Last Updated on Friday, 15 April, 2022 at 8:40 am by Andre Camilleri
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 agreed between OECD countries and approved by the G20 (Malta signed with some reservations).
Once adopted by member states, the proposal should come into force on 1 January 2024. The proposal does not apply to entities in third countries. 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 (shell entities reputed to add up to 500)? The answer is that the directive will consist of three benchmarks (see below).
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 will 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 criticised that due to our competitive corporate tax structure, this may attract shell companies. Luxembourg and Netherlands have, on many occasions, been labelled 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 to help 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: the “gateways” as described below to identify companies that present a risk of not complying with minimum levels of economic substance. To qualify as a shell company, it is necessary to fulfil all three of these criteria: i) companies where more than 75% of their revenues from the previous two financial years is passive income; ii) companies that mainly engage in cross-border activities; and iii) companies do not have their own resources to engage in their activity and resort to the outsourcing of management functions, whether this is day-to-day management or at the level of strategic decision-making, in the previous two financial years. What are the consequences of being a company without substance?
In a nutshell, companies without economic substance will no longer be able to benefit from the tax advantages arising from the application of Double Taxation Conventions and the European Directives. Furthermore, certain income will be imputed and taxed at the level of the shareholder who is tax resident in a member state of the European Union.
Companies that do not comply with the minimum indicators of substance and simultaneously fail to demonstrate the economic rationality of their existence (that is, companies without economic substance or shell companies) will be subject to the following consequences: i) Non-applicability of Double Taxation Conventions concluded with the member state of residence of the shell company; and ii) Non-applicability of the Parent-Subsidiary and Interest and Royalties Directives. It is estimated that in the EU tax avoidance linked to the misuse of shell companies amounts to around €23bn.