Is my footprint big enough? Implementing ATAD 3 – substance requirements and impact on transatlantic investment structures

Wednesday 17 May 2023

Session Chairs

Pia Dorfmueller, Dentons, Frankfurt

J Leonard Teti II, Cravath, Swaine & Moore, New York


Olivier Dauchez, Gide Loyrette Nouel, Paris

Rachel Fox, William Fry, Dublin

Fabian Sutter, Loyens & Loeff, Zürich

Adam J Tejeda, K&L Gates, New York

Pieternel Verhoeven, NautaDutilh, Amsterdam [panellist not in attendance but their work was presented]


Stefan Stellato, Hannes Snellman, Helsinki


The subject of the panel discussion was the European Commission’s proposed Anti-Tax Avoidance Directive 3 (ATAD 3). The directive, also known as the Unshell Directive, is designed to combat tax avoidance and tax evasion practices. The directive is still in the process of being drafted. Topics included in the scope of the proposed directive concern gateways and substance indicators to be assessed, as well as reporting obligations and tax consequences for entities in the scope of the directive.

Panel discussion

First, Pia Dorfmueller provided an overview of the current draft directive, namely its scope and what new obligations and tax consequences it would set for entities that fall within it. She focused especially on the determination of ‘shell entity’ under the proposed directive. Regarding the tax consequences for shell entities, Dorfmueller presented the so-called super controlled foreign company (CFC) rule, which is included in the draft directive, that has been subject to heavy discussion by the EU Member States and is particularly likely to be dropped in the final version of the directive. Consequently, the most important remaining tax consequence for shell entities seems to be the denial of withholding tax relief under EU directives and double tax treaties. Dorfmueller also presented an official’s view that the directive is not a continuation to ATAD 1 or 2, which is why it should actually be called the Unshell Directive rather than ATAD 3.

Adam Tejeda then discussed the impact of the directive outside of the EU on different phases of the company formation process: setting up a company, entering a structure and exiting a structure.

Fabian Sutter introduced the first case study concerning a holding company. Through this case study he delved, in more detail, into the cumulative criteria for the reporting obligation. The first criterion is that more than 75 per cent of the revenues of the taxpayer should consist of relevant income in the two preceding years. Rachel Fox pointed out that the scope of the term ‘relevant income’ is broad and that no distinction is made between income from active trading and passive income, the definition refers to passive royalties as well as income generated from active exploitation of intellectual property (IP). Sutter continued that the second criterion is that at least 60 per cent of the relevant income is earned or paid out via cross-border transactions. The third, and in practice often the most important, criterion is that the administration of the day-to-day operations and decision making are outsourced in the preceding two years. The European Parliament has proposed lowering the thresholds for the first and second criteria, thereby tightening the directive. There is also an additional rule, according to which the first criterion is deemed to be fulfilled if more than 75 per cent of the entity’s assets consist of certain types of assets. Sutter concluded that there are three ways in which an entity can be free of any consequences brought about by the directive: (1) not be in the scope of the directive, (2) qualify under a carve-out rule, or (3) be in scope of the directive but not pass the gateway test.

J Leonard Teti II introduced the second case study concerning an acquisition structure, with material prepared by Pieternel Verhoeven who was not able to attend the panel session. In the second case study, the substance indicators were in focus. An entity subject to the reporting obligations must report on the following substance indicators: the undertaking has its own premises in the EU Member State or premises for its exclusive use, the undertaking has at least one active bank account in the European Union and meets a set of criteria related to its directors or employees. These indicators are assessed entity by entity, not country by country. Regarding the requirement for the entity to have its own bank account, Teti noted that the requirement essentially imports bank regulatory rules into the criteria. Concerning the indicators relating to directors and employees, it is sufficient to satisfy just one. This means that either at least one director needs to satisfy certain requirements, or the majority of the full-time employees must satisfy certain requirements. Teti assessed that the director test seems easier to satisfy, as only one director needs to fulfil the criteria, as opposed to the majority of the employees. Reporting that the substance indicators have been satisfied creates the assumption that the entity is not a shell entity. However, the entity will still be subject to information exchange, meaning that the substance indicators cannot be considered as an actual safe harbour.

Fox then introduced the third case study, one regarding financing. She explained that undertakings falling within the scope of the carve-outs are considered to have a low risk of tax avoidance and do not need to consider the gateways. The carve-out rules are considered entity by entity. The carve-outs most likely to be relevant to a financing structure are those relating to securities listed on a regulated market or multilateral trading facility and a ‘regulated financial undertaking’. The directive contains an exhaustive list of what constitutes a ‘regulated financial undertaking’. Fox also discussed the exemption that applies when there is lack of tax motive. The entity must provide sufficient and objective evidence that its existence does not reduce the tax liability of the beneficial owner or the group. This means providing evidence which allows the comparison of the tax liability of the beneficial owner and the group with and without the entity in question. She anticipates that companies in the financing sector will have difficulties showing that the existence of an EU holding company does not create some tax benefits or reduce the tax liability of some shareholders, although there are often robust commercial reasons for the structure. Fox deemed the usefulness of the exemption questionable.

Finally, Oliver Dauchez introduced the fourth case study, one relating to a permanent establishment (PE) structure. He explained that PE structures are directly exposed to the draft directive. An issue is that the current draft only exempts the authorised investment fund (AIF) itself, but not its subsidiaries, as the draft directive does not consider the subsidiaries as clearly low-risk entities. Dauchez then drew attention to other challenges posed by the draft directive, including concerns about timing differences between the different EU countries. Dauchez concluded that the concept of substance has not been harmonised and that ATAD 3 adds a new concept of substance on top of all the others. Dauchez expects it to be less difficult to prove substance for ATAD 3 purposes than for the purposes of beneficial ownership.

Conclusion and final remarks

The panel discussion closed with some audience questions pondering the objective and effectiveness of the directive and its relation to other EU legislation. Significant doubts were cast about the general appropriateness of introducing ATAD 3. As a more specific note, Fox explained that meeting the substance criteria of the EU Interest and Royalties Directive or the EU Parent–Subsidiary Directive does not necessarily save a company from falling within the scope of ATAD 3, because ATAD 3 seems to be added on top of the other directives in a somewhat awkward and unusual way.