EUROPEAN COMMISSION Brussels, 22.12.2021 SWD(2021) 578 final COMMISSION STAFF WORKING DOCUMENT



IMPACT ASSESSMENT REPORT

Accompanying the document Proposal for a COUNCIL DIRECTIVE laying down rules to prevent the misuse of shell entities for tax purposes and amending Directive 2011/16/EU {COM(2021) 565 final} - {SEC(2021) 565 final} - {SWD(2021) 577 final} - {SWD(2021) 579 final}



Table of contents 1.Introduction: Political and legal context 2.Problem definition 2.1 What is/are the problems? 2.1.1 Indicators of the use of shell entities to escape tax 2.1.2 Why the existing EU legislation and the international tax frameworks are not sufficient to address the problem 2.1.3 The challenge of defining shell entities 2.1.4 Tax avoidance and tax evasion via the use of shell entities 2.2 What are the problem drivers? 2.2.1 Lack of EU rules defining common minimum substance requirements for tax purposes in the EU. 2.2.2 Lack of information to effectively apply existing rules 2.2.3 Promotion of shell entities by certain intermediaries 2.3 How will the problem evolve? 3.Why should the EU act? 3.1 Legal basis 3.2 Subsidiarity: Necessity for EU action 3.3 Subsidiarity and Proportionality: Added value of EU action 4.Objectives: What is to be achieved?

4.1 General objectives 4.2 Specific objectives 5.What are the available policy options? 5.1 What is the baseline from which options are assessed? 5.2 Description of the policy options 5.2.1 Option 1: Non regulatory option 5.2.2 Option 2: EU wide common substance requirements 5.2.3 Option 3: EU wide common substance requirements accompanied by provisions for administrative cooperation 5.2.4 Option 4: EU wide common substance requirements accompanied by provisions for administrative cooperation and a common sanctioning framework 5.3 Options discarded at an early stage 6.What are the impacts of the policy options? 6.1.Introduction 6.2.Impact on Small and Medium Enterprises (SMEs) 6.3.Data limitations and assumptions 6.4.Option 0: the baseline scenario (no change) 6.4.1. Compliance costs for businesses 6.4.2. Regulatory charges 6.4.3. Enforcement costs for tax administrations 6.4.4. Direct costs and benefits 6.4.5. Indirect costs and benefits

6.5.Option 1: Soft-law option, sub-option a): review of the scope of the EU Code of Conduct Group 6.5.1. Compliance costs for businesses 6.5.2. Regulatory charges 6.5.3. Enforcement cost for tax administrations 6.5.4. Direct costs and benefits for Member States treasuries 6.5.5. Indirect costs and benefits 6.6.Option 1: Soft-law option, sub-option b): Commission recommendation on substance 6.6.1. Compliance costs for businesses 6.6.2. Regulatory charges 6.6.3. Enforcement cost for tax administrations 6.6.4. Direct costs and benefits for Member States treasuries 6.6.5. Indirect costs and benefits 6.7.Option 2: A Directive that requires reporting of shell entities but without automatic exchange of information or common sanctions. 6.7.1. Compliance cost for businesses 6.7.2. Regulatory charges Regulatory charges 6.7.3. Enforcement cost for tax administrations 6.7.4. Direct costs and benefits for Member States 6.7.5. Indirect benefits 6.8.Option 3: A Directive that involves reporting of shell entities with automatic exchange of information (AEOI) but without common sanctions 6.8.1. Compliance costs for businesses

6.8.2. Regulatory charges 6.8.3. Enforcement costs for tax administrations 6.8.4. Direct costs and benefits for Member States 6.8.5. Indirect benefits 6.9.Option 4: A Directive with automatic exchange of information (AEOI) and common framework of sanctions 6.9.1. Compliance cost for businesses 6.9.2. Regulatory charges 6.9.3. Enforcement cost for tax administrations 6.9.4. Direct costs and benefits for Member States 6.9.5. Indirect benefits 7.How do the options compare? 7.1.Effectiveness in reducing the misuse of shell entities for tax purposes 7.2.Tax gains for public finances 7.3.Compliance costs 7.4.Coherence with other policy initiatives 7.5.Different stakeholder views on the opportunity for an intervention 8.Preferred option 8.1.Description of the preferred policy option 8.2.Different stakeholder views on the preferred option 9.How will actual impacts be monitored and evaluated?

Annex 1: Procedural information Annex 2: Stakeholder consultation Annex 3: Who is affected and how? Annex 4 (A): Methods for estimates - Estimation of potential tax losses Annex 4 (B): Methods for estimates - Estimation of companies in scope of the initiative Annex 5: National Measures to tackle shell entity abuse and related substance requirements Annex 6: Third Country Measures Annex 7: The OpenLux investigation, some key findings Annex 8: How do the options compare? An overview table Annex 9: Additional Information on the Necessity of EU Action Annex 10: Additional information on handling of personal data under the preferred option



Term or acronym Meaning or definition AEOI Automatic exchange of information AML Anti-money laundering AMLD Anti-money laundering directive ATAD Anti-Tax Avoidance Directive, Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market. ATP Aggressive Tax Planning. Defined in the Commission Recommendation of 6 December 2012 on Aggressive Tax Planning as: “(...) taking advantage of the technicalities of a tax system or of mismatches between two or more tax systems for the purpose of reducing tax liability. Its consequences include double deductions (e.g. the same loss is deducted both in the State of source and residence) and double non-taxation (e.g. income which is not taxed in the source State is exempted in the State of residence).” BEPS Base Erosion and Profit Shifting BO Beneficial ownership CD Central Directory for automatic exchange of information CFT Counter-terrorism financing CIGA Core income-generating activities CRS Common reporting standard DAC Directive on administrative cooperation, Council Directive (EU) of 15 February 2011 on administrative cooperation in the field of taxation, as amended. DTT Double tax treaties EOIR Exchange of information on request FATF Financial Action Task Force FHTP OECD Forum on Harmful Tax Practices IFCs International Financial Centres IBFD International Bureau of Fiscal Documentation IMF International Monetary Fund Legal arrangement The term is used to refer to trusts and partnerships and any other similar legal arrangements. Legal entity The term is used to refer to any body corporate that has legal personality. NACE The Statistical Classification of Economic Activities in the European Community (NACE) is the industry standard classification system used in the European Union. MEP Member of the European Parliament MNEs Multinational enterprises OECD Organisation for Economic Co-operation and Development ORBIS A database on private companies compiled by Bureau van Dijk PPT Principal purpose test SEOI Spontaneous exchange of information TCSPs Trust or company service providers 1.Introduction: Political and legal context The EU tax policy agenda aims at enabling fair and sustainable growth. EU tax policy priorities are guided by the principles of fairness, efficiency and simplicity. To contribute to achieving fair and effective taxation, in May 2021 the Commission committed to stepping up the fight against the abusive use of shell entities for tax purposes through a new legislative initiative. Targeting this type of abuse has become all the more important after massive media revelations regarding abusive shell entities in the beginning of 2021. The initiative would focus on entities establishedin EU Member States that have no or minimal substantial economic presence, for example in terms of employment, and that may be used for tax avoidance or evasion. The overall objective of the initiative whose impact is assessed in this document is therefore to counter the misuse of shell entities for tax purposes only, and in so doing contribute to fair and effective taxation. Shell entities serve a variety of purposes. The use of a shell entity is not per se an indication of tax avoidance or evasion. Nevertheless, what are generically called shell entities are sometimes used for illegal purposes such as money laundering. Moreover, they can be used for evading and avoiding taxes. Examples of their persistent misuse were revealed by the OpenLux investigation. Based on publicly available information, OpenLux journalists found significant amounts of assets located in Luxembourg held by non-resident taxpayers in holding companies, some of which neither maintain their own premises, nor have employees nor carry out economic activity in Luxembourg. The investigation found that this enabled, for instance, some French investors to significantly lower their tax bill. Such tax savings may be indicative of evasion and avoidance and warrant further investigations. More recently, the Pandora Papers, a massive data leak concerning offshore accounts of several high-net-worth individuals, have revealed that shell entities continue to be used in complex offshore structures, also with the aim of avoiding if not evading taxation.

