The EU member states have reached an agreement on the Anti-Tax Avoidance Directive (ATAD). The Directive will be adopted at a future meeting, but the outline of the ATAD has already become clear. The ATAD will provide for a minimum level of protection for the EU market and strengthen the average level of protection against aggressive tax planning.
The ATAD will provide for common minimum rules in the areas of interest limitation, exit taxation, general anti-abuse rules (GAAR), rules concerning controlled foreign companies (CFC) and hybrid mismatches. The switch-over clause which was also proposed has been deleted. In general these provision need to be effective in the member states as from 1 January 2019. Below we will provide a short overview on these subjects. We also assess the impact for the Netherlands.
A so-called earning stripping limitation will be introduced, which will limit interest deduction to 30% of the taxpayer’s earnings before interest, tax, depreciation and amortization (EBITDA). Member states can choose to introduce a € 3 million threshold; if interest costs are below the threshold, they are fully deductible. Furthermore, the limitation will not be applicable if the taxpayer isn’t part of a group. Also, member states can choose to introduce a group test on either an “equity/total assets”-ratio or a group EBITDA-test. Next, member states can choose to grandfather loans existing on 17 June 2016. Financial undertakings can be excluded from this interest deduction limitation. Also, third party loans used to fund a qualifying long-term public infrastructure project may be excluded.
Member States which already have national targeted rules (e.g. thin capitalization rules) which are equally effective to the proposed interest limitation rule will have up to 1 January 2024 to implement this provision and phase out their domestic rules, unless an agreement is reached on interest limitation rules at OECD level prior to this date. This will be subject to notification prior to 1 July 2017 of all information necessary for evaluating the effectiveness of the national rules to the European Commission.
For the Netherlands, we expect that the earning stripping limitation will need to become effective as from 1 January 2019.
The exit tax rules will apply to certain cross-border transfers of assets or residence within the EU or to non-EU countries. The rules broadly reflect EU case law, including a tax deferral mechanism for transfers within the EU/EEA in a period of 5 years. However, if a taxpayer doesn’t pay the annual instalments of the exit tax, the tax debt becomes immediately recoverable. Furthermore, the ‘receiving’ member state needs to provide for a corresponding step up in value. Certain financial transactions may be excluded from the exit tax. Member States may defer the implementation of this provision to 31 December 2019.
For the Netherlands, we expect the impact to be small, as exit taxation rules already exist. The tax deferral mechanism in the Netherlands needs to be shortened from 10 to 5 years.
General anti-abuse rule (GAAR)
Member states need to implement a General anti-abuse rule (GAAR) in order to fill any national gaps there may be. The wording of the GAAR is in line with the recently amended GAAR in the Parent-Subsidiary Directive and is intended to reflect the anti-abuse principle of the EU Court of Justice. The GAAR has both a motive test and a substance test.
For the Netherlands, although we already have a fraus legis doctrine this is only been introduced in case law. Therefore, we expect that this principle is introduced in Dutch corporate income tax law.
Controlled foreign corporations (CFC)
The Controlled Foreign Corporations rules will apply to both EU and non-EU situations. These rules should avoid the transfer of passive income to low taxed jurisdictions. Income from CFC’s will be taxed at the level of the parent entity if it owns at least 50% of the shares and the tax paid at the level of the CFC is 50% or less of the amount of the tax due if the CFC would be a resident of the jurisdiction of the parent entity. These rules also apply to permanent establishments. However, a member state may opt not to impose this taxation if either (i) the CFC carries out substantive economic activity based upon the amount of staff, equipment, assets and premises or (ii) the CFC is part of genuine arrangements or non-genuine arrangements which essential purposes is not obtaining a tax advantage. In the case of the latter, the significant people functions relevant for the income generating assets and risks owned/undertaken by the CFC should be considered. In both cases, more specific rules and exclusion may be applicable.
For the Netherlands, the participation exemption and the exemption for foreign business profits (i.e., relating to permanent establishments) may be amended in other to take these minimis rules into account. However, generally speaking, income relating to low-taxed passive participations and/or permanent establishments are taxable under the Dutch corporate income tax law.
The current provision in the ATAD on hybrid mismatches will only cover EU situations. This provision is aimed to target hybrid mismatches n the legal characterization of a financial instrument or with regard to the question whether an entity is transparent or opaque. In case of a mismatch in either situation, such mismatch may currently be used to either obtain a double deduction (douple dip) or a deduction without inclusion (without pick up). In case of a double deduction, a deduction shall only be given in the member state where a payment has its source. In case of a deduction without inclusion, the member state of the payer should deny the deduction of such payment. This approach, the disallowance of a deduction, is more in line with the OECD’s BEPS project.
Furthermore, the political agreement on the ATAD includes a request to the European Commission to issue a proposal on hybrid mismatches involving third countries by October 2016.
For the Netherlands, although Dutch tax law already targets some hybrid mismatches (especially following implementation of the amended Parent-Subsidiary Directive), further implementation of these rules against hybrid mismatches needs to take place.
It is expected that the final Anti-Tax Avoidance Directive will be formally adopted at the next ECOFIN meeting on 12 July 2016. In that case, the member states will be required to implement the aforementioned provision by 1 January 2019 (except if a longer implementation period is mentioned).
We will inform you on relevant updates at the EU and/or Dutch level.
If you have any questions regarding the above and/or if you would like us to conduct a high level impact assessment, please do not hesitate to contact us.