New ATAD Directive 3: Prepare your business for upcoming changes

Directives aimed at preventing tax avoidance (Anti Tax Avoidance Directive – ATAD) have been the subject of works by the European Union for a long time. The first such directive (ATAD 1) was adopted by the Council of the European Union in 2016.

The ATAD 3 Directive is a work in progress to apply from January 1, 2025.

What is the purpose of the ATAD 3 Directive?

The ATAD 3 Directive, which establishes rules against the misuse of shell entities for tax purposes, aims to tighten tax systems in the European Union and prevent tax abuse.

In order to achieve this objective, additional reporting obligations will be introduced for international capital groups.

Which entities the ATAD 3 Directive will apply to?

The ATAD 3 Directive will apply to all entities that are tax residents of the European Union and are entitled to obtain a tax residency certificate in the relevant Member State.

This means that the directive will not cover only the so-called low-risk entities within the scope of use of shell companies for tax optimization, such as companies listed on a regular stock exchange or regulated financial companies.

Furthermore, the aforementioned provisions will apply to companies carrying out operational activities whose beneficial owners are tax residents in the same Member State.

The originally published proposal of the ATAD 3 Directive also included an exemption for entities employing at least five of their own employees or staff members on a full-time basis. However, amendments introduced by the European Parliament on January 17, 2023 deleted this exemption. In practice, for some entities, this may be difficult to go beyond the scope of the ATAD 3 Directive.

What is the content of the ATAD 3 Directive?

One of the instruments used by capital groups to avoid taxation are shell companies. Hence, the ATAD 3 Directive is also called the “Unshell Directive”.

The ATAD 3 Directive will introduce a number of indicators of the “minimum substance” of assets and personnel of an entity to assess whether the entity does not conduct business activity or conducts it to a minimal extent.

The so-called higher risk entities will need to determine whether:

1. More than 65% (75% in the proposal before the European Parliament amendments) of the entity’s total revenue for the previous two tax years is “relevant income”. 

“Relevant income” according to the ATAD 3 Directive is generally passive income (e.g. interest, dividends, royalties, income from immovable and movable property), but also income from financial activities and income from outsourced services;

1. At least 55% (60% in the version before European Parliament amendments) of the “relevant income” comes from cross-border transactions;

1. The audited entity has outsourced its day-to-day management and decision-making regarding important functions in the last two fiscal years.

If the enterprise meets the above criteria jointly, it will be subject to additional reporting on the “minimum substance” of assets and personnel in its annual tax returns.

Demonstrating the assets and personnel includes proving that the enterprise:

1. owns or rents premises in a Member State;
2. has at least one active bank account in the European Union;
3. has directors or employees qualified to perform their functions who are tax residents in the same Member State as the enterprise or who reside sufficiently close to the enterprise’s country of residence to be able to properly perform their functions.

What are the consequences of the ATAD 3 Directive?

If the enterprise fails to demonstrate its “minimum substance” of assets and personnel, the tax authorities of the country of its residence may refuse to issue a tax residency certificate. 

Failure to obtain a certificate may result in the inability to benefit from tax preferences resulting from international legislation, such as exemption from withholding tax (WHT) for interest, royalties, or dividends.

Taking the above into account, international capital groups should carefully analyze whether their structure will not result in negative tax consequences when the ATAD 3 Directive enters into force. In the event of such a risk, they might consider reorganizing their business.

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