The European Parliament has at several occasions stressed the importance of tackling tax evasion and avoidance via shell entities. It has called for EU intervention on the matter, inviting the Commission to exercise its right of initiative and act to counter the misuse of shell entities for tax purposes. In its resolution of 26 March 2019 on financial crimes, tax evasion and tax avoidance, the European Parliament put forward several actions to address the tax challenges posed by companies registered in a jurisdiction mainly for tax avoidance or tax evasion purposes and without any significant economic presence. Some of the actions requested include establishing a common definition of shell companies and economic activity requirements tests. More recently, in March 2021, the European Parliament discussed in plenary, the findings of the OpenLux investigation. The initiative assessed here fits within a larger set of Commission initiatives for fair and effective taxation. Among others, key recent initiatives include the Anti-Tax Avoidance Directives (‘ATAD’) and expanding on several occasions the scope of the Directive on Administrative Cooperation (‘DAC’). Moreover, related work has been done and is ongoing by the Code of Conduct Group on business taxation not only on the EU Member States but also with regard to non-EU countries through the EU list of non-cooperative tax jurisdictions. Since 2018, the EU has been reviewing the robustness of non-EU countries’ tax systems against tax avoidance or tax evasion, in part conducted via the misuse of shell entities. Technically, this process proposes the introduction of substance requirements to some non-EU countries to counter the use of shell companies to avoid or evade tax. This initiative also relates to other EU interventions currently under preparation to ensure fair and effective business taxation. In its recent Communication on Business Taxation for the 21st century, the Commission argued in favour of a fair sharing of tax burden across businesses. As outlined in the Communication, the Commission remains committed to building a Union framework for business taxation in the EU: the “Business in Europe Framework for Income Taxation” (or BEFIT). Alongside BEFIT, the Commission will propose new initiatives with the aim of: (i) addressing the debt-equity bias in corporate taxation; (ii) enhancing tax transparency of large multinational companies; and (iii) proposing the initiative subject of this impact assessment. The Commission will also launch a broader reflection on the EU tax mix, the proportion of total tax revenues derived from various tax sources (corporate income tax, personal income tax, VAT, etc.). The initiative assessed here also aligns with the objective of fair taxation shared by the international community and fits with related international actions to tackle cross-border tax avoidance. In the late 2010s, the OECD Base Erosion and Profit Shifting (BEPS) project introduced substance criteria for tax purposes. In particular, BEPS Action 5 aims to ensure that participants in the so-called Inclusive Framework on BEPS have significant economic activities linked to preferential tax regimes and their incentives. The same action introduced substantial activity requirements for no or only nominal tax jurisdictions and provided guidance on the application of the requirements. BEPS Action 6 on Treaty Shopping aims to prevent the abuse of double tax treaties by interposed shell entities. In addition, the Commission and Member States are also actively promoting fair taxation in international fora to fight harmful tax practices at worldwide level, e.g. the OECD Forum on Harmful Tax Practices (FHTP). Mandated by the G20, the OECD Inclusive Framework is currently working on the implementation of a global, consensual solution to reform the international corporate tax framework. The reform is based on two main work streams: Pillar 1 (re-allocation of taxing rights) and Pillar 2 (minimum effective taxation). The two pillars aim to address different but related issues linked to the increasing globalisation and digitalisation of the economy. Pillar 2 is expected to put an end to the race to the bottom in tax competition among jurisdictions and to tackle corporate tax avoidance. Pillar 1 aims to better link taxing rights to place of economic activity. Note that Pillar 1’s scope will be limited to a relatively low number of the large and most profitable multinationals only, while Pillar 2 will apply to multinational companies that meet the EUR 750 million threshold, thus leaving all companies below this threshold out of the scope. As such, this process will not provide a comprehensive solution to tackle the use of shell entities for tax avoidance or evasion. In addition, it is important to stress that shell entities are by no means only associated with large, multinational enterprises. Smaller companies and individuals, often high-net worth individuals, make use of them as well. As revealed by the OpenLux investigation, thousands of foreign nationals make use of Luxembourg-based holding companies, including about 15 000 French individuals. Addressing the abusive use of shell entities is important as, despite broader efforts to counter tax avoidance and evasion loopholes in the EU and globally, the estimated tax revenue losses of the affected jurisdictions remain high. Globally, corporate tax avoidance is estimated at between USD 90 billion and USD 240 billion per year. Within the EU tax avoidance is estimated at between EUR 35 billion and EUR 70 billion of tax revenues lost per year. To conclude, the current political context points to the need for additional and specific policy actions to tackle the abusive use of shell entities for tax purposes. More generally, the ongoing economic and health crisis also adds to the urgency of putting in place a fair and effective tax framework for sustainable public spending that can help fund and sustain the recovery. Countering the misuse of shell entities for tax avoidance and evasion purposes can contribute to that aim. 2.Problem definition 2.1 What is/are the problems? 2.1.1 Indicators of the use of shell entities to escape tax Anecdotal and investigative evidence suggests that high net-worth individuals and companies sometimes make use of shell entities to minimise their tax bill. For instance, the media reported that, in 2020, without any employee other than directors, an Irish subsidiary of Microsoft made a “tax-free” profit of USD 315 billion. According to research by an Australian based tax research institute CICTAR, Uber shifted almost EUR 6 billion through about 50 shell companies in the Netherlands in 2019, after creating a massive tax shelter. According to a US fair tax think-tank, between 2011 and 2015, Walmart transferred ownership of more than USD 45 billion in assets to a network of shell companies in Luxembourg, where Walmart does not have stores. In 2017, when investigating illegal tax benefits to Amazon in Luxembourg, the Commission found that considerable income (royalties) was generated by a holding company that was an empty shell with no employees, no offices and no business activity, and paid only minimal taxation. The initiative intends to address both tax avoidance and tax evasion. Both tax avoidance and tax evasion undermine the fairness and integrity of tax systems. Businesses that avoid or evade tax gain a competitive advantage over enterprises that pay their fair share. Taxpayers with similar incomes or assets may end up paying different amounts of tax. Ultimately, both tax avoidance and tax evasion in practice mean less resources (tax revenues) to finance public services including, among others, “(…) infrastructure, social security and education systems”. For the sake of clarity, it is worth stressing that the problem to be addressed is not the existence of shell entities per se. Indeed, the latter can serve several valid and fully legitimate commercial and business purposes. Just to provide some examples obtained via the public consultation on this initiative, shell entities can be used to: ensure limitation of liability; protect investors and maintain the value of the portfolio; meet the requirements of third party lenders to ring-fence assets and liabilities; facilitate joint ventures between funds and other investors; streamline decision making by giving authority to the directors of holding entities; provide a convenient vehicle for sale or partial sale. As said, shell entities as such are not the problem. Therefore, it would not be appropriate to distinguish between legitimate and problematic shell entities: rather, the issue is about distinguishing between the legitimate and problematic uses of shell entities. As other technologies or forms of innovation and organisation, shell entities can be exploited or rather serve broader economic and social goals. Specials purpose entities (SPEs) are also used for legitimate business purposes and have characteristics in common with shell entities. For example although they are formally registered with a national authority and subject to their fiscal and legal obligations, they can lack substance activities like having few non-financial assets and employees. Legitimate uses of SPE's include spreading financial risk and facilitating complex financing and project operations. The aim of the current initiative is not to curtail these operations but instead to prevent such vehicles from being used for tax avoidance or tax evasion. Shell entities have also been set up to avoid double taxation, for example when the resident jurisdiction of a company does not have a double taxation treaty with another jurisdiction with which it is doing business. However, Member States have decided both at national level and international level through the OECD BEPS project that their resident companies are required to have substance in order to benefit from their double taxation treaties. The problem, as the evidence above suggests, is the misuse of such entities for tax abuse purposes only. On the geographical scope of the problem The use of shell entities for tax avoidance or evasion is not an “EU problem” only. Shell entities are spread across the globe, especially in zero or very low tax jurisdictions. Data from tax leaks by the International Consortium of Investigative Journalism (ICIJ) can suggest an answer to the geographical scope and magnitude of the problem. For instance, the recent Pandora Papers revelations point to shell entities in many third countries: British Virgin Islands, Seychelles, Hong Kong, and the United Arab Emirates to cite only some. On the other hand, in the Pandora Papers there is also mention of entities in some EU Member States, namely Cyprus, Ireland and Luxembourg. Most of the entities involved in the Panama Papers were from the British Virgin Islands, followed by Panama and The Bahamas. The Panama Papers also mentioned several entities in Cyprus and Malta. On the question of the geographical scope of the problem, it may also be relevant to consider the work of some civil society organisations, in particular the NGO Tax Justice Network. The latter has developed a combined indicator ranking jurisdictions according to how much they facilitate tax avoidance by multinational corporations. The indicator is called the Corporate Tax Haven Index (CTHI). According to the latest edition of the CTHI, the countries ranking at the top 10 of the index are mainly third countries, however also the Netherlands and Luxembourg score high.

