Will Unshell be washed away? An uncertain future for ATAD 3 - the EU’s tax proposal on shell entities

The European Commission put forward a proposal in 2021 to tackle shell entities (known as ATAD 3). Despite widespread support for the concept, reaching agreement on the technical details of the Unshell Directive has proved difficult, with diverging views on fundamental aspects of the proposals. Can the Spanish Presidency reconcile these differences and prevent the ATAD 3 proposals from being washed away?

Unshell is the Commission’s third swing at an Anti-Tax Avoidance Directive. The original Anti-Tax Avoidance Directive (or ATAD), introduced in 2016, sought to implement some of the recommendations from the OECD/G20 project on base erosion and profit shifting (BEPS). ATAD 2 was introduced the following year to extend the scope of the hybrid mismatch rules. ATAD 3, known as the Unshell Directive, seeks to tackle a different issue, namely the misuse of shell entities for tax avoidance or tax evasion purposes. The proposal aims to do this by requiring entities to report on certain indicators of “substance”, which will allow tax authorities to identify shell entities lacking adequate substance and impose certain tax consequences on them.

In a political climate where governments are keen to be seen as “tough on avoidance” and ensuring companies “pay their fair share”, in recent years it has seemed (relatively) easy for the EU to reach unanimous agreement on tax directives that might never have got off the ground in the past. Proposals aimed at tackling avoidance have found themselves becoming politically charged, with DAC 6 (a Directive about reporting information to tax authorities on cross-border tax arrangements) making it through the EU legislative process in the blink of an eye, despite the many concerns about the impracticalities and ambiguities lurking within those rules. So, you might be forgiven for thinking that a proposal to tackle abuse involving shell entities would be similarly easy to agree.

The Unshell proposal was initially announced as part of the European Commission’s Communication on Business Taxation for the 21st Century in May 2021 and a proposal for Directive was adopted by the Commission in December that year. An amended version of the proposal received unprecedented levels of support in the European Parliament (only 7 votes short of unanimity) and the Committee on Economic and Monetary Affairs adopted the amended proposal in January 2023.  However, Member States under the Swedish Presidency of the Council have struggled to reach agreement on some key aspects of the proposals, including (i) what the appropriate indicators of substance should be; (ii) what tax consequences should follow from being designated a shell entity; and (iii) what information has to be reported by taxpayers and exchanged between Member States.

The ECOFIN report from June 2023 on the progress made during the Swedish Presidency notes that going into that Presidency, whilst most delegations supported the objectives of the proposal, further important technical work would be necessary before agreement would be feasible. The proposal was discussed several times over the course of the Swedish Presidency, with the objective of making “as much progress on this file as possible” and in spite of the Presidency having prepared various partial and complete compromise texts and background texts to help move the discussions forward the ECOFIN report noted that “further discussions will be needed in order to find compromise solutions on outstanding issues”. One of the barriers to progress is that some of the issues are interlinked: for instance what people consider to be appropriate criteria for being a shell entity will to some extent depend on what the tax consequences are of being classified as a shell entity.

So, whilst there may well be consensus that “something” should be done to tackle shell entities, the difficulty seems to be in agreeing what that “something” should be. Negotiations have been fraught, with some favouring a light-touch with the emphasis on reporting information and little or no tax consequences attaching to being a shell entity. Whereas others are clearly concerned that Unshell may become a “toothless tiger”. And, until recently, it seemed that there was little prospect of these differences being reconciled. The proposals were taken off the agenda of the ECOFIN meeting in May and, recently, MEPs wrote an article in Euractiv asking Member States to justify why they were blocking the proposal. Frustration levels were clearly high.

However, it seems that there may have been a breakthrough under the Spanish Presidency of the Council that started on 1 July. At the recent IFA European Region conference, there were renewed levels of optimism about the proposal. The Spanish Presidency has indicated that reaching agreement on Unshell is a priority for them and their aim is to reach political alignment on this by the ECOFIN meeting in November. Benjamin Angel of the Commission commented that the substance criteria were now more stable and that it is now about “fine-tuning” the tax consequences of being a shell entity. And the indications are that the tax consequences may well have to be watered down if Member States are to reach a consensus on this (for instance being a shell entity would not prevent a tax residence certificate being issued, but rather the certificate would be issued with a warning statement attached) and the emphasis may be more around the information reporting elements.

The representative of the Spanish Presidency noted that she was confident that agreement could be reached on Unshell, but acknowledged it was going to be difficult. And, whilst it might be unsurprising that the current left-leaning government is strongly in favour of the Unshell proposals, the upcoming Spanish elections, due to take place on 23 July could shake things up. Not only is there the uncertainty as to who will win the election and whether the Unshell proposal will feature amongst their priorities, but there could be a period of up to three months before a new government is installed, which could hinder progress significantly. So it may well be a race against time to move things forward by that November deadline. The uncertainty as to the fate of Unshell continues, but it has not been washed away just yet.

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