The Anti Tax Avoidance Directives

ATAD I & II – Where do we stand?

In January 2016, the European Commission proposed for an Anti Tax Avoidance Directive (“ATAD”). In June 2016, the Council adopted the Directive that would later be referred to as ATAD I (Directive 2016/1164). A second complementary proposal on hybrid mismatches was subsequently released by the Commission in October 2016 (“ATAD II”) and adopted as Directive 2017/952.

In this article, you will find a short practical summary of each of the key topics included in the Directives, as well as a quick overview on where the initiatives stand as per today in the Netherlands.

For some of the measures, a legislative proposal was included in the Dutch Tax Plan 2019 (issued in September 2018). More details on these specific measures can be found in Intaxify’s summary on the Dutch Tax Plan).

ATAD I

1. The Controlled Foreign Company Rule

The Issue

Some (multinational) businesses operating in regularly taxed EU jurisdictions are currently able to artificially shift their profits to affiliated entities located in low-taxed jurisdictions. In most cases, the residence jurisdiction of the regularly taxed company is not able to impose tax on the artificially shifted income, as this income is not part of the taxable income of the regularly taxed company. However, at the level of the low-taxed affiliate, no tax is imposed either on the “shifted” income.

The Solution

To take away the benefit from artificially shifting profits to low-taxed jurisdictions, so-called CFC rules will be put in place. Under these rules, regularly taxed companies that hold a certain percentage of ownership in an low-taxed affiliate must include the income of this affiliate in their own taxable income. As a result, the income that was shifted to the low-taxed jurisdiction is now still taxed against a regular rate. This way, the benefit of artificially shifting profits to low-taxed jurisdictions is taken away.

The Status

EU Member States are required to implement the measure by 1 January 2019. The Netherlands included a legislative proposal for the CFC measures in its Tax Plan 2019 (issued in September 2018 – please see a summary here).

In short, the proposal affects taxpayers that directly or indirectly own 50% or more in a qualifying low-taxed CFC. In case the CFC rule applies, a Dutch taxpayer will be taxed for certain income of the CFC in its Dutch tax base, even when this CFC income has not been distributed formally to the Dutch taxpayer yet. Items of qualifying income are for example interest, royalties and dividends.

ATAD I

2. The Switchover Rule

The Issue

EU companies may invest in low-taxed companies. In some cases, dividends flowing out of these low-taxed companies may be eligible for an exemption at the level of the EU parent company (under e.g. a participation exemption) as the EU Member State of the parent company will generally consider that the dividends income that is already taxed at the level of the distributing company. However, this means that the income is not taxed properly.

The Solution

To tax dividends efficiently, EU Member States may tax the dividends received from low-taxed subsidiaries if their income has not been properly taxed at the level of the subsidiary.

The Status

The switchover rule was removed form the ATAD package. Therefore, it is no longer necessary for Member States to implement this rule. For the Netherlands, the participation regime may have been adversely affected under this rule. However, with the rule removed from the package, the participation exemption regime does not require any adjustments.

ATAD I

3. Exit Taxation

The Issue

Companies can transfer their tax residence, their assets or (part of) their business to other jurisdictions. Such relocation may result in tax avoidance, especially if the country of origin cannot impose tax upon such exit.

The Solution

Exit taxation ensures that EU Member States can tax the value of any gain created in their jurisdiction upon an “exit” (companies moving assets or their tax residence to another jurisdiction). In certain specific situations, ATAD prescribes that a transfer of assets, business or tax residence may result in exit taxation imposed by the country of origin. A deferral of maximum five years may apply if the transfer takes place to another EU or EEA Member State. The deferral may however be discontinued in certain situations, such as when the relocated asset or business is subsequently sold, or when a new transfer takes place to a third country. Also a failure to pay the installments may result in a cancellation of the deferral.

The Status

In the Netherlands, an exit taxation regime is already in place. Some changes are however required to make sure the Dutch regime meets the ATAD criteria. For example, the Dutch regime allows for a ten-year deferral so this should be limited to five years as prescribed by ATAD. Another difference relates to guarantees. Under the Dutch tax framework, the tax office may require taxpayers to provide guarantees in general, whereas the ATAD measure only allows for this when there is a risk of non-recovery.

The required changes were included in the documents released on Budget Day 2018 and are expected to be effective as of 1 January 2019.

ATAD I

4. Interest Deduction Limitation

The Issue

Taxpayers can decrease their overall tax liability by engaging in financial arrangements aimed at creating (artificial) tax deductible borrowing expenses.

The Solution

Interest limitation rules can discourage companies to engage in (artificial) financing arrangements by limiting the deductibility of taxpayers’ excessive borrowing costs. The rule proposed in ATAD I limits the tax deductibility of interest to 30% of the taxpayer’s EBITDA or a pre-set threshold (whichever is higher). In ATAD I, the threshold is set at EUR 3 million.

The Status

EU Member States are required to implement the measure by 1 January 2019. The Netherlands included a legislative proposal for the new interest deduction limitation rules in its Tax Plan 2019 (issued in September 2018 – please see a summary here).

Under the rule included in the Tax Plan 2019, interest expenses exceeding 30% of the earnings before interest, taxes, deductions and amortizations (EBITDA) will be non-deductible for tax purposes. The threshold of interest that remains deductible is set at EUR 1 million.

ATAD I

5. The General Anti-Abuse Rule (GAAR)

The Issue

Taxpayers may engage in (a series of) artificial transactions that do not reflect economic reality at all, with the (sole) purpose of avoiding tax or obtaining tax benefits. Absent of specific anti abuse rules that tackle the specific structure, the tax benefits may actually be achieved.

The Solution

To take away the benefit from creating wholly artificial arrangements, Member States are allowed to ignore such arrangements if they are not genuine (i.e. arrangements are not put into place for valid economic reasons which reflect economic reality).

The Status

The Netherlands already has a generic anti abuse framework in place (“fraus legis“), which tackles wholly artificial arrangements aimed at tax avoidance. Therefore minimal impact is expected in the Netherlands as regards this part of the ATAD I Directive.

ATAD II

6. Hybrid Mismatches

The Issue

Due to the fact that jurisdictions each have their own set of tax rules, mismatches may occur in cross border situations. Such mismatches may be caused by various types of qualification differences. For example, a payment from country A to country B may be considered an interest payment in country A (tax deductible), whilst country B considers it a dividend (tax exempt). This way, a deduction is claimed while no corresponding pickup is taxed. In addition to differences in qualifications of income, also entity classification may result in hybrid mismatches (country A considers an entity to be opaque, while country B considers it tax transparant and therefore looks through the entity to the shareholders/owners of such entity).

The Solution

To take away the tax benefit from hybrid mismatches, ATAD I originally included a measure on “double deductions” (only a deduction where the payment has its source) and one on “deduction but no inclusion schemes” (no deduction in the payer’s jurisdiction). In ATAD II, further measures are included to capture a wider range of structures used by taxpayers trying to obtain tax benefits from hybrid mismatches.

The Status

EU Member States are required to implement ATAD II as per 1 January 2020 (although a specific part is postponed to 1 January 2022). In the Netherlands, a public consultation was initiated on 29 October 2018 (closing date 10 December 2018). Following the consultation, it is currently expected that a final legislative proposal will be released in the beginning of 2019.

Please be referred to Intaxify’s update on ATAD II (which can be found here).

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