States), Member States must grant taxpayers deferral of the exit tax payment. Taxpayers will be allowed to pay in instalments over a period of at least five years. During the time the payment is deferred, Member States may charge the taxpayer interest on the deferred amount and demand security for the payment. The ATAD provides that the amount deferred becomes due immediately if
- the transferred assets are disposed of,
- the transferred assets are transferred to a third country,
- the taxpayer migrates to a third country,
- the taxpayer goes bankrupt, or
- the taxpayer fails to fulfil its obligations with regard to the instalments.
The Netherlands has already implemented comprehensive exit taxation rules.
The GAAR provides that non-genuine arrangements or series of those arrangements that have been carried out with the main purpose or one of the main purposes of obtaining a tax advantage that defeats the objective of the applicable tax provisions must be ignored for the calculation of a taxpayer’s corporate tax liability. Whether an arrangement qualifies as non-genuine depends on the extent to which the arrangement was not put in place for valid commercial reasons that reflect economic reality.
The wording of the GAAR corresponds to the general anti-abuse rule included in the EU Parent Subsidiary Directive and effective in Member States since 1 January 2016.
Controlled Foreign Companies
If an entity or permanent establishment qualifies as a controlled foreign company (CFC) of a taxpayer, the ATAD requires that the taxpayer will immediately be taxed on the non-distributed income of such a CFC if certain requirements are met.
An entity or permanent establishment, will qualify as a CFC of a taxpayer if:
- The taxpayer, by itself or together with associated enterprises, directly or indirectly, holds more than 50% of the voting rights, owns more than 50% of the capital, or is entitled to more than 50% of the profits of that entity
- The actual corporate tax paid by the entity or permanent establishment is lower than the difference between the corporate tax that the entity or permanent establishment would have had to pay under the tax laws of the Member State of the taxpayer and the actual corporate tax paid by the entity or permanent establishment.
The second requirement has the effect that an entity or permanent establishment will qualify as a CFC of a taxpayer if it is subject to an effective tax rate of less than 50% of the effective tax rate applicable in the Member State of the taxpayer.
The ATAD allows Member States two different approaches to determine which non-distributed income of a CFC will be included in the taxable income of the taxpayer.
Inclusion of certain categories of perceived “passive” income
The first approach prescribes inclusion of certain specific categories of perceived “passive” income of the CFC. The ATAD defines the following categories:
- interest or other income from financial assets
- royalties or other income from intellectual property
- dividends or capital gains on shares
- income from financial leasing
- income from banking, insurance and other financial activities
- income from invoicing associated enterprises for goods and services while the CFC adds little or no economic value.
Under this approach, Member States may exempt CFCs:
- whose income from the defined categories does not exceed one-third of its total income, and
- that are financial undertakings and whose income from the defined categories resulting from transactions with the taxpayer or associated enterprises does not exceed one-third of its total income.
Inclusion of non-distributed income from non-genuine arrangements
The second approach prescribes inclusion of non-distributed income derived from non-genuine arrangements or a series of arrangements that have been carried out essentially to obtain a tax advantage. Arrangements will qualify as non-genuine if the CFC would not have owned the assets or would not have undertaken the risks that generated the CFC’s income, had it not been controlled by the taxpayer where the relevant significant people functions were carried out. Under this approach, Member States may opt to grant exceptions from the rule for CFCs whose accounting income is no more than EUR 750,000 and whose non-trading income is no more than EUR 75,000, or to a CFC that has accounting profits of no more than 10% of its operating costs.
The CFC rules also provide for relief from double taxation through a credit for the corporate tax paid on the income by the CFC itself.
The ATAD prescribes rules addressing structures that result in a double deduction, or a deduction without inclusion, because of a difference in legal characterisation by Member States of certain entities or financial instruments. If a hybrid mismatch results in a double deduction, only the Member State where payment has its source is allowed to grant the deduction. If the hybrid mismatch results in a deduction with inclusion, the Member State of the taxpayer must deny the deduction.
The rules regarding hybrid mismatches are limited to mismatches between Member States and thus do not apply to mismatches with third countries. The European Commission was asked to put forward a proposal regarding hybrid mismatches with third countries by October 2016 with the aim of reaching agreement on the proposal by the end of 2016.
Switch-over clause removed
The switch-over clause that was included in the previous draft is no longer part of the ATAD. This switch-over clause prohibited tax exemption for profits derived from subsidiaries and permanent establishments located in low-tax jurisdictions. The implementation of this clause would have affected the application of the Dutch participation exemption for typical offshore jurisdictions.
With the exception of the rules on exit taxation, the Member States must implement the measures in their national legislation by 31 December 2018. The measures must become effective as of 1 January 2019. The rules regarding exit taxation must be implemented by 31 December 2019 and must become effective as of 1 January 2020. Since the ATAD introduces only minimum measures, Member States remain free to adopt additional or more stringent versions of the anti-tax avoidance rules.