18 March 2016
European Commission Adopts Anti-tax Avoidance Package
The European Commission has proposed an anti-corporate tax avoidance package, which could impact Hong Kong traders and those they supply to, active within the EU. The measures are intended to align corporate tax laws of the EU Member States, and to coordinate the EU Member States’ international action in the context of tax avoidance measures and treaties. While the proposed package may take several months, if not years, to be adopted, Hong Kong traders may like to familiarise themselves with the future provisions which could most impact their business dealings in the EU.
The proposals, which the Commission presented on 28 January 2016, have been launched in the aftermath of the development of global tax avoidance standards by the Organisation for Economic Co-operation and Development (OECD) in October 2015. They are based on three core pillars, namely: ensuring effective taxation in the EU; increasing tax transparency; and securing an international level playing field.
The proposed package contains two draft legally binding measures, namely: (i) a proposal for an anti-tax avoidance Directive, in order to combat the most widespread tax avoidance schemes; and (ii) a revision of the administrative cooperation Directive, in order to require EU Member States to exchange fiscal information with each other on multinational companies.
In addition, the package also includes a number of non-binding measures, such as a Recommendation on Tax Treaties, which advises Member States on how to protect their tax treaties against abuses, in a manner compliant with EU law. Another non-binding measure included in the package is the Communication on an External Strategy for Effective Taxation, aimed at an enhanced international cooperation in the fight against tax avoidance and promoting fair taxation, thereby creating a level playing field.
The proposed anti-tax avoidance Directive prescribes six key measures to prevent corporate tax-avoidance:
- The Controlled Foreign Company (CFC) rule: this rule will allow the EU Member State where the parent company is based, to tax profits that have been shifted to a subsidiary in a low or no tax country. The CFC rule will be applicable in case the effective tax rate in that third country is less than 40% of the rate in the EU Member State where the parent is located. Any taxes paid abroad will result in a tax credit, thereby avoiding double taxation.
- The Switchover rule: according to this rule, companies will have to inform the EU tax authority of any dividends received, and whether or not they have been taxed. This would allow tax authorities to deny tax exemptions in case the dividend has not yet been taxed (or taxed at a very low rate). The goal of this rule is to prevent double non-taxation of certain income.
- Exit Taxation: all EU Member States will apply an exit tax on assets moved from their territory. The purpose is to prevent the practice of moving assets, such as intellectual property rights, to a low or no tax country once they start generating profits, with the aim of avoiding taxation within the EU, even though the development costs have been deducted from taxable income within the EU.
- Interest Limitation: the amount of net interest that a company can deduct from its taxable income will be limited, based on a ratio of its earnings. This rule is aimed at discouraging artificial structures of intra-group loans, which allow one company of the group to deduct the interests paid on the loan, while the lender company of the group is based in a country where interests are taxed at a very low rate or not at all.
- The Hybrid Mismatch rule: certain income is treated differently in various EU Member States, and can be deducted in one Member State even though it is not taxed in the other, or can simply be deducted in both Member States (a so-called “hybrid mismatch”). The proposed Directive prescribes that the legal characterisation of the EU Member State where the payment originates from, will be binding on the EU Member State of destination.
- General Anti-Abuse rule: this general rule will allow tackling an artificial tax arrangement in case such arrangement is not covered by any other more specific rule. Tax authorities would be able to disregard the artificial arrangement, and tax the company on the basis of the actual economic substance.
The proposed changes to the Administrative Cooperation Directive would result in an obligation for multinational entities to annually submit a report, containing information on revenue, profit before tax, income tax paid and accrued, employees, stated capital, retained earnings and tangible assets, in each jurisdiction. The Member State where the report was submitted will automatically communicate the information to all Member States in which the multinational entity is active according to the report. Currently, the existing Directive already provides for such automatic exchanges of information in a number of cases. However, the proposed changes would broaden the scope, and render such exchange mandatory in all situations.
Both legislative proposals have been submitted to the Council of the EU, and the European Parliament will also have to be consulted. Moreover, both institutions will have to endorse the Recommendation on Tax Treaties, which, even after adoption, EU Member States will be at liberty to follow when concluding international tax treaties.