In order to effectively counter tax avoidance, our proposal puts forward tax rules that ensure that an income cannot go untaxed (or taxed at very low level). While the CCCTB will offer a holistic approach to the problem of tax avoidance, it is important to ensure that in the shorter term, the 28 national corporate rules are coordinated in order to effectively address aggressive tax planning. If there is one weaker link within the EU, it could be exploited by MNEs that seek to avoid taxes. This calls for putting forward rules that would set a common minimum level of protection against tax avoidance in the Single Market. Such rules would address issues that similarly feature in the CCCTB Proposal. The proposed rules should also ensure that the BEPS outcomes are implemented in full compliance with EU law, including the fundamental freedoms as well as fundamental rights as enshrined in the EU Charter of Fundamental Rights. Finally, a Directive will allow for the necessary coordination of all Member States' tax system thereby safeguarding the integrity of the Single Market, limiting distortions and providing legal certainty.
The following tools are being used: deductibility of interest; exit taxation; a switch-over clause; a GAAR; CFC rules; and a framework to tackle hybrid mismatches.
Interest deductibility
Interest costs are deductible for tax purposes in all Member States. Some MNEs have engaged in debt shifting whereby they obtain tax relief for excessive financing costs in high tax jurisdictions, while the interest income is shifted towards low or no tax jurisdictions. Interest limitation rules aim at discouraging such practices. By limiting the amount of interest that can be deducted, it aims at reducing the incentive to shift profits out of the State of origin to low or no tax jurisdictions. The ATP Study shows that four out of seven model ATP structures could be restricted by applying to rules that limit the deductibility of interest.
The interest deductibility rule proposed in the Directive is covered by the OECD/G20 BEPS outcome on action 4. In particular, the Directive foresees a fixed ratio expressed in terms of a taxpayer’s earnings before interest tax depreciation and amortisation (EBITDA), above which net interest expenses cannot be deducted. This is complemented by a group ratio rule. Finally, a safe-harbour provision ensures that companies that have limited net interest expenses are not caught by the rules as these companies are less likely to engage in debt shifting.
It should be noted that the asymmetric tax treatment of debt and equity fuels international debt shifting. Most tax systems give incentives to companies to take on more debt by allowing the deductibility of interest payments while not granting similar treatment to equity. Addressing this tax bias would encourage more equity investments and create a stronger equity base in companies. This view was shared by many respondents to the stakeholders' consultation on the Commission's Green Paper on Building a Capital Market Union. 83 It needs to be ensured that it does not open up new tax avoidance strategies. The Commission will examine the possibilities to address debt-equity bias in a new proposal on the CCCTB.
Exit taxation
Tax base erosion in the State of origin may occur when assets which have an underlying but unrealised economic value are moved, without a change of ownership, out of that State. The ATP study identifies that the lack of capital gains tax upon transfer of IP plays a role in three model ATP structures, as it allows the transfer of IP to low or no tax jurisdictions, while paying little or no tax in the country from which the IPs are moved away. While the ATP study focuses on transfers between independent legal entitities, a similar risk could arise in the case of a transfer within a single legal entity where this results in the departure Member State losing its taxing rights over the transferred assets. In such a case, exit taxation would also be relevant.
Exit taxes aim at ensuring that States are in a position to tax the economic value of any capital gain created in their territory even though this gain has not yet been realised at the time of the exit. The OECD/G20 BEPS package did not focus any of its Actions on exit taxation. However, it is worth noting that the Report on Action 6 (Preventing Treaty Abuse) finds that exit taxes are legitimate in the light of what a tax treaty is meant to regulate. The provision of the Directive reflects the Presidency's compromise proposal in the context of discussions on the international aspects of the CCCTB.
The proposed rule on exit taxation would allow taxpayers either to immediately pay the amount of exit tax assessed or defer payment of the amount of tax. The design of the rule ensures compliance with the fundamental freedoms, in particular the freedom of establishment as well as fundamental rights as enshrined in the EU Charter of Fundamental Rights.
