International Taxation – Anti Tax Avoidance Reforms from the European Commission
INTERNATIONAL TAXATION – ANTI TAX AVOIDANCE REFORMS
FROM THE EUROPEAN COMMISSION
Earlier in 2016, the European Commission published an anti tax avoidance package containing measures designed to combat aggressive tax planning, increase tax transparency and create a level playing field within the European Union.
Whilst the European Union is going through a bumpy period with Brexit, it still remains a vital trading block. It will take Britain many years to leave the European Union. The new anti tax avoidance package will be applicable within Britain as it is applicable in all other European Union countries.
The object of the anti tax avoidance package is to ensure that companies pay tax wherever they make their profits within the European Union.
The anti tax avoidance package is based around a new directive which lays down rules against tax avoidance in six specific fields:
a) Deductibility of interest;
b) Exit taxation;
c) Exemption of low tax profits of a subsidiary or permanent establishment – the so-called “switch-over”;
d) A general anti-abuse rule;
e) Controlled foreign company rules; and
f) A framework to tackle hybrid mis-matches.
The interest deduction rules and switch-over rules are particularly important. After the introduction of the directive, the deduction of net interest expense will be limited to €1 million. The limitation relates to group interest as well as third party interest expense. Under the switch-over clause, income from low tax subsidiaries or permanent establishments cannot be exempt. An entity or permanent establishment is regarded as low tax if it is subject to a statutory corporate tax rate lower than 40% of the statutory corporate tax rate of the parent company or head office. At present, many European Union States exempt income from active subsidiaries and permanent establishments. An example is Ireland.
The European Commission stresses that the directive will function as laying down minimum standards and Member States may apply additional or more stringent provisions if they wish.
Member States may allow taxpayers to deduct net interest expense in excess of €1 million if the taxpayer can demonstrate that the ratio of its equity over its total assets is equal or higher than the equivalent ratio of the group in which its accounts of the taxpayer are consolidated. This exemption is subject to the rule whereby temporary capital contributions are disregarded if the group pays more than 10% of its total net interest expense to associated enterprises.
The directive also provides for an exit tax to be assessed in the Member State of origin on the difference between the market value of the transferred assets and their tax value. This exit tax will be triggered in the case of:
Transfer of assets from the head office to an associated entity located in another Member State;
Transfer of assets from an associated entity in a Member State to its head office in another Member State;
Transfer of tax residency to another Member State;
Transfer of the business carried out in an associated entity of a Member State.
The switch-over clause requires Member States within the European Union to deny an exemption from corporate tax with respect to distributions of profits and proceeds from the sale of shares in low taxed entities that are resident in non-EU countries. Many European Union Member States currently exempt such income under a participation exemption system. An entity is regarded as low taxed when that entity is subject to a statutory corporate tax rate lower than 40% of the statutory corporate tax rate that would apply in the Member State of the taxpayer receiving the income.
The directive also requires Member States to implement controlled foreign company legislation in their national laws. This legislation is to be applied to non-distributed income of entities when the following conditions are met:
A taxpayer by itself or together with associated enterprises holds directly or indirectly more than 50% of capital or voting rights or is entitled to receive more than 50% of the profits of an entity;
Profits are subject to an effective tax rate lower than 40% of the effective tax rate that would have been applied in the Member State of the taxpayer; and
More than 50% of the income accrued to that entity falls within one or more of thee categories listed in the Anti-Tax Avoidance Directive.
The controlled foreign company legislation in the Directive provides rules with respect to the calculation of the income to be included. The rules also provide for relief of double taxation whereas previously, taxed undistributed income is not tax to gain when received or realized by controlled foreign companies. There is no provision, however, for a credit for underlying tax. The European Commission also warns Member States that additional measures to the ones provided in the Anti-Tax Avoidance Directive may need to be adopted towards third countries that are included in the tax haven list. This list will include jurisdictions that do not meet the European Union standards on tax good governance; transparency, information exchange and fair tax competition. Possible measures could include the levy of withholding taxes and non-deductibility of payments made to entities resident in those tax haven jurisdictions.
An example of the Anti-Tax Directive may be seen in the recent decision to impose substantial taxes on Apple.
Australian companies will need to be aware of the provisions of the Anti-Tax Avoidance Package and of the Anti-Tax Avoidance Directive. The Australian Taxation Office is watching these initiatives closely with a view to recommending their introduction within Australia in an endeavour to ensure that multi-national companies headquartered overseas pay tax in Australia which reflects the value of the economic activity and turnover/profit which is generated from Australia. International companies may find that the world of international tax havens is diminishing quickly.
This article is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render legal advice. No reader should act on the basis of any matter contained in this article without first obtaining specific professional advice.