On 21 June 2016, an agreement was reached on the Anti-Tax Avoidance Directive. This Directive introduces a common set of rules aimed at preventing tax avoidance in the European Union (EU).
The Directive introduces minimum standards with respect to three areas addressed by the OECD:
- interest limitation rules
- controlled foreign company (CFC) rules
- rules on hybrid mismatches.
In addition, the Directive addresses two areas not specifically considered by the OECD:
- exit taxation rules
- general anti-abuse rule (GAAR)
The Directive applies to all taxpayers that are subject to corporate tax in an EU Member State, including corporate taxpayers resident outside the EU with a permanent establishment in the EU.
The Directive will have to be transposed into national law by 31 December 2018. Exit taxation rules will have to be transposed 31 December 2019.
Interest limitation rules
The Directive limits the deduction of ‘net’ interest expenses to 30% of taxable earnings before interest, tax, depreciation and amortisation (EBITDA).
The EBITDA of a tax year that it is not fully absorbed by the borrowing costs incurred by the taxpayer in that tax year or previous years may be carried forward.
Member States are provided with discretion to include an exception: taxpayers which are part of a consolidated group can fully deduct their net interest if they can demonstrate that the ratio of its equity over its total assets is no more than 2% points lower than the equivalent ratio of the group.
Controlled foreign company (CFC)
CFC rules oblige a taxpayer (ie the parent company) to include the non-distributed income of some related entities in its tax base (these include low-taxed controlled entities and permanent establishments). Initially, it had been proposed that the CFC rules would target undistributed profits that are subject to taxation at an effective corporate tax rate lower than 50% of the equivalent effective rate in the controlling Member State. The agreed Directive, however, provides Member States with the discretion to employ a higher threshold in comparing the actual corporate tax paid with the corporate tax that would have been charged in the Member State of the taxpayer.
Rules on hybrid mismatches
Hybrid mismatches or arrangements that are the consequence of a different legal characterisation of payments or entities by two legal systems that results in double deduction will be countered by defining that only the source state should grant the deduction. Furthermore, where a hybrid mismatch results in a deduction without inclusion, the Member State of the taxpayer shall deny the deduction of such payment.
Exit taxation rules
The Directive requires Member States to apply an exit tax when a taxpayer moves its tax residence or assets out of the tax jurisdiction of a Member State. The Directive specifies four scenarios in which an exit tax should apply:
- The transfer assets from a head office to a permanent establishment in another Member State or a third country.
- The transfer of assets from a permanent establishment to the head office or a permanent establishment in another Member State.
- The transfer of tax residence to another Member State or to a third country except for those assets which remain effectively connected with a permanent establishment in the original Member State.
- The transfer of a permanent establishment out of a Member State to another Member State or to a third country.
The exit tax is to be applied to an amount equal to the market value of the transferred asset minus their value for tax purposes (ie unrealised capital gains).
In order to avoid double taxation (from the application of different asset valuation methods) in intra-EU transfer, the inbound Member State will be obliged to accept the value of the asset as established by the Member State of origin at the moment of transfer as the starting value of the asset. This rule does not cover any solutions to EU-thrid country transfers, including transfers from EEA coutnries.
General Anti-Abuse Rules (GAAR)
GAAR targets ‘non-genuine’ arrangements that avoid the purpose of the applicable tax law. The Directive specifies that an arrangement will be regarded as 'non-genuine' where it has not been put into place for valid commercial reasons which reflect economic reality. The term 'arrangement', however, is not defined in the Directive, though, it is expected that the term will encompass any transaction, scheme, action, operation, agreement, grant, understanding, promise, undertaking or event.