2.1.2 Why the existing EU legislation and the international tax frameworks are not sufficient to address the problem The BEPS project has been a major step forward in addressing the problem of shell companies being used for tax purposes. However, the implementation of BEPS measures in practice proves challenging for tax authorities, as it emerged also from the public and targeted consultation conducted for preparing this initiative. For instance, one respondent to the public consultation pointed out that current rules are challenging to implement. As part of the targeted consultation for this initiative, some Member States pointed out the difficulty of using existing measures. The main challenge lies in the fact that BEPS relies primarily on general anti abuse rules to tackle shell entities, namely via the General Anti Abuse Rule (GAAR). The latter was introduced within the EU through the Anti-Tax Avoidance Directive (ATAD), the main existing anti-tax avoidance tool at the EU level. “General” in practice means that tax administrations address the use of shell entities in tax schemes on a case-by-case basis. As put by one Member State in the targeted consultation: “The current rules in ATAD with respect to General Anti Avoidance Rule and Controlled Foreign Company Rule apply the notion of non-genuine economic activity, valid commercial reasons and the substantive economic activity test, however, the interpretation is facts and circumstances dependent.” Challenges with tackling shell entities are reported by other Member States. For instance, a Member State stressed how difficult it is for Member States to come up with “defensive measures” addressing the problem. Member States at present have limited scope to implement effective measures to fight harmful tax practices. Operationally, tax administrations need significant time and resources to implement existing measures to counter the use of shell entities for tax purposes. Moreover, tax administrations often lack the information necessary to detect such use. As the problems of tax avoidance and tax evasion persist, it is important that shell entities are addressed in a targeted, specific manner, providing tax administrations with the information they need to prevent (preferably, rather than to react ex post) tax avoidance and tax evasion. It is also important, to ensure a level playing field and to avoid distortions between Member States, that specific provisions to tackle tax avoidance and tax evasion via shell entities are introduced at the EU level, via common provisions so that, to put it simply, a shell entity is identified and recognised as such, on the basis of the same objective criteria. To avoid distortions, moreover, the same tax consequences should be applied no matter where the problem emerges within the EU. 2.1.3 The challenge of defining shell entities There is currently no standard and comprehensive definition of shell entities, which in itself may partly explain our limited ability to measure and understand the extent of tax avoidance or tax evasion by shell entities. Nevertheless, there are a number of definitions available both at EU and at international level that can help us identify shell entities. The International Bureau of Fiscal Documentation (IBFD) refers to a letterbox company that ‘lacks any further business substance’. The Guidance paper on transparency of beneficial ownership prepared by the Financial Action Task Force (FATF) lists several definitions of letterbox companies (shell, front or shelf companies) and defines shell companies as those companies that have ’no independent operations, significant assets, ongoing business activities, or employees’. The OECD describes a letter box company in the following manner: ‘A paper company, shell company or money box company, i.e. a company which has complied only with the bare essentials for organization and registration in a particular country. The actual commercial activities are carried out in another country’. 2.1.3.1 Common features of risky shell entities Despite the lack of a universal definition, available international definitions such as those above, definitions at national level and a literature review on shell entities, indicates that there are a number of characteristics common to shell entity definitions: I)Lack of substance or economic activity – there are no or minimal non-financial assets, employees, production or operations; II)No physical presence beyond a ‘brass plate’, sometimes with multiple entities using the same postal address; III)Anonymity – the identity of the real owner behind a shell entity (‘the beneficial ownership’) is often concealed; IV)Cross-border element – use of complex group structures typically using multiple jurisdictions which can conceal beneficial ownership; V)Use of intermediaries - for example, trust and company service providers (TCSPs) are required to set up shell entities given their complexity and the knowledge needed to set them up. These elements, often combined, point to a risk of shell entities being used for tax evasion or avoidance. While most of these risk characteristics are common to both tax evasion and tax avoidance, existing literature points to essential differences depending on whether entities are used for tax avoidance or tax evasion. For example, tax evaders may more often make use of anonymous shell entities not to pay tax. Given the difficulties in establishing a general definition of shell entities, this initiative aims to define a common set of objective criteria which, if met, would imply that there is sufficient substance in an entity not to be at risk to be misused for tax purpose. 2.1.3.2 Shells of different form Shell entities come in many different legal forms. Both legal entities like private limited liability companies and foundations can be used as shell entities for tax avoidance or tax evasion, as can legal arrangements like express trusts or partnerships and similar arrangements. The problem to be addressed is tax avoidance and tax evasion though shell entities, irrespective of which tax (corporate income tax, personal income tax, and other taxes) is avoided or evaded. Different legal forms may lead to different tax consequences. From a tax perspective, legal entities, such as companies, established in a jurisdiction will be considered as resident for taxation purposes, subject to corporate income tax, and will normally be entitled to tax treaty benefits. This is different from a situation where there is a legal arrangement, a partnership, which, under the applicable national law, might not be considered as a tax resident. Instead, it might be transparent for tax purposes implying that the relevant beneficiaries should be taxable for the income of the partnership at their residence jurisdiction. 2.1.3.3 How many shells? The number of shell entities within the EU is unknown. This is in particular because within the EU, there is no common definition of what shell entities are and consequently nor statistics about them.

