Anti-Tax Avoidance Directives Issued by European Commission

Editor: Sally P. Schreiber, J.D.

The European Commission issued two proposed directives regarding international taxation. The first would provide a framework for countries to use to enact tax avoidance rules (Anti-Tax Avoidance Directive, 2016/0011 (CNS) (Jan. 28, 2016)). It follows on the heels of the finalization of the Organisation for Economic Co-operation and Development’s (OECD’s) base erosion and profit shifting (BEPS) project and is designed to provide a “more coherent EU approach against corporate tax abuse.”

The second directive would facilitate mandatory exchange among EU member states of information collected under the new country-by-country reporting regime (2016/0010 (CNS) (Jan. 28, 2016)).

The European Commission also issued recommendations to member states on how to prevent tax treaty abuse and a new process for listing countries that, in the words of the commission’s press release, “refuse to play fair.”

Anti-Tax Avoidance Directive

The anti-tax avoidance directive aims to curb the ability of companies to take advantage of disparities among the tax systems of the various countries in which they operate to reduce their overall tax burden. The directive says this practice “distorts business decisions in the internal market and . . . could create an environment of unfair tax competition.” The directive focuses on the functioning of internal markets and not on reduced tax revenues as the evil to be combated.

The European Commission says the directive is being introduced in an effort to avoid the fragmentation of Europe’s single market that could ensue if member countries implement the OECD’s BEPS recommendations unilaterally and inconsistently. The EU is also concerned that piecemeal implementation of the recommendations could create new opportunities for companies to exploit loopholes.

The directive focuses on six areas: deductibility of interest, exit taxation, a switchover clause, a general anti-abuse rule, controlled foreign company rules, and hybrid mismatches. It sets out principles-based rules to allow each country to conform the legislative details to its existing corporate tax system.

Deductibility of interest: The proposal aims to limit the amount of interest that a taxpayer is entitled to deduct in any one tax year. This is designed to prevent multinational groups from financing subsidiaries in high-tax jurisdictions through debt and having those subsidiaries pay inflated interest to sister subsidiaries in low-tax jurisdictions.

Exit taxation: This proposal would prevent companies from moving their tax residence and/or assets to low-tax jurisdictions without paying a tax on the unrealized underlying gains in their country of origin.

Switchover clause: This proposal would subject companies’ foreign earnings to taxation with a credit for foreign tax paid instead of exempting foreign earnings from tax. This is designed to discourage companies from shifting profits out of high-tax jurisdictions.

General anti–abuse rule: This proposal is designed to cover gaps that may exist in a country’s specific tax avoidance rules.

Controlled foreign company rules: This proposal would reattribute income of low-taxed controlled foreign subsidiaries to the parent company to avoid income-shifting to low-tax jurisdictions.

Hybrid mismatches: This proposal aims to curb the consequences of different characterizations of financial instruments in different countries. It requires that the legal characterization given to a hybrid instrument in the country where a payment, expense, or loss originates must be followed by the other country involved in the transaction.

EU member states are directed to adopt “laws, regulations and administrative provisions” to comply with the directive.

Automatic Exchange of Information

The second directive would amend current Administrative Cooperation Council Directive 2011/16/EU to implement mandatory automatic exchange of information gathered by the OECD’s country-by-country report, which most EU member states have committed to. Like the anti-tax avoidance directive, it is aimed at curbing “aggressive tax planning” and ensuring that “all contributors pay their fair share of tax payments.”

Under the OECD’s BEPS project, multinational enterprise (MNE) groups with consolidated group revenue of €750 million ($825 million) or more will be required to file the country-by-country report. The directive would introduce automatic exchange of this information among EU member states. The directive also announces that the European Commission is assessing whether additional disclosure of corporate tax information should be required.