At the beginning of 2022, we informed you about a new EU proposal for a Directive laying down rules to prevent the abuse of shell entities for tax purposes and amending Directive 2011/16/EU (the “Directive”) – the article can be found HERE.

The purpose of this proposal is to prevent entities established in the European Union with minimal or no economic substance (empty entities with the main objective of obtaining tax benefits) from being able to obtain tax advantages resulting from international treaties or other EU directives. In principle, it is about imposing a reporting obligation on these entities, or an obligation to provide evidence that the companies in question are not “empty” for the purposes of the Directive.

On 17 January 2023, a Legislative Resolution of the European Parliament was issued proposing amendments to the draft Directive.

We would like to mention the most significant changes adopted by the European Parliament:

1) Change in the three cumulative entry criteria (meaning that they must be met together) qualifying an entity as a shell entity that is required to submit notification

• More than 65% of the income (originally 75%) for the last 2 tax years is considered passive income. Passive income includes interest, dividends, royalties, income from finance leases, income from immovable and movable property, income from financial activities, etc.
• Significant cross-border element in the form of assets or income. In this case, the cross-border element is understood to mean that more than 55% (initially 60%) of the book value of the immovable and movable property was located outside the Member State of tax residence of the entity in the previous two tax years, or at least 55% (initially 60%) of the passive income of the entity is earned or paid through cross-border transactions.
• In-house management and administration of the entity was outsourced to a third party (originally only “outsourced”).

2) Cancellation of the exemption for entities with a minimum of 5 employees

• The Directive defines entities that are not subject to reporting and are not required to documenting minimum materiality indicators. In the original draft of the Directive, this included, among other things, entities that have at least 5 full-time employees of their own exclusively performing activities that generate relevant income for the entity.
• However, this exemption has been dropped in the new draft Directive.

3) Moderation of minimum substance indicators

• Newly deleted from the minimum materiality indicators (i.e. meeting the conditions below is not explicitly relevant under the Directive) are the conditions that one or more directors of the company:
  • make regular use, in an active and autonomous manner, of the authority to make decisions relating to the revenue-generating activities of the business or in relation to the assets of the business;
  • is not an employee of a non-affiliated company and does not perform a directorship or equivalent function in other non-affiliated companies (i.e. the new existence of an outsourced director does not seem to imply a priori that the minimum substance is not met).

4) Addition of documentary evidence for reporting entities

• The new Directive requires reporting entities to document in their tax returns, among other things:
  • the structure of the company and affiliated companies and any significant arrangements for outsourcing services or activities, including the rationale for the structure,
  • a summary report on the documentary evidence, including in particular (a brief description of the nature of the company’s activities, the number of full-time employees, the amount of profit and/or loss before and after tax).

5) Modification of penalties for non-compliance

• Originally, the Directive provided for a general minimum penalty of 5% of the company’s turnover if no notification was made or a false declaration was made about the minimum substance indicators.
• The new Directive introduces differentiated minimum sanctions:
  • at least 2 % of the company’s income in the relevant tax year, unless the company submits the notification within the prescribed period,
  • at least 4 % of the income of the company if the company that is required to make the notification makes a false statement in its tax return,
  • in the case of a zero- or low-income company, which is defined as an company that does not reach a threshold set by the national tax authority and that does not fall below a minimum threshold set by the Commission in an implementing act, the penalty should be based on the total assets of the company.

As far as the planned entry into force of the Directive is concerned, there have been no changes and for the time being the original entry into force from 1 January 2024 applies. However, for the Directive to be effective, unanimous approval of the Directive by the European Council and subsequent implementation in individual EU jurisdictions is necessary, which we consider less likely.

We will keep you informed about further legislative developments in the EU and the Czech Republic. However, it is highly recommended to check now already, if the Directive will lead to reporting, documentary evidence or even an additional tax burden for you (or your group).

If you have any questions about the above Directive, the legislative fate of which we will continue to monitor for you, please do not hesitate to contact us.

Author: Petr Němec, Martin Hahn