Switch-over clause
Taxpayers may take advantage of the fact that foreign income is tax exempt in the state of residence to shift profit. Such exemptions may be provided given the inherent difficulties in giving credit relief for taxes paid abroad. However, they may have the unintended negative effect of facilitating profit shifting.
The ATP study identifies the tax exemption of dividends received as a factor facilitating ATP, especially when this is too generously applied and does not make any reservation for other tax avoidance factors. In several model ATP structures, the ATP study identifies the generous tax exemption of dividends as a factor allowing ATP. Switch-over clauses are commonly used preventing or reducing such practices.
Switch-over rules were not the subject of an OECD/G20 BEPS Action. However, it is noted that they are complementary to CFC rules (discussed under Action 3 of the BEPS) as they serve a similar purpose. In the CCCTB, there were discussions around denying the exemption method in cases where economic double taxation would not arise or would be very limited due to the low level of taxation in the third country. The proposed rules in the Directive build upon discussions on the CCCTB in technical working groups in Council.
The proposed switch-over rules target profit distributions, proceeds from the disposal of shares and permanent establisment profits which are otherwise tax exempt in the EU and originate in third countries. This income will become taxable in the EU, if it has been taxed below a certain level in the third country. A credit is given for the tax paid abroad.
GAAR
The GAAR complements specific anti-abuse rules. It ensures that tax avoidance strategies that were not envisaged by the legislator can be addressed, by granting the authorities the power to deny taxpayers the benefit of ATP arrangements. It was identified in the ATP study as one of the tax rules that could be useful to counter the ATP structures.
While there is no action dedicated to a GAAR in the OECD/G20 BEPS package, it is noteworthy that action 6 (Preventing Treaty abuses) proposes the introduction of a principal purpose test that acts as general anti-abuse rule with respect to tax treaties. The proposed GAAR in the Directive is based on the one presented in the Commission Recommendation on aggressive tax planning 84 .
The proposed GAAR provides for the artificiality tests present in the case law. The fundamental freedoms can be legitimately restricted on grounds of tax abuse only to the extent that the taxpayer’s arrangements are ‘wholly artificial’ (non-genuine). The proposed GAAR would apply domestically, intra-EU and internationally.
CFC rules
MNEs with subsidiaries in low-tax jurisdictions may engage in tax planning practices whereby profit is shifted out of the parent company towards those subsidiaries. The effect is to reduce the overall tax liability of the group. CFC rules allow the reattribution of this income of a (low-taxed) controlled subsidiary to its parent company for tax purposes in certain situations. CFC rules therefore can ensure that profits parked in low or no tax countries are effectively taxed. The ATP study considers that CFC rules, if well designed and effective, are critical anti-abuse rules as they could defeat most model ATP structures identified in the study.
CFC rules were discussed in the context of the CCCTB. The proposed CFC rules in the Directive are generally in line 85 with the outcome of Action 3 of the OECD/G20 BEPS project. The proposed Directive covers both intra-EU and extra-EU situations. For intra-EU situations, the rules have to be designed to ensure EU law compliance, and in particular the respect of the fundamental freedoms as well as fundamental rights as enshrined in the EU Charter of Fundamental Rights.
Hybrid mismatches
Hybrid mismatches arise from differences in the legal characterisation of payments (financial instruments) or entities in different jurisdictions. The ATP study identifies two model structures that could be defeated thanks to anti-abuse provisions in this area.
Hybrid mismatches were covered by Action 2 of the OECD/G20 BEPS project. They have also been extensively discussed in the Code of Conduct Group where guidance on hybrid entities and hybrid Permanent Establishments was agreed. Finally, it was also discussed in the context of the CCCTB. The proposed directive includes rules to address hybrid mismatches, which should close the doors to exploiting such mismatches both for entities and transactions.