Some studies estimate the number of shell entities using proxies. For instance, a 2018 study by the European Parliament uses the number of foreign-owned companies as a proxy. In this impact assessment, the estimation of shell entities is conducted in three steps: first, the sectors of activity often associated with the existence of shell entities are identified. Second, the number of companies active in those sectors is estimated. Third, using firm-level data, a rather conservative estimation for the number of shell companies in the EU could be some 29 000 entities. An upper-bound estimate, based on Irish data, arrives at a number of max 75 000 shell companies in the EU. This is also the closest estimation possible to the overall number of entities (including companies) that would be targeted by the regulatory options considered in this impact assessment. The estimate suggests that shell companies are relatively few. Put in perspective, the upper bound estimate of 75 000 companies amounts to only circa 0.5 per cent of the overall number of corporate income taxpayers and about 0.3 per cent of the overall number of active enterprises within the EU. 2.1.4 Tax avoidance and tax evasion via the use of shell entities Shell entities can be used for both tax avoidance and tax evasion purposes. This is why the intervention intends to tackle both tax avoidance and tax evasion through the use of shell entities. An example of tax avoidance via shell entities would be the use by a large multinational of a holding company to transfer money within its corporate group through payments which are not in line with economic reality. As a result, the company ends up paying substantially less tax than other companies. Several examples could be made of tax evasion via shell entities. For instance, it could be the case of a wealthy individual evading wealth tax by concealing the ownership of a yacht by interposing a shell entity. A concrete example: an Italian businessman using a Maltese shell company to evade direct taxes on his employees. Distinguishing between legal and illegal aspects as well as what is fair and unfair is not always straightforward. Generally, tax evasion is always illegal, while tax avoidance is generally legal but in some cases it may not be so. The European Commission has however on several occasions explicitly pointed out that both tax evasion and tax avoidance are unfair. Recently, for instance, Commission President von der Leyen stated: “(…) social fairness is (…) also a question of fair taxation. In our social market economy, it is good for companies to make profits. And they make profits thanks to the quality of our infrastructure, social security and education systems. So the very least we can expect is that they pay their fair share. This is why we will continue to crack down on tax avoidance and evasion.” This statement seems to suggest that the European Commission considers both tax avoidance and tax evasion unfair. The challenge of defining tax avoidance The conceptual (as well as legal and administrative) boundary between illegal tax evasion and legal tax avoidance, or tax planning, is robust and well known. However, the divide within the concept of avoidance between what amounts to 'aggressive' or 'unacceptable' avoidance and what can still be considered acceptable 'planning' is a source of on-going disputes between governments and taxpayers. Ongoing and past law cases provide clear evidence of the challenges of distinguishing different forms of tax avoidance. For instance, in the case concerning the selective tax advantage in favour of a Luxembourg subsidiary of the Amazon group, the European Commission’s view differs from that of the other parties. In May 2021, the General Court of the European Union concluded that no selective advantage was given. However, the European Commission is considering possible next steps and the case does not seem settled yet. Part of the difficulty is inherent in the challenge of defining tax avoidance to begin with. The term is generally used to describe the arrangement of a taxpayer's affairs that is intended to reduce his tax liability in such a way that, although the arrangement could be strictly legal, it is usually in contradiction with the intent of the law it purports to follow. Furthermore, the definition of tax avoidance is dynamic. The understanding of what amounts to unacceptable tax avoidance evolves over time. A major development in that respect has been the OECD Base Erosion and Profit Shifting (BEPS) project, probably the most fundamental international tax reform of the 2010s. The project has been referred to as “International collaboration to end tax avoidance”. The fact that more than 130 countries have subscribed to the delivery and implementation of this project shows that there exists a widespread consensus that tax avoidance is increasingly becoming unacceptable. The internal division, within tax avoidance, between what constitutes acceptable vs. unacceptable tax avoidance is shifting, limiting more and more the scope for acceptable ‘tax planning’. 2.1.4.1 Tax avoidance by shell entities Although there is no precise definition of tax avoidance, tax practitioners and policy makers use it to describe the arrangement of a taxpayer's affairs that is intended to reduce their tax liability. In their input to the public consultation on this initiative, IBFD defined tax avoidance as “(…) actions or omissions of a taxpayer that are aimed at obtaining a tax advantage by exploiting the friction between the form (which is chosen from those that do not trigger the liability to tax) and the substance, which is akin to events that would otherwise trigger the liability to tax”. In other words, although tax avoidance could be strictly speaking legal, it is usually in contradiction with the intent of the law that it is meant to follow. Tax avoidance includes treaty shopping. The latter consists of arrangements through which a person who is not a resident of one of the two States that concluded a tax treaty may attempt to obtain benefits that the treaty grants to residents of these States. Other forms of tax avoidance involves exploiting differences in national laws of different jurisdictions. As put by IBFD in their input to the public consultation for this initiative, “(…) tax avoidance is typically arduous to estimate and quantify”. Focussing on the problem at stake, there are no robust, reliable estimates of tax avoidance caused by shell entities. Yet, raw estimates may provide an indication of the size of the problem. For instance, in the case of the US, it has been estimated that tax avoidance facilitated by Delaware companies, cost other US States USD 9.5 billion per year. Other estimates of corporate tax avoidance size the problem in the order of tens of billions of dollars in tax losses annually for large economies such as the US or the EU. Businesses that operate cross-border can exploit the different tax rules that apply across the EU to set up structures with the ultimate aim of minimising taxation. They take advantage of the current European legal framework, which facilitates the flow of dividend, interest and royalty payments within the EU with a view to avoiding double taxation, while rules on applicable taxes, rates and the fight against artificial tax structures remain mainly the responsibility of national authorities. In particular, the Directive on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States, known as the Parent Subsidiary Directive (PSD), abolished withholding taxes on payments of dividends between associated companies of different Member States, thereby preventing economic double taxation. Similarly, the Directive on a common system of taxation for interest and royalty payments between associated companies of different Member States, known as the Interest and Royalty Directive (IRD), has eliminated withholding tax obstacles in the area of cross-border interest and royalty payments within a group of companies. Removal of tax obstacles as above can however be manipulated to give rise to tax avoidance in the cross-border context. A similar case concerns the abuse of double tax treaties, commonly known as “treaty shopping”. For example, when a group wishes to make a payment between two countries that have no tax treaty between them, this payment should be subject to the domestic taxation of both countries. However, there may be a third country, irrelevant to the transaction, which has an “attractive” tax treaty network, i.e. it has double tax treaties with both countries concerned. By routing the payment through such third country, potentially using a shell entity there, the payment could benefit from relevant treaty benefits, including for example no or lower withholding tax rates. Another mechanism to avoid taxation via the use of shell entities involves establishing entities in Member States with a favourable regime of outbound (out of the EU) withholding taxation of dividend, interest and royalties. As put by IBFD in their submission for the public consultation for this initiative: “(…) third-country based MNEs take advantage of the interplay between the Parent-Subsidiary and Interest-Royalty directives (PSD and IRD) and the domestic laws of several EU Member States. The ultimate result is a withholding tax-free repatriation of profits from any EU Member State to a third country simply by relying on the withholding tax exemption of the directives (from the Member State of origin to the Member State of the interposed intermediary) and the subsequent lack of withholding tax in the domestic laws of a handful of Member States (from the Member State of the interposed company to the desired third-country, regardless of the existence of a tax treaty with that jurisdiction).” Furthermore national tax systems can also grant exemptions to income received by resident entities from abroad, for example dividend income, irrespective of whether withholding taxes are levied on the payment of the dividend or whether the state of residence of the payee group company has a tax treaty with the state of residence of the shell entity. While there have been a number of initiatives at international level to tackle tax avoidance, including by shell entities, for example, the OECD BEPS project and at EU level, through ATAD, none of these is targeted specifically to shell entities. In addition none provides objective criteria with which to assess lack of substance at the time when the tax benefit is requested. 2.1.4.2 Tax evasion by shell entities Tax evasion may be characterised as intentional illegal behaviour or as behaviour involving a direct violation of tax law in order to escape the payment of taxes. The use of shell entities for illegal activities such as tax evasion purposes has been the subject of much research in recent years. As pointed out by one respondent to the public consultation for this initiative: “There is indeed evidence that shell companies might be used in the context of criminal activity to conceal funds, and move assets without authorities being able to identify those asset movements.” In such scenarios, shell entities are often established in jurisdictions (i) with tax systems that have zero or next to zero tax at the level of the entity; (ii) that exempt from tax income received from abroad; and/or (iii) have no withholding taxes on distributions of income made from the entity. Due to the criminal nature of tax evasion, estimates on direct tax evasion caused by shell entities are not widely available. However, a number of leaked data in recent years has pointed to the scale of the problem. For example, following revelations of the Panama Papers in 2016, tax authorities have recovered more than USD 1.3 billion. The leak concerned more than 214 000 shell companies created by specific law firms, among others, for tax evasion purposes.

