2.4.3.4 Anti-Tax Avoidance Directive

Introduction

The ATAD1 aims to create a minimum level of protection against tax avoidance practices.2 By means of the ATAD, the EC attempts to implement the fifteen OECD action points following from the BEPS project in a coordinated manner. In doing so, it seeks to improve the effectiveness of the internal market as a whole. The ATAD includes various provisions, such as a generic interest deduction limitation (the earnings stripping rule) and a general anti-abuse provision. It is important to note that the ATAD rules contain minimum standards. A Member State is therefore free to implement stricter rules in national legislation.

The rules of the ATAD should apply to all taxpayers subject to corporate tax in a Member State. Therefore, a permanent establishment of a third country resident which is situated in a Member State also falls within the scope of the rules.3 The ATAD does not contain an overarching group concept. For various provisions a form of a group concept is introduced. There is no clear justification in the ATAD for these different choices. In this context, the final reports of the BEPS project may provide some guidance. Below, the various implicit and explicit group definitions as included in the ATAD will be discussed, also citing the explanatory notes from the reports. First, the earnings stripping measure and the CFC rule that are included in ATAD1 will be discussed.4 Then the anti-hybrid legislation from ATAD25 will be discussed.

In applying the earnings stripping rule, Member States may choose to allow a taxpayer – if it is part of a group preparing statutory consolidated accounts – to take into account worldwide liabilities.6 A group of companies consolidated for financial accounting purposes is defined in the Directive as:7

So, in essence, reference is made in this context to the group definition as described by IFRS (see par. 2.3.2.2). On top of that, the national accounting system of a Member State may be used.8 The background to this ‘group exception’ is that the interest deduction limitation does not apply if a taxpayer can demonstrate that, in short, its financing ratio does not exceed the group financing ratio.

The BEPS report, which specifically addresses the introduction of a generic interest deduction limitation, emphasises that consolidated financial statements are the most reliable source of global group financial information.9 After all, the group financing ratio can easily be determined on the basis of the consolidated accounts. The OECD thus argues that the definition of the group concept that applies to consolidated accounts for accounting purposes is a practical and workable definition which can be used for the application of the earnings stripping rule. The scope of the group concept includes a parent company and all entities that are fully consolidated into the parent company's financial statements. The parent company should in principle be the ultimate parent of the group. Where consolidation takes place at more than one level, the highest level of consolidation should be considered for the application of a group exception, if any.

For the application of the CFC rules in ATAD1, in short, there is a controlled entity if there is a direct or indirect shareholding of more than 50% (voting rights, capital or profits in the entity). Permanent establishments which are not subject to tax or are exempt in the Member State of the taxpayer, also fall within the scope of the CFC regime.10 However, this seems to apply only to directly held permanent establishments.11 The CFC rules are in principle limited to situations where the majority of the decision-making functions, which have generated the diverted income in the subsidiary, are carried on in the Member State of the taxpayer.12

The BEPS report, which aims to provide guidance for the design of effective CFC legislation, includes a description of how the concept of control should be interpreted. The OECD recommends that, for the application of CFC legislation, a combination of legal control and economic control should be used as a minimum.13 According to the OECD, these two tests are reasonably easy to apply, which limits the administrative burden. In general, control is also measured on the basis of these two elements.14 In particular, the OECD advises against the de facto control test because of its complexity and the additional administrative burden it would entail.

The OECD report indicates that, as a minimum, 50% of the shares should be held to cover all situations where a controlling party has the possibility to shift profits to a foreign entity. Most existing CFC rules require a minimum 50% shareholding as well. Furthermore, the OECD notes that influence can also be exercised in situations where 50% or less of the shares are held. Therefore, it indicates that a lower threshold could be applied too.15

The OECD emphasises that in the case of minority shareholders exercising joint control, the existence or absence of control should be assessed on the basis of the common interests. The OECD describes three methods to do this16 and recommends using one of these methods on applying a CFC rule:

The rules described above aim to take more account of economic reality when applying the CFC rule. The rules increase complexity, especially if they are applied to both residents and non-residents. The OECD does not express an explicit preference for any of the rules, since the report particularly focuses on providing guidance for effective CFC legislation.

Apart from the above, according to the BEPS report control should include both direct and indirect control, so that simple avoidance possibilities can be countered. For indirect control the question arises how to determine whether there is indirect control at several steps in the legal structure. If entity A holds 60% in entity B, and entity B holds 70% in entity C, the standard 50% control requirement is, in principle, met in both direct relationships. However, entity A indirectly holds less than 50% of the shares in entity C.17 The OECD recommends that in such a case the holding requirement should be met at both levels, as there is sufficient economic control at both levels despite the limited legal control.

In determining whether a parent company has control over a subsidiary, attention should also be paid to the moment when such a test should take place. From a practical point of view, a test at the end of the calendar year can be opted for. In order to prevent abuse, continuous testing could be opted for.

Additionally, the question is what type of entities can have control. To prevent abuse, the OECD believes that this should concern all domestic taxpayers rather than only legal entities.

As regards the rules for combatting hybrid mismatches, the preamble to ATAD2 notes that the definition of associated enterprise should be broad enough to serve the purpose of the rules on hybrid mismatches.18 These rules are designed to prevent situations in which there is a double deduction, or a deduction of income in one state while it is not included in the tax base in the other state. The aim is to neutralise hybrid mismatches in as comprehensive a manner as possible.19 The anti-hybrid rules apply to situations involving associated enterprises, including relationships between a head office and its permanent establishment, as well as structured arrangements. ATAD1 in principle defines an associated enterprise as follows:20

Specifically for application of certain anti-hybrid mismatch rules, the percentage of 25 is increased to 50.21 Persons who act together in respect of the voting rights or capital ownership of an entity will be treated as holding a participation in all of the voting rights or capital ownership of the entity that are held by the other person.22 In addition, the concept of associated enterprise includes an entity that is part of the same consolidated group for accounting purposes.23 The concept of associated enterprise also includes an enterprise in which the taxpayer has a significant influence over the management. Furthermore, an enterprise is associated if the enterprise exercises significant influence over the management of the taxpayer.24

The BEPS report that deals with the introduction of hybrid mismatch rules uses a different terminology than the ATAD.25 For this reason, this terminology will not be discussed here.