Crack down on multinational tax avoidance!Eu proposes minimum substantive law

2022-05-05 0 By

The once-in-a-century reform of the global tax system has taken a step further.Following the adoption of a global minimum corporate tax rate of 15% announced by the Organization for Economic Cooperation and Development, the European Union recently issued a minimum substantive law and a withholding tax framework bill.The EU’s move is purely to crack down on cross-border tax avoidance.Multinationals have long entered the EU market by setting up shell holding companies in low-tax countries such as Ireland, Luxembourg and the Netherlands before setting up controlled companies in the destination countries.This can not only enjoy the European Union to promote investment and flows liberalisation and set by the member countries to pay dividends, interest and royalty shall be exempted from withholding tax breaks, and can make the controlled shell company in low taxes, taxes, less tax, to a third countries outside the eu pay the proceeds to again, also enjoy preferential, exemption or levied tax treaty formed on preferential enjoy fully staffed.As a result, the European Union has become a hub for international tax avoidance, costing as much as 300 billion euros a year in tax evasion in a market of more than 700 million people.Targeting shell companies The EU has suffered from cross-border tax avoidance for a long time. In order to effectively curb this situation, the European Commission (hereinafter referred to as “the Commission”) issued the “Communication on Corporate Taxation in the 21st Century” in May 2021, proposing an initiative to eliminate the abuse of shell companies for tax avoidance.On 22 December the Commission issued a proposal for a directive on rules to prevent the abuse of shell company tax avoidance.The proposal aims to introduce an EU “substance test”, including taxpayers’ reporting obligations, to help member states identify businesses (shell companies) that are engaged in economic activity but do not meet the minimum substance requirements and are, in the Commission’s view, being abused in order to obtain tax benefits.In addition, the Commission proposed that companies should impose tax consequences on those deemed shell companies.The draft directive also proposes automatic exchange of information by amending the Directive on Administrative Cooperation in Taxation (Directive 2011/16/EU or DAC) and the possibility for any EU Member State to request a tax audit from another Member State.The proposal is consistent and interrelated with other EU initiatives, including those on minimum tax rules, but there are some key differences with the draft Pillar II directive in terms of objectives and scope.While the Pillar II Directive essentially seeks to establish minimum tax levels for large multinational corporations, this directive aims to address the problem of using low material entities to avoid direct tax.In brief, the present proposal establishes a minimum substantial level and does not provide for measures related to the minimum level of taxation.The proposal will now go through consultations among member states to reach a final consensus.In the European Union, tax rules are usually agreed by all 27 member states.Under the Commission’s proposal, member states have until June 30, 2023, to translate the directive into national law and implement its provisions from January 1, 2024.At the end of January this year, the European Parliament put forward the withholding tax framework act, which is expected to come into effect in 2023. It should be the pearl of the minimum substantive act, and attack the problem of tax avoidance from different angles.In its proposals, the Commission proposes a seven-step process that should be followed by all entities that are residents of member states for corporate income tax purposes.The seven-step method specifically from the declaration threshold, declaration content, tax bureau judgment, enterprise self-defense, additional exemption, tax consequences and information exchange step by step to determine whether it is a shell company, and give the corresponding disposal methods.Industry insiders point out that the biggest professional bright spot of this act is quantifiable and operable, such as negative income over 75% declaration, full-time employees up to 5 people exemption, no substance, no account, directors have no decision-making power in a shell company.This is a big change from the main objective principle of the subjective and too general principle of preferential judgment of tax treaties advocated by the EU in the past.The proposal, which for the first time harmonizes minimum substantive standards within the EU from a tax perspective, will have a huge and far-reaching impact, with European media calling it the most ambitious and far-reaching tax-related bill in recent years.Industry analysis, the proposal will mark an important step in the eu direct tax field.While the Commission recognises the need to respect tax agreements with third parties, the indirect effect of the proposed directive is that tax authorities may use the minimum substance in the draft directive as a benchmark for applying primary purpose tests to third parties within and outside the EU.While the Commission’s initiative only targets specific low material shell companies, the implementation of the proposal will result in additional compliance obligations for many taxpayers.There are also significant compliance implications for the tax authorities of member States. For example, the proposals described in Step 6 will significantly increase the administrative burden of issuing tax resident certificates.With this in mind, and with many issues currently being raised, the proposal may change during the negotiation process.This minimum substantive bill will also have a huge impact on China.Experts analyze that the impacts and changes mainly involve three aspects: first, how Chinese enterprises investing in the EU adjust their structure and functions, and how China’s controlled foreign enterprise provisions impose taxes on controlled entities judged as shell companies;How to deal with the dividend, interest and licence fee paid by these shell companies to the Chinese parent company when they do not enjoy the preferential return credit of the agreement.Ii. A large number of US and European capitals, Hong Kong and Taiwan capitals invest in China through holding companies in low-tax eu countries. If these holding companies are judged to be shell companies, can dividend, interest and concession fees paid to these companies from China enjoy preferential tax rates stipulated in the tax agreements signed between China and the countries where these companies are located?Third, whether it is the red chip structure or the protocol control structure, whether it is the overseas listing or family trust, a series of shell structures have been designed in tax havens such as Cayman, Hong Kong, Singapore and other places.In the future, such as the determination of shell companies in accordance with the EU minimum material standards, the determination of Chinese resident enterprises, the use of controlled foreign enterprises, indirect share transfer standards, preferential treatment of tax agreements, etc., need to be studied and solved.The EU’s minimum substantive standards are bound to influence global rules and national legislation and have more life and influence than the so-called Cayman economic substantive Act.While it remains to be seen whether member states will adopt the Commission’s initiative, multinational companies and investors should closely follow the process of revising and clarifying the proposal.Moreover, the initiative is in line with a broader trend towards greater tax transparency in the EU. Even if the 27 member states fail to adopt the rules unanimously, individual member states may choose to introduce the proposed rules unilaterally.Link: Cayman Economic Substance Act The core contents of the Economic Substance Act are:”Related entities” incorporated in the Cayman are required to pass the appropriate “economic substance” test for their “related activities” or risk being fined or even cancelled, and the local tax authorities may exchange information about such related entities with the tax authorities of the place where the ultimate beneficial owner is located.”Relevant entities” engaged in “related activities” will be required to meet the “economic substance” requirements starting in 2019 and report annually to local tax authorities on their compliance with “economic substance” requirements.Local tax authorities can fine the subject if they believe it does not meet the “economic substance” requirement.Take the Cayman Islands: the first fine is equivalent to about $12,000;The second penalty will be 10 times that of the first, or about $120,000.If the two fines still do not meet the requirements, the relevant subject may be written off.