A fair taxation directive mitigates against shell companies

George M. Mangion is a partner in PKF an audit and business advisory firm

Last December, the European Commission presented a key initiative to fight against the misuse of shell entities for improper tax purposes. At the same time, it presented a proposed legislative text to impose a 15% minimum tax on corporations as worked out between OECD countries and approved by the G20 (Malta signed with some reservations). Once adopted by member states, the proposal should come into force as of 1 January 2024. The proposal does not apply to entities in third countries. The Commissioner for Economy, Paolo Gentiloni, said: “This proposal will tighten the screws on shell companies, establishing transparency standards so that the misuse of such entities for tax purposes can more easily be detected.”

What is the gist of such directive and will it target Malta’s own list of companies (shells reputed to add up to 500)? The answer is that the directive will consists of three benchmarks. It starts by assessing the extent of a company’s passive income, whether most of its transactions are cross-border and if its management and administration is outsourced. Tax advisers in Malta will have a tough job to screen their clients and determine whether clients fall into the category since if they do, they would be subject to new tax reporting obligations and unable to benefit from tax breaks. This will protect the level playing field for the vast majority of European businesses, who are key to the EU’s recovery and will ensure that ordinary taxpayers do not suffer additional financial burden due to those that try to avoid paying their fair share. Some may ask, what are the uses for shell companies? These can serve useful commercial and business functions (for example, offshore oil and gas drilling), but there are abuses when used for aggressive tax planning or tax evasion purposes. Malta can be criticized that due to our competitive corporate tax structure, this may attract shell companies. Luxembourg and the Netherlands have on many occasions been labeled as havens for individuals to use such jurisdictions to shield assets and real estate from taxes, either in their country of residence or in the country where the property is located. At a time, when the EU has pumped so much recovery assistance into trouble stricken companies (due to the pandemic) obviously it wants to make sure tax leakages are minimised. Executive Vice-President for an Economy that Works for People, Valdis Dombrovskis, said: “Shell companies continue to offer criminals an easy opportunity to abuse tax obligations. In two years’ time, if the directive is approved by all member states it shall be monitoring shell companies. It will make it harder for them to enjoy unfair tax advantages and easier for national authorities to track any abuse arising from shell companies.” An entity must satisfy all three indicators in order to meet the minimum substance requirements. These are:

1. own or have exclusive use of premises in the entity’s member state;

2) hold an active bank account in the EU and

3) have at least one qualified director who is a tax resident in the entity’s member state or employ a majority of full-time employees who are tax resident.

If the entity does not meet all of the minimum substance requirements (or does not provide sufficient evidence to prove it does), it will be classified as a shell entity. The consequences of being classified as a shell company are that certain tax benefits will be disallowed. It is estimated that in the EU tax avoidance linked to the misuse of shell companies amounts to around €23bn.