How to ride the waves of EU tax developments

Michael Gallagher

Walkers (Ireland), Dublin, Ireland

Michael.Gallagher@walkersglobal.com

Report on a session at the 12th Annual IBA Finance & Capital Markets Tax Conference – London

Monday 16 January 2023

Session Chair

Margriet Lukkien, Loyens & Loeff, Amsterdam

Speakers

Michael Orchowski, Sullivan & Cromwell, London

Mariana Díaz-Moro Paraja, Gómez-Acebo & Pombo, Madrid

Andrew Quinn, Maples Group, Dublin

Karin Spindler-Simader, Wolf Theiss, Vienna

Susanne Schreiber, Bär & Karrer, Zurich

Dr Marco Ottenwälder, Frankfurt

Introduction

There are many EU tax developments, almost like a constant wave of proposals and changes. The EU tax developments panel discussed a selection of recent and upcoming tax developments at the EU level.

The panel, which was chaired by Margriet Lukkien, focussed on the following topics:

• the adoption of the OECD's Pillar Two rules in the EU;
• the ATAD 3/Unshell Directive proposal;
• the EU's debt-equity bias reduction allowance (DEBRA) proposal;
• the BEFIT (Business in Europe: Framework for Income Taxation);
• withholding tax (WHT) recoveries;
• practical experiences of DAC6; and 
• the tax enablers consultation (SAFE).

Panel discussion

Pillar 2

Margriet Lukkien reminded the panel that the EU Directive (2022/2523) on Pillar Two was adopted on 15 December 2022 and that EU Member States need to implement the income inclusion rule by 31 December 2023 and the undertaxed payments rule by 31 December 2024.  

The Netherlands has published draft Pillar Two rules and has already held a public consultation to gather input from different stakeholders in the Netherlands at the end of 2022. The Netherlands will implement Pillar Two in a separate Pillar Two Act.

Marco Ottenwälder explained that the German government will issue a discussion draft by March 2023 and aims to meet the implementation deadline. Karin Spindler-Simader indicated that Austria expects to meet the implementation deadline and Lukkien mentioned that the Netherlands also expects to meet the deadline.

Mariana Díaz-Moro Paraja explained that Spain should be able to meet the deadline and that the Pillar Two implementing legislation is in principle going to be enacted in a separate text to the existing corporation tax legislation. Andrew Quinn explained that Pillar Two implementing legislation will form part of Ireland's Finance Bill in September 2023. 

Susanne Schreiber mentioned that Switzerland is aiming to implement Pillar Two by 1 January 2024, with a constitutional change and interim ordinance.

Michael Orchowski explained that in the UK, Pillar Two should be implemented as part of the Spring Budget. Orchowski added that it is unlikely that the US will enact Pillar Two in the next two years, unless there is overwhelming demand from the US business community.

BEFIT

Ottenwälder explained that BEFIT seeks to address the issues caused to the EU single market by 27 different Member State tax codes, by replacing the national rules of the Member States. Companies that operate in multiple EU countries would be required to calculate a single set of profits for the EU, with those profits then allocated to the relevant countries depending on factors including the per-country sales, assets, intangible assets and labour costs. No draft directive has been published for BEFIT.

DEBRA

Ottenwälder explained that DEBRA proposes to introduce an allowance on equity, but also an interest limitation rule (ILR) for entities subject to corporate income tax in one or more EU Member State. The European Commission's aim is for DEBRA to enter into force from 1 January 2024. He further explained that allowances on (net) equity under DEBRA would generally be limited to 30 per cent of a taxpayer's earnings before interest, taxes, depreciation and amortisation (EBITDA) and can also lead to a negative allowance.

Ottenwälder indicated that the DEBRA interest limitation rule (ILR) would be in addition to the EU Anti-Tax Avoidance Directive (ATAD) ILR and can limit deductions of borrowing costs to 85 per cent of the borrowing costs incurred during the tax period without any de minimis rules, ie, also affecting small and medium-sized businesses (SMEs).

The Unshell Directive

Spindler-Simader explained that the EU Commission originally proposed that the Unshell Directive would have an effective date of 1 January 2024, but noted this may be delayed to 1 January 2025.

The Unshell Directive proposal provides for a seven-step test, which incorporates:

1. entities that should report;
2. reporting;
3. an exemption for lack of tax motives;
4. a presumption of lack of minimal substance for tax purposes;
5. a chance for rebuttal;
6. tax consequences; and
7. exchange of information provisions. 