Tax evasion is often associated with money laundering. The EU has now in place a strong framework against money laundering and terrorism financing. It includes the establishment of EU beneficial ownership registers to enhance transparency of beneficial ownership information in the EU. The 5th AML Directive extended the requirement of beneficial ownership registration to trusts and similar legal arrangements and granted access by the public to a certain amount of information relating to beneficial ownership of legal entities. More recently, the Commission adopted a new AML/CFT legislative package to strengthen the EU’s AML/CFT rules as part of the Commission’s commitment to protect EU citizens and the EU’s financial system from money laundering and terrorist financing. It includes four legislative proposals consisting of a regulation establishing a new EU AML/CFT Authority, a Regulation on AML/CFT containing directly-applicable rules, a sixth AML/CFT Directive replacing the existing Directive 2015/849/EU, and a revision of the 2015 Regulation on Transfers of Funds. Despite having a strong AML framework in place, essentially preventing the existence of anonymous shell entities in the EU and reducing the risk of tax evasion, the issue of non-compliance with tax laws cannot be solved by AML rules alone. 2.2 What are the problem drivers? As indicated in Figure 2, there are three key drivers behind the problem, i.e. the use of shell entities by individuals or organisations to avoid or evade tax. The first driver is the lack of a common definition of substantial economic presence for tax purposes. The second driver is that tax administrations within the EU do not have sufficient information to prevent, detect or stop tax avoidance or tax evasion through the use of shell entities. Advertising and promoting the use of shell entities for tax avoidance or even tax evasion is the third driver considered. Each of these three drivers is described below. 2.2.1 Lack of EU rules defining common minimum substance requirements for tax purposes in the EU. Substance criteria do exist at EU level in various contexts. Regarding taxation, the EU Code of Conduct for business taxation has used substance requirements when assessing preferential tax regimes in the EU. However, these requirements are non-legally binding and are limited in the context of specific regimes. In the context of the EU list of non-cooperative jurisdictions for tax purposes, substance requirements in line with the international standards established in the context of the BEPS project, need to be met in relation to preferential tax regimes adopted by third countries. Substance requirements also apply beyond specific regimes, in the context of national tax systems of third countries which have no or only very low corporate tax. It follows that currently there are no legal requirements at EU level asking for common minimum substance requirements for tax purposes. Moreover, with some exceptions, most Member States do not have domestic substance criteria to prevent abuse. While the tax treaties may include provisions like substance criteria and beneficial ownership rules to prevent abuse, these differ across Member States and may well differ in the double taxation treaties concluded by a single Member State with other countries. As regards anti-tax avoidance rules, while common EU rules have been introduced, e.g. by virtue of ATAD, enforcement at domestic level may vary. For example, national courts may differ in the application of the EU and national anti-abuse rules to prevent a shell entity being used for tax avoidance or tax evasion. Sanctions may also differ among Member States. Differences can then be exploited by economic agents, resulting in shell entities used for tax avoidance or tax evasion purposes being set up in Member States with a more favourable tax framework. This context may also translate in weaker, fragmented and uncoordinated measures to combat tax avoidance or tax evasion by shell entities in the Single Market. 2.2.2 Lack of information to effectively apply existing rules Member States also lack readily available information to levy taxes correctly in a cross-border context. Even when Member States have in place anti-abuse rules, tax authorities do not necessarily have the necessary information to make effective use of such rules for cross-border transactions. This can be explained via a hypothetical example. A subsidiary company established in Member State A pays a dividend to its parent company in Member State B. This dividend is paid “tax free”, on the basis of the EU Parent-Subsidiary directive that exempts intra-company dividends from tax within the European Union. For the sake of this example, let us consider that the parent company in Member State B is a shell company. The general-anti abuse rule introduced by the EU anti-tax avoidance directive clearly says that: “(…) Member State shall ignore an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, are not genuine having regard to all relevant facts and circumstances.” Even assuming the shell company getting the dividend was “not genuine”, Member State A has limited information to check that is indeed the case. As put by IBFD in their input for the public consultation for this initiative, the main problem is that where the information is available (residence country i.e. Member State B in the example) and where the information is needed (source country i.e., Member State A in the example), are two different countries. As a result of complex cross-border arrangements/contexts, tax authorities lack readily available information to assess substance or whether an arrangement is genuine or not. They cannot prevent tax avoidance and tax evasion in a timely manner but can only attempt to recover part of the tax losses ex-post, following an audit for example, and with difficulties - as obtaining the information necessary to implement existing anti-abuse provisions is costly. Lack of information makes the implementation of existing anti-abuse rules particularly challenging or indeed insufficient to address the problem described here. As put by IBFD in their contribution to the public consultation for this initiative: “(…) both the incentive for treaty and jurisdiction shopping and the consequences, should an abusive structure be discovered, suggest that traditional anti-avoidance measures do not suffice.” It is also relevant to stress that under existing rules, even where information is obtained, it is corrective, rather than preventive, measures that apply: once tax avoidance or tax evasion is discovered, mainly through a tax audit, tax administrations can intervene to redress it.

