All 28 European Union (EU) member states reached political agreement on the European Commission’s (EC’s) Anti-Tax Avoidance Directive designed to combat multinational corporation tax avoidance.
During negotiations, some amendments were made to the proposal, including the deletion of the controversial “switch-over clause” to prevent double nontaxation of certain income.
The approval came before Britons voted to leave the EU, a move that has significant tax implications (see box below).
The final Anti-Tax Avoidance Directive includes the following:
- Controlled foreign corporation (CFC) rules to reattribute the income of a low-taxed controlled foreign subsidiary to its (usually more highly taxed) parent company. A common scheme involves first transferring ownership of intangible assets (such as intellectual property) to the CFC and then shifting royalty payments.
- Exit taxation rules to prevent corporate taxpayers from moving their tax residence and/or assets to a low-tax jurisdiction in order to reduce their tax bill.
- Hybrid mismatch rules to prevent corporate taxpayers from taking advantage of disparities between national tax systems in order to reduce their overall tax liability, often leading to either double deductions or the deduction of income in one country without the inclusion of the corresponding income in the other country.
- A general anti-avoidance rule (GAAR) to cover gaps that may exist in a country’s specific anti-abuse rules. Corporate tax planning schemes can be very elaborate, and tax legislation doesn’t usually evolve fast enough to include all the necessary defenses. A general anti-abuse rule enables tax authorities to deny taxpayers the benefit of abusive tax arrangements.
Switch-over clause is gone
The original directive proposal contained a controversial “switch-over clause” to prevent double nontaxation of certain income (for example, taxing dividend distributions coming into the EU, if they haven’t been properly taxed outside of the EU). That clause has been deleted. Some ministers had feared that the clause would scare away multinational investors.
The agreed measures are aimed at ensuring that the base erosion and profit shifting (BEPS) measures of the Organisation for Economic Co-Operation and Development (OECD) are put into effect in a coordinated manner in the EU, including by seven member states that aren’t members of the OECD, the European Council said. Moreover, pending a revised proposal from the European Commission (EC) for a common consolidated corporate tax base (CCCTB), it takes account of discussions since 2011 on an existing CCCTB proposal within the council.
Three of the five areas above implement OECD best practices (the interest deduction limitation rules, the CFC rules, and the hybrid mismatch rules). The two others (GAAR and the exit taxation rules) deal with BEPS-related aspects of the CCCTB proposal.
The Anti-Tax Avoidance Directive, as agreed upon by the 28 EU member states, will be forwarded to the European Council for adoption.
The EU member states will have until December 31, 2018, to transpose the directive into their national laws and regulations, except for the exit taxation rules, for which they will have until December 31, 2019. Furthermore, the EU member states that have targeted rules that are equally effective to the interest limitation rules may apply them until the OECD reaches agreement on a minimum standard or until January 1, 2024, at the latest.
Sidebar: EU tax implications of Brexit
The effect of the Britons’ vote to exit the EU — “Brexit” for short — remains to be seen. Reuters reported that the EU will need to “quickly fill a 7-billion-euro hole in its 145-billion-euro annual budget, which is currently fixed out to 2020, as it loses Britain’s contributions while saving on what Britons receive from EU accounts. The EU will also want to clarify as quickly as possible the status of firms and individuals currently using their EU rights to trade, work and live on either side of a new UK-EU frontier.”
Other potential tax ramifications of Brexit include the following:
- If Britain exits the EU, multinational enterprises (MNEs) with holding companies there may contend with withholding taxes on distributions from their EU subsidiaries. For this reason, Britain might be a less attractive European holding company jurisdiction compared to certain other EU member states. For example, the EU parent-subsidiary directive was originally conceived to prevent companies with operations in different EU states from being taxed twice on the same income. In this regard, it generally exempts dividends and other profit distributions from subsidiaries to their parents from withholding taxes.
- In addition, the EU interest and royalty directive was intended to eliminate the withholding tax on cross-border interest and royalty payments among tax residents of the EU that fall within the scope of its application. As a result, the British patent box regime, intended to protect inventions and intellectual property rights, may need to be evaluated in conjunction with the potential withholding tax on royalty payments from certain EU member states to Britain.
- EU law governs value added tax (VAT), which is a consumption tax charged on most goods and services traded for use in the EU. The EU single market abolished border control for intracommunity trade and allows exports from one EU nation to another to be exempt from VAT. While VAT may be recoverable by British exporters, it may give rise to cash flow problems.
Membership in the EU also provides access to a broad network of preferential trade agreements between the EU and third countries. The impact of Brexit on these and other measures will depend on the terms that are negotiated as part of Brexit, which could take up to two years to negotiate.