Spindler-Simader mentioned that under the initial proposal a ‘shell’ entity can be denied a tax residency certificate, denied benefits under double tax treaties and would not be able to benefit from the EU Interest and Royalties Directive or the Parent-Subsidiary Directive. An entity must pass three gateways in order to be required to report under the Unshell Directive.

Where the gateways are passed, it is proposed that the entity must make a report in its annual tax return and provide information on substance indicators, which look to whether the entity has premises, a bank account and whether it has qualifying directors or a majority of qualifying employees.

Discussion points concerning the practical application of the Directive include the two-year look-back period and credits for taxes paid by the entity in its residence state and the source state of the income. 

Schreiber explained that Switzerland has a more balanced approach on substance than the ‘tick the box’ approach in the EU, although Switzerland does have strict anti-abuse rules.

Orchowski explained that US treaties all have a limitation of benefits (LOB) clause, which limits the ability of shells to claim treaty benefits. Orchowski noted that the UK does require a tax residence certificate to claim treaty relief.

WHT recoveries

Spindler-Simader explained that the European Commission is proposing to introduce an EU-wide system for WHT relief on dividend and/or interest payments. Proposed options include an improvement of WHT refund procedures, a common EU relief at source system and automated exchange of information of beneficial owner-related information among tax authorities.

It is proposed that an EU directive will be issued, though the timing is unknown.

SAFE

Díaz-Moro Paraja explained that SAFE aims to tackle the role of ‘enablers’ in facilitating tax arrangements in non-EU jurisdictions that leads to tax evasion and aggressive tax planning impacting EU Member States. A legislative proposal is expected to be made available by the Commission in June 2023. The main concerns raised are related to the appropriateness of this initiative when there are other similar, recently introduced, rules for which the impact has not been analysed. In addition, there are many open issues related, among others, to the definitions of enabler, tax evasion or aggressive tax planning, and the transactions within the scope.

Orchowski explained that the UK has enablers legislation, which has been in effect since 16 November 2017. The rules allow the UK authorities to impose penalties on the enablers of defeated, abusive tax arrangements.

Quinn commented that under the Irish Tax Code, providing advice on tax evasion is already a criminal offence. He questioned the basis for proposing that a lawyer be subject to penalties for advising on something that is legal, such as advising a client on how to deal with sanctions.

Ottenwälder explained that the tax profession in Germany is quite regulated and that the German tax chambers view SAFE as unfavourable to tax advisers and damaging to their reputation.

DAC6

Quinn discussed a recent European Court of Justice (CJEU) judgment from 8 December 2022, in which the CJEU held that a requirement in Belgian law to notify a cross-border arrangement to other intermediaries under DAC6 was in violation of the attorney–client privilege, on the basis of the Charter of Fundamental Rights of the EU.

Lukkien explained that, in the Netherlands, notifications to intermediaries would in principle no longer take place following this CJEU decision; notification to clients would still be needed. She also noted that a number of other interesting DAC6 questions from Belgium are pending before the CJEU, challenging among others the vague terminology used and the principle of legality and legal certainty. The outcome could have a significant impact in practice.

While no public data is available anecdotally, the speakers believe there is a reasonable amount of DAC6 reporting in Ireland and the Netherlands, particularly under Hallmark E3. Quinn expects that the Irish Office of the Revenue Commissioners may audit DAC6 procedures in place in law firms.

Spindler-Simader and Díaz-Moro Paraja explained that their perception is that there is limited reporting in Austria and Spain at present compared to other countries, although there is no official data on this.

Ottenwälder noted that there has not been as much reporting as originally expected in Germany. In some industries, however, over-reporting has been seen due to conservative approaches considering potential reputational risks.

Conclusion and final remarks

On Pillar Two, Lukkien concluded that there are a lot of moving targets and that there is a lot of legislation to be drafted in each EU Member State. She noted that there will be inconsistencies between the rules in different Member States. Thus, it will be important to monitor what other Member States are doing to implement Pillar Two uniformly.

Lukkien concluded that DEBRA seems to be low on the agenda for the European Commission at present and may violate the principle of subsidiarity.

On SAFE, Lukkien suggested that it might be better to update DAC6 with additional hallmarks instead of introducing SAFE.