2.2.3 Promotion of shell entities by certain intermediaries Some intermediaries seem to play a catalyst role in the establishment and use of shell entities. They provide corporate administration and management services which are necessary to establish and operate shell entities in the EU. Shell entities can avail of the administrative support from such intermediaries, such as postal address, which allows the entity to have a minimum physical presence in the Member State to be deemed existing there. The use of intermediaries to set up such shell entity schemes have been cited in various leaks like the Panama Papers, and at international level through the FATF and the OECD. At EU level, Directive 2018/822/EU (’DAC6’) requires that intermediaries like trust and company service providers, to report cross-border tax arrangements to their national tax authorities.

Different stakeholders’ views on the problem The public consultation survey included several questions to gain a better understanding of the problem. Respondents’ views are mixed when it comes to possible remaining causes of tax avoidance. The most relevant cause cited by all respondents was ‘insufficient capacity of tax administration to process the available information on tax avoidance structures’, followed by ‘insufficient cooperation between EU Member States’. The least relevant cause appears to be insufficient information of tax administration on potential tax avoidance structures. Respondents were asked whether they agree or not with a series of problem statements. The statement with which most respondents agreed is that current EU rules in the field of taxation already provide tools to tackle aggressive tax planning schemes including through the use of shell entities. Understandably, the most “opposed” statement on the other hand is that current EU rules cannot fully and effectively address the use of shell entities for tax avoidance purposes. It is relevant to consider, however, whether and how stakeholders belonging to different categories perceive the problem differently. Views vary significantly between business associations and companies (business stakeholders) on the one hand and civil society (NGOs and trade union) stakeholders on the other hand. While almost 50% of business stakeholders disagree with the view that shell entities are used in the EU mostly for abusive tax purposes, 66% of NGOs and trade unions agree. Almost all (95%) business stakeholders are of the view that current EU rules in the field of taxation already provide tools to tackle aggressive tax planning schemes including through the use of shell entities. A similar view is held by one third of civil society stakeholders, while half of this category of respondents disagree. 90% of business stakeholders do not agree that current EU rules cannot fully and effectively address the use of shell entities for tax avoidance purposes, while all civil society respondents agree.

2.3 How will the problem evolve? In the absence of a public intervention, it is expected that tax avoidance and tax evasion through shell entities will persist. If both the European Union and its Member States do not act to tackle the problem, it is most likely that it will not be solved. The use of shell entities for tax abusive purposes will continue to lead to a loss of tax revenues for the national treasuries, negatively impacting on the provision of public services and creating an unlevelled playing field for companies and differences in the treatment of individuals. A few Member States, for example the Netherlands and Italy, have acted to ensure that legal entities and legal arrangements without substance are precluded from tax benefits. However, as a key characteristic of the problem is its cross-border nature, unilateral, uncoordinated measures are unlikely to be effective solution to the problem considered here. Without EU action tax avoidance may be expected to continue to impact EU Member States. Individual and uncoordinated action may also lead to the costs of doing business cross-border going up. If Member States were to act individually establishing their own criteria, for a hypothetical, real “pan-European” group operating across all Member States, the costs of compliance with 27 diverse substance requirements would be higher than having to face one single rulebook. In the latter case, the group would be able to standardise some of its compliance activities and benefit from economies of scale. A patchwork of national interventions to tackle the problem may inadvertently increase, rather than reduce, distortions in the Single Market. This scenario would be a “lose-lose” evolution, where both public authorities and businesses would be worse off. If economic agents are seen to react to incentives including regulatory settings, then one should not expect a change in their behaviour (i.e. increased tax compliance) if the ‘rules of the game’ and the existing tax-related incentives remain the same. In sum, without public EU intervention, tax avoidance and tax evasion linked to shell entities could be expected to continue, as economic agents typically want to maximise their income. In a scenario of uncoordinated national measures to neutralise the misuse of shell entities for tax purposes, it is likely the problem will persist and worsen.



3.Why should the EU act? 3.1 Legal basis Article 115 of the Treaty on the Functioning of the European Union (TFEU) serves as the legal basis for the regulatory option of this initiative. Article 115 aims at ensuring the proper functioning of the internal market. 3.2 Subsidiarity: Necessity for EU action The use of legal entities and arrangements without substance for tax avoidance or tax evasion purposes is usually not limited to the territory of only one Member State. Instead, it is a key feature of such schemes that they involve the tax systems of more than one Member State at a time. Some schemes involve a legal entity or arrangement being established in one Member State, where it has no premises and resources to perform an economic activity, to receive profits generated by a related entity in other Member States or even a third country. Several Member States could therefore be impacted by a scheme that would include the use of shell entities. In other words, the problem has a cross-border dimension. In addition, the problem has the same drivers and underlying causes no matter in which Member State it appears. The review of Member States anti-tax avoidance rules indicates that some Member States have developed targeted rules or practices, including criteria on substance, to counter abuse by shell entities in the area of taxation. However, most Member States do not apply targeted rules, but may rely on general anti-abuse rules, which Member States tend to apply on a case-by-case basis. Even amongst the few Member States that have developed targeted rules at national level, the rules differ significantly, and reflect more national tax systems and priorities, rather than target the Internal Market dimension. It follows that the majority of existing rules does not address the case where the existence of a shell entity affects a Member State other than the one where the shell entity or arrangement is located. Such differences could lead to tax and regulatory arbitrage. The above findings have been confirmed in the context of the public consultation on the basis of the materials provided by the contributors. In particular, IBFD provided data ascertaining that “a comparative desktop review of the domestic rules of EU Member States shows that domestic rules targeting specifically shell arrangements are relatively uncommon”.

