Merchant Connect Incorporations Ltd

What is ATAD III?

The ATAD 3 Directive was proposed by the European Commission in December 2021 with the purpose of preventing the misuse of “shell” entities. The draft Directive provides indicators of minimum substance for entities in Member States and rules regarding the tax treatment of those entities that do not meet the indicators.

The adoption of the Directive requires unanimous vote by all EU Member States in which transposition into national law of the EU Member States by 30 June 2023 and would come into effect as of 1 January 2024.

The Directive will apply to all entities that are considered tax resident in a Member State (subject to some exclusions), including SMEs, partnerships, trusts and other legal arrangements. It is likely to result in extra reporting requirements and possible additional tax liabilities for those impacted. If the entities lack minimum substance under ATAD 3, they will be seen as a “shell” and denied benefits of EU directives or tax treaties.

Minimum Substance Requirements

The purpose of the directive is to identify companies that lack substance. EU entities are relevant, irrespective of their legal form or size. An entity will be considered “at-risk”, and subject to further reporting requirements if it meets the following conditions:

  • Revenue – More than 75% of revenue in the preceding two tax years is relevant income (broadly, royalties, dividends, and income from assets).
  • Cross Border – The undertaking is mainly engaged in cross-border activity.
  • Management and Administration – The administration of day-to-day operations and decision-making is outsourced
 
Exemptions

Entities that present none or only some of the above criteria are considered low-risk cases and are not subject to the reporting requirement.

Entities that meet any one of the following criteria are exempt from the Minimum Substance Test:

  • Any company with a security listed on a regulated market,
  • An entity that is a regulated financial undertaking,
  • An entity that holds shares in an operational business located in the same Member State of the entity (holding companies with no / limited cross-border elements (e.g. managing domestic operational businesses, provided their beneficial owners are tax residents in the same jurisdiction, or where its shareholder or ultimate parent entity is resident in the same state), or
  • An entity with at least five full-time employees carrying out the income-generating activities of the entity.
 
Reporting

An entity that checks all conditions is required to report the following on their yearly tax return:

  • Company address and type of premises;
  • Amount and type of gross revenue and business expenses;
  • Type of business activities performed to generate the relevant income;
  • An active bank account in the EU. (Including any mandates granted to access the bank account and to use or issue payment instructions and evidence of the account’s activity);
  • Number of directors, their qualifications, authorisations, and place of residence for tax purposes or the number of full-time equivalent employees performing the business activities that generate the relevant income and their qualifications, their place of residence for tax purposes;
  • Outsourced business activities.
 

The relevant tax authority will have the final say in determining whether the indicators are met or not. If an entity is considered a ‘shell’ by the tax authority, the burden of proof to rebut this classification is on the entity to prove it has minimum substance or it is not misused for tax purposes. Information to be provided in making its case may include:

  • Reasons for setting up the entity;
  • Resources it has at hand;
  • Proof that key decisions occur in the Member State it is resident in.
 
Consequences

If an entity does not meet these requirements, it would be treated as a shell company for the purposes of the directive. Furthermore the relevant Member State in question will be able to take action against the shell company Including denying a certificate of tax residence and restricting treaty freedoms. The entity would no longer be able to claim double tax relief in other jurisdictions.

Banking institutions (EU licensed banks, PIs, EMIs, processors, acquirers) will be following ATAD III closely and are widely expected to begin requesting tax residency certificates from EU companies in order to prove they are compliant. For this reason it is important for merchant companies to be compliant with ATAD III in order to avoid interruption to their business.

Penalties

A minimum 5% penalty on an entity’s turnover will apply if an entity is found to be non-compliant with the reporting requirements set out above.

Exchange of information

Member States to share data to a central directory. They will be required to report within 30 days of:

  • Receiving a tax return,
  • Approving a rebuttal or an exemption or;
  • Following an audit into an entity under the provisions of the proposed Directive.
 
Considerations

ATAD 3 is currently a proposal and has not yet been adopted by Member States. The current timeline suggests that the proposed Directive should be implemented into Member States’ national laws by 30 June 2023 and come into effect from 1 January 2024.

In view of the above, we are suggesting that businesses should take a critical look at their structures in order to identify any undertakings that may be considered to lack economic substance and be impacted by the implementation of ATAD 3.

This needs to be addressed now as the ATAD 3 substance test includes a look-back period of the preceding two tax years, meaning that should the Directive come into effect in 2024, an undertaking’s compliance as of January 2022 may be taken into consideration.

Minimum economic substance requirements

Under ATAD3 should declare in their annual corporate income tax return whether they have met the following minimum substance requirements:

  • The Qualifying Entity has its own premises in the Member State or premises for its exclusive use;
  • The Qualifying Entity has at least one own and active bank account in the European Union;
  • One of the following indicators:
 

One or more directors of the Qualifying Entity:

  • Are resident for tax purposes in the Member State of the Qualifying Entity, or are resident at no greater distance from that Member State insofar as such distance is compatible with the proper performance of their duties;
  • Are qualified and authorised to take decisions in relation to the activities that generate relevant income for the Qualifying Entity or in relation to the Qualifying Entity’s assets;
  • Actively and independently use the authorisation referred to in point ii on a regular basis;
  • Are not employees of an enterprise that is not an associated enterprise (25% criterium) and do not perform the function of director or equivalent of other enterprises that are not associated enterprises;
  • The majority of the full-time equivalent employees of the Qualifying Entity are resident for tax purposes in the Member State of the Qualifying Entity or are resident at no greater distance from that Member States insofar as such distance is compatible with the proper performance of their duties, and such employees are qualified to carry out the activities that generate relevant income for the undertaking.
 

In addition, these Qualifying Entities will be required to provide documentary evidence that these substance requirements are met along with their annual corporate income tax return. This documentary evidence should consist of the following: (i) description of business activities, (ii) address and type of premises, (iii) type and amount of gross revenue, and (iv) business expenses, number and qualification of directors, outsourced activities, and bank account.

Qualifying Entities that do not meet these minimum substance requirements may still be able to prove that the Qualifying Entity features a minimum level of substance (rebuttal rule), by providing evidence of:

a) the commercial rationale behind the establishment of the company,
b) information about employees, and
c) that the decision-making concerning the relevant income-generating activity is taking place in the Member State of the Qualifying Entity.

Our Recommendation

ATAD3 will have a significant impact to Qualifying Entities that have no or minimum substance, which impact could consist of the levying of taxes on transactions that would have normally been exempt from taxation based on an arrangement for the elimination of double taxation.

The rules of ATAD3 will in principle enter into force as per January 1, 2024. However, based on the conditions to be a Qualifying Entity under ATAD3 in 2024, the income and outsourcing of administration and day-to-day operations in the “two preceding years” are also relevant to determine whether your company qualifies in 2024 or not. As such, based on your business structure and needs, it is recommended to consider the minimum economic substance requirements.

ATAD3 may in principle already be relevant to your company as per January 1, 2022. We recommend assessing as soon as possible whether the ATAD3 measures will have adverse consequences for your company and to consequently take adequate measures to mitigate the impact of ATAD3 where such consequences have been identified.

How can Merchant Connect help?

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