Author: George Mangion - Senior Partner PKF Malta
Published on Business Today: 3rd February 2022

Last December, the European Commission presented a key initiative to fight against the misuse of shell entities for improper tax purposes. At the same time presented its proposed legislative text to impose a 15-percent minimum tax on corporations as worked out between OECD countries and approved by the G20 (Malta signed as well with some reservations).

It is estimated that in the EU tax avoidance linked to the misuse of shell companies amounts to around 23 billion euros. Once adopted by Member States, the proposal should come into force as of 1st January 2024. The proposal does not apply to entities in third countries. The Commissioner for Economy, Paolo Gentiloni, said: This proposal will tighten the screws on shell companies, establishing transparency standards so that the misuse of such entities for tax purposes can more easily be detected.

What is the gist of such directive and will it target Malta’s own list of companies (Shells reputed to add up to 500). The answer is that the directive will consists of three benchmarks.  It starts by assessing the extend of a company’s passive income, whether most of its transactions are cross-border, and if its management and administration is outsourced.

Tax advisers in Malta will have a tough job to screen their clients and determine whether clients fall into the category since if they do, they be subject to new tax reporting obligations and unable to benefit from tax breaks. This will protect the level playing field for the vast majority of European businesses, who are key to the EU’s recovery, and will ensure that ordinary taxpayers do not suffer additional financial burden due to those that try to avoid paying their fair share.

Readers may ask - what are the uses for Shell companies? These can serve useful commercial and business functions (such as offshore oil and gas drilling), but there are abuses when used for aggressive tax planning or tax evasion purposes.  Malta can be criticised that due to our competitive corporate tax structure, this may attract shell companies.  Luxembourg and the Netherlands have on many occasions been labeled to serve as havens for individuals to use such jurisdictions to shield assets and real estate from taxes, either in their country of residence or in the country where the property is located.

At a time, when the EU has pumped so much recovery assistance into trouble-stricken companies (due to the pandemic) obviously it wants to make sure tax leakages are minimized. Executive Vice-President for an Economy that Works for People, Valdis Dombrovskis, said: Shell companies continue to offer criminals an easy opportunity to abuse tax obligations.

In two years’ time, if the directive is approved by all Member States it shall be monitoring shell companies. It will make it harder for them to enjoy unfair tax advantages and easier for national authorities to track any abuse arising from shell companies.  An entity must satisfy all three indicators in order to meet the minimum substance requirements. These are:

• Own or have exclusive use of premises in the entity’s Member State;
• Hold an active bank account in the EU; and
• Have at least one qualified director who is tax resident in the entity’s Member State or employ a majority of full-time employees who are tax resident in the entity’s Member State (or as close-by as can sufficiently carry out activities).

That 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.

If the entity does not meet all of the minimum substance requirements (or does not provide sufficient evidence to prove it does), it will be classified as a shell entity.  An entity crossing all three gateways will be required to report information in its tax return related, for example, to the premises of the company, its bank accounts, the tax residency of its directors and that of its employees.  These are known as substance indicators.  All declarations need to be accompanied by supporting evidence. The consequences of being classified as a shell company are three-fold:

• Tax benefits provided by the Parent-Subsidiary Directive or the Interest and Royalties Directive and bilateral tax treaties are denied;
• New taxing rights over the income are provided to the shell entity’s shareholders (deducting any tax paid by the shell entity assuming both entities are resident in an EU Member State), and
• A request for a tax residence certificate will be denied or issued with a warning to prevent claiming double tax relief in another jurisdiction. One may ask if exemptions exits under the proposed directive. The answer is yes. A number of exemptions for certain entities exist as well as a rebuttal of presumption for genuine activities. There is also the opportunity to request an exemption where it is possible to demonstrate there is no tax advantage arising from the use of the shell entity.

The list of exempt entities includes listed companies; regulated financial undertaking; domestic holding entities; and entities that have at least five full-time employees exclusively carrying out income-generating activities. These exemptions should be helpful for large groups that have sufficient people on the ground. In the case of investment managers, the exemption for regulated financial undertakings will be helpful for entities within the fund structure that are regulated, however holding companies further down the chain will prove more difficult and may need to rely on one of the other exemptions to relieve themselves.

It also captures legal arrangements, such as partnerships, that are deemed residents for tax purposes in a Member State. In the case of payments to/from a deemed shell entity and a third country, the allocation of taxing rights should be determined by existing double tax agreements. Unfortunately, all companies in Malta need to pass the test as there is no exemption for small and medium-sized enterprises.

Author: George Mangion - Senior Partner PKF Malta
Published on Business Today: 3rd February 2022
Get in touch: info@pkfmalta.com