Recent EU actions could be considered relevant to curbing the problem of shell entities and arrangements. These include the DAC and the ATAD, already cited above. However, there are some limitations in their use to tackle tax abuse by shell entities. At EU level there are currently no legislative measures defining substance of an entity or arrangement for tax purposes. The Court of Justice of the European Union has established general principles regarding substance requirements for tax purposes in the context of the prevention of tax avoidance. In addition, the Code of Conduct Group (Business Taxation) has developed substance requirements, of a soft law nature, in the context of specific preferential tax regimes. However both case-law and current Code of Conduct practices cannot be used as self-standing provisions of general application. They are rather of limited scope, either by the circumstances of the specific case in dispute (for jurisprudence), or in the context of specific regimes (for the Code of Conduct review). Importantly, existing instruments do not ensure timely identification of the cases of lack of substance and prompt communication of the information to all Member States that may be affected. The persistence of the problem, described in the previous section, is reflected in the Open Lux investigation (see Annex 7). In light of the above, specific EU level action appears a necessary course of action against shell entities. This is especially because a patchwork of individual actions, if at all, at national level could render some Member States vulnerable to regulatory and tax arbitrage especially if national action translates in some not imposing substance requirements or imposing more beneficial requirements. Importantly, as shell entities are commonly used to erode the tax base of a Member State, different from that where the shell entity is located, Member States might not have sufficient incentive to introduce robust rules at national level. 3.3 Subsidiarity and Proportionality: Added value of EU action The current initiative does not seek to replace existing measures aimed at tackling tax avoidance and tax evasion through shell entities. Rather the initiative aims to reinforce, and complement existing measures by providing objective substance criteria to identify shell entities that may be used for tax avoidance and evasion with the aim to prevent such abuse in a timely manner. The necessity to act in response to the problem and its drivers and the multi-country nature of the problem suggests that it would be preferable to establish a common set of rules across EU Member States that would ensure consistency on the definition of substance requirements for tax purposes as well as on the countermeasures to be applied. It will allow Member States to assist each other in identifying harmful schemes regardless of a) where they are located in the EU and b) which Member State’s tax base these schemes put under threat. EU level intervention would also minimise the risk of unfair tax competition amongst legal entities and legal arrangements in different Member States, potentially generated by unilateral definition and implementation of substance requirements. A common approach would ensure consistency of treatment of shell entities in the EU, irrespective of their location or residence or establishment and thus avoid tax arbitrage. Without such a common approach to the denial of tax benefits, the issue of profit shifting would not be addressed. Due to the transnational nature of the problem, EU regulation would provide a common instrument for the exchange of information and ensure that the information timely reaches all concerned Member States. Given its extensive practical experience in operating the DAC, the EU is in a better position than any Member State individually to ensure the effectiveness and completeness of the system for exchanging information. In the evaluation of the DAC, tax authorities have indicated that the common exchange modalities, infrastructure and schemas have led to stronger and more effective cooperation. In this regard, better cooperation also been the outcome of using EU funds (disbursed under the Fiscalis programme), which generated economies of scale and lower transaction costs for tax administrations. The preferred option has to respect the principle of proportionality, i.e. achieving the objectives yet minimising negative consequences for business. The importance of ensuring in particular the proportionality of the initiative has been extensively stressed by business stakeholders. When replying to the public consultation, for instance, the Malta Business Bureau expressed its disagreement with the need for EU coordination on defining what a shell entity for tax purposes is and how it should be treated in terms of taxation. This business association stressed that: “Coordination at EU level must strictly be based on the principles of subsidiarity and proportionality”. The intervention “must comply with a principle of proportionality regarding the objective of fraud repression”, according to the French Association of Large Companies (AFEP). Similar, explicit concerns on the proportionality of the initiative were also raised by the Cyprus International Businesses Association (CIBA), the American Chamber of Commerce in Belgium, the Institute of Certified Public Accountants of Cyprus and the Movement of the Enterprises of France (MEDEF). To ensure proportionality and answer to concerns raised by business stakeholders, the intervention is meant to keep compliance costs to a minimum. Business would need to adhere to a single set of, rather than different, national rules in the EU. This would enhance predictability, provide legal certainty and ensure a common EU defence against tax avoidance via the misuse of shell entities for tax purposes. For a group active across the EU, there would be gains in terms of economies of scale, as all its entities, no matter in which Member State, would need to follow only one and the same set of basic requirements. All affected entities would face the same minimum requirements for substance, which would promote a level playing field and fair competition. In this way, the integrity and functioning of the internal market are likely to be improved.

4.Objectives: What is to be achieved? 4.1 General objectives The general objective of the initiative is to tackle tax avoidance and evasion via shell entities and in doing so contribute to the proper functioning of the internal market and to fair and effective taxation. The initiative would reduce the tax revenue loss caused by tax avoidance and tax evasion through the use of shell entities. When a shell entity has been identified in a Member State, all other Member States will be informed about its existence and can therefore take necessary action by denying tax benefits to the shell entity including cross-border transactions. A tax framework for businesses based on fairness, efficiency and effectiveness can support productive investment and entrepreneurship, while ensuring inclusive and sustainable social protection systems. The initiative will allow Member States to describe and even quantify the extent of the problem of shell entity abuse in a more accurate and comprehensive way with the use of data to be submitted by Member States under the proposal. Ultimately the initiative should also further disincentive the creation of shell entities in the EU. This general objective is rooted in the EU Treaties, fits within the political guidelines of Presidents’ von der Leyen, the mission letter of Commissioner Gentiloni and is in line with several calls for actions made by the European Parliament. 4.2 Specific objectives More specifically, the initiative aims to achieve the following three objectives: First, it aims at introducing, within the EU, common rules to be able to identify shell entities at high risk of tax abuse. Such rules would define objective substance requirements and would ensure that shell entities used for tax abuse can be identified promptly. However, substance requirements alone are not enough to prevent tax abuse. To be effective, the initiative will set clear, pre-determined, common tax consequences throughout the EU in order to prevent tax losses and also to prevent tax and regulatory arbitrage in the EU.

