Minimum taxation of groups and shell entities

On December 22, 2021, the European Commission published two draft directives : the first one is the European adaptation of the model rules published two days earlier by the OECD in order to guarantee a minimum taxation of multinational groups (see on this point our news flash); the second one aims at regulating shell entities by creating new reporting obligations for groups and by drawing the tax consequences of the lack of economic substance of these entities.

The European adaptation of Pillar 2

As the European Union has actively supported the project of minimum taxation of international groups, the publication of a draft directive on the subject is not a surprise. The content of the proposal is largely based on the model rules developed by the OECD and G20 inclusive BEPS framework.

However, the draft directive contains a few specific features. The first is to allow a Member State of the European Union in which the effective tax rate of a member company of an international group is less than 15% to remedy this under-taxation itself by levying an additional top-up tax. Whereas in the system devised by the Inclusive Framework, it is the State of the parent company that is supposed to do this, the particularity of the draft directive consists in giving the State of the subsidiary the possibility of levying this additional tax.

The second specificity of the draft directive consists in the compulsory extension of the minimum taxation system to purely domestic groups. A parent company established in a Member State and having a subsidiary in the same State with an effective tax rate of less than 15% will thus have to pay a top-up tax. This identity of treatment between purely domestic groups and groups with foreign subsidiaries and permanent establishments is presented by the European Commission as necessary to respect the freedom of establishment. However, the resulting additional taxation should only start to apply after a period of five years from the date on which a purely domestic group falls within the scope of the rule.

The recitals of the draft directive also specify the relationship between the rules on controlled foreign companies provided for in the ATAD directive (the "CFC" rules such as, in France, Article 209 B of the French Tax Code) and the new income inclusion rule. It is thus stated that the income inclusion rule under the draft directive and the CFC rules should apply in parallel. In practice, ATAD CFC rules will apply first and any additional taxes paid by a parent company under a CFC regime in a given fiscal year will be taken into consideration in the GloBE Model Rules by attributing those to the relevant low-taxed entity for the purpose of computing its jurisdictional effective tax rate. No reform of the ATAD is therefore envisaged at this stage.

The transposition date provided for in the proposed directive is December 31, 2022 for an implementation from January 1, 2023. However, the rule on under-taxed payments would only apply as of 2024. 

The draft directive on shell entities

The draft directive on shell entities is based on a different philosophy than the previous one. The goal is not to provide for a minimum taxation of these entities. It is rather to ensure that these entities and the groups to which they belong do not enjoy undue tax benefits. The proposal only concerns shell entities established in the European Union; another proposal concerning those established in third countries is announced for 2022.

The draft directive provides for three sets of rules. 

First, the draft establishes a new reporting obligation for certain companies with objective characteristics that give rise to a priori suspicion that they may lack economic substance. In summary, this includes entities that operate cross-border, have essentially passive income and outsource the administration of day-to-day operations as well as the decision-making on significant functions. Once it has been established that an entity has these characteristics, it must declare whether it has premises and personnel (directors or other employees) in its state of establishment as well as an own bank account in the European Union. If it does not meet these conditions in substance, it will be presumed to be a shell entity, unless it can demonstrate the contrary according to the modalities specified by the draft directive. It is also foreseen that a company may apply for an exemption of the reporting obligation when it can demonstrate that it or the group to which it belongs does not derive a tax advantage from its very existence.

The second set of rules is designed to draw the tax consequences of the qualification of a shell entity. In short, the proposal provides that a shell entity cannot be eligible for the withholding tax exemption provided for in the Parent-Subsidiary and Interest-Royalty Directives, nor for the advantages granted by tax treaties concluded between EU Member States. The draft directive also governs the tax treatment of income flows to or from third countries by applying a principle of transparency of shell entities. Finally, the text provides that the State where the shell entity is established must either refuse to grant it a certificate of tax residence, or grant it but specify that it is a shell company ineligible for the advantages provided for by the directives and the tax treaties.

The third part of the draft directive aims at organizing the exchange of information between Member States on shell entities. 

The transposition of the directive should take place by June 30, 2023 at the latest for application from January 1, 2024.