Second, Member States need to know about the existence of shell entities being identified as such in another Member State. This would allow other Member States to take effective and prompt actions to address cross-border tax abuse by, for example, denying tax treaty benefits on withholding taxes paid to the shell entity by a company in their own jurisdiction. Timely availability of information on the existence of identified shell entities, both at national level and in other Member States, will provide Member States with an effective mechanism to prevent shell entity tax abuse in the EU. Third, the initiative aims to disincentive the use of TCSP's from creating shell entities in the EU. If the substance requirements include criteria which aim at counteracting the services provided by TCSP's then demand for their services, for example setting up a postal address for a shell entity, would decrease which would have a significant negative impact on their business model. If successful, the initiative could also translate into higher tax revenues for Member States, compared to a baseline scenario. 5.What are the available policy options? 5.1 What is the baseline from which options are assessed? In a baseline scenario, tax avoidance or evasion through the use of shell entities within the EU would be tackled primarily ex-post, and not prevented, via existing instruments, namely: ·At EU level: with the technical assistance of the Commission, Member States would continue to examine preferential tax regimes in a peer review manner in the context of the Code of Conduct Group, to assess if they are prone to be abused by shell entities not actually conducting the activities targeted by the regime. Legal entities and arrangements that benefit from preferential tax regimes within the EU should have substance, according to the Code of Conduct on business taxation. However, beyond the scope of preferential tax regimes, the issue of substance is unexplored in the EU context and would remain so in a baseline scenario. ·At national level: implementation by Member States of a general anti-abuse rule (GAAR). The GAAR is a last resort measure for tax administrations to stop artificial arrangements or structures to obtain tax benefits. For making use of it, Member States need substantial time and resources, having to look at the objective facts and circumstances of each and every case. ·Implementation of other anti-tax avoidance measures, mainly: limits to interest deductions, controlled foreign company rule, and exit taxation provisions. Such rules do not contain specific requirements for substantial economic activity of legal entities and arrangements as such. ·Member States would also continue to implement domestic measures for effective taxation which, in some cases, include measures targeting the use of shell entities for tax purposes. These are not coordinated. ·Courts would continue to interpret obligations for taxpayers, including legal entities and arrangements, against the framework of existing EU law and case-law. It is likely that such interpretation would continue being linked to the specific circumstances of each case. ·At global level: more than 130 jurisdictions of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) have signed an agreement on the main features of a reform of the global corporate tax framework, comprising of two pillars: a partial reallocation of taxing rights to market jurisdictions (Pillar 1) and the establishment of a minimum effective corporate tax rate (Pillar 2). Pillar 2 is relevant to the assessment of the initiative. Signatories agreed to establish a minimum effective tax rate of “at least 15%” on the profits of multinational companies on a jurisdictional basis, meaning that, in principle, passive income paid to a shell entity established in a Member State should be subject to a 15% tax rate. However, Pillar 2 only applies to multinational companies that meet the EUR 750 million threshold as determined under BEPS Action 13 (country by country reporting), thus leaving all companies below this threshold out of the scope. 5.2 Description of the policy options In addition to the baseline, the following options are presented and assessed: Soft law option (or Option 1): Expanding the mandate and scope of the Code of Conduct Group on business taxation to explicitly tackle the use, by taxpayers operating cross-border, of legal entities and legal arrangements with no or minimum substance and no real economic activities to reduce their tax liability. This soft-law option could also take the form of a dedicated, new Commission recommendation to address the problem. Regulatory options (Option 2, 3 and 4): ·Option 2: Introducing common substance requirements across the EU, obliging (certain) legal entities and legal arrangements – those that would not be carved out from the start and that would pass certain gateways – to demonstrate to the tax administration that they have substantial economic activity in their Member States of tax residence. Lack of substance requirements, if not rebutted, would lead to pre-determined tax consequences, with the determination of sanctions for non-compliance left to the tax administrations. ·Option 3: Common substance requirements as above, backed up by exchange of information. As for the previous option, this option would introduce common substance requirements across the EU along with a definition of tax consequences in lack thereof, leaving the determination of sanctions for non-compliance to national tax administrations. In addition, this option would include the establishment of a mechanism for administrative cooperation and exchange of information concerning shell entities, expanding the existing DAC framework.

·Option 4: Common substance requirements along with tax consequences in lack thereof backed up by exchange of information and a definition of sanctions in case of non-compliances. This option maintains the features of Option 3 above, yet, it also includes sanctions to be imposed by Member States’ tax administrations to entities that do not comply with the new obligations. It is worth emphasising that the regulatory options are cumulative. Option 4 builds upon option 3, which itself builds upon option 2, as shown in Figure 2 below. Option 1 is a soft-law option. Option 0 is the baseline scenario. 5.2.1 Option 1: Non regulatory option With Option 1, tackling the use of entities and arrangements without substantial economic activity for tax avoidance and evasion purposes would continue on a soft-law basis at EU level. This Option 1 could be implemented following two sub-options: in the context of the EU Code of Conduct Group or as a standalone recommendation. 5.2.1.1.Sub-option a): review of the scope of the EU Code of Conduct Group Scrutiny of substantial economic activity is at the core of the work of the EU Code of Conduct Group for business taxation, assisted by the Commission. Yet, the scope of such work at EU level is limited in the context of identified preferential tax regimes. In essence the Group verifies if such regimes include adequate safeguards to prevent their abuse by entities without substantial economic presence. Option 1 would remove the existing limits and explicitly expand the remit of the Code of Conduct Group review beyond the context of preferential tax regimes. As a result, the Group would be entrusted to verify if the general tax framework in each Member States includes rules to prevent abuse by entities without substance. The option would not affect the external dimension of the Code of Conduct Group. The latter would continue to screen third countries and assess their compliance with, among others, substance requirements for offshore structures and arrangements. The Group would do so either in the context of specific regimes or more generally, in the case of zero or almost zero tax jurisdictions. Member States would be primarily responsible for the implementation of this option. The Commission may well play an active role. Yet, ultimately it is only Member States which have the power to decide, at unanimity, whether and how to change the mandate and scope of the Code of Conduct Group. 5.2.1.2Sub-option b): Commission recommendation on substance In a different soft-law option, the Commission recommends a common approach to define what may be considered a shell entity or arrangement for tax purposes and how it should be treated by Member States. It could also encourage Member States to exchange information on findings regarding shell entities. In the past, the Commission has made use of recommendations in the tax area, most recently with its May 2021 recommendations on the domestic treatment of losses. Institutionally, the recommendation would be an initiative by the Commission, adopted by the Commission and addressed to Member States. Key differences Sub-option 1 a) Sub-option 1 b) Form / instrument Revised mandate of the Code of Conduct Group Commission recommendation Decision-making Consensus by all Member States Commission’s own initiative 5.2.2 Option 2: EU wide common substance requirements This policy option is the first and most basic scenario of a trio of regulatory options aiming at enhancing, in the area of taxation, the anti-avoidance and evasion tools available to Member States. Options 3 and 4 build on this basic scenario, including in addition further obligations for tax administrations, in terms of exchange of information, and a common approach on sanctions. This option would establish a set of minimum substance requirements common across the European Union. It would introduce a common understanding of what constitutes a shell entity for the purposes of this tax initiative. It would allow tackling their use for tax purposes by defining the implications (tax consequences) of such findings. The introduction of substance requirements takes stock of existing experience, within the EU and internationally, on assessment of substance. As mentioned above, under Option 1, Member States have been using substance requirements to assess harmful tax regimes in the EU as well as in international fora. The substance requirements put forward in the context of this Option 2 (and subsequently Options 3 and 4) are in line with the standards used so far. Hence the actors involved, namely Member States, taxpayers, tax administrations, international partners, should be familiar with this notion. They should find relatively straightforward to implement it in relation to new concepts. In the same vein and taking into account that there is no commonly accepted definition of what is a shell entity, definition of substance requirements could offer a more familiar and acceptable approach to distinguish between shell and non-shell entities. In this context it is acknowledged that substance requirements have been established primarily in the context of traditional business models and may be less apt when it comes to digital business models. Nevertheless, it must also be acknowledged that digitalisation of the economy is an ongoing process, which has altered the way business is done but not overhauled it yet: a certain physical presence seems to still be essential today and cannot be disregarded, at least not at the present stage. Furthermore, this option, which constitutes a proposal for a directive, is consistent with actions recently taken in the EU in order to tackle tax avoidance. Namely this action builds on and follows up to the 2016 ATAD directive, as well as to the DAC as amended. It is nevertheless proposed as a standalone measure in order to allow, on the one hand, for a scope broader than the one of ATAD and, on the other, for the introduction of specific tax-related consequences that go beyond the mere reporting and/or exchange of information under the DAC. As a result, this option is envisaged to complement the existing EU directives, seeking to tackle tax avoidance and evasion through a specific practice identified to be used for tax avoidance or evasion purposes. 5.2.2.1 Carve-outs and exemptions As the aim of this initiative is to tackle tax avoidance and evasion, situations or arrangements where no tax avoidance and evasion is expected to take place should not be burdened with the consequences of this initiative. As with previous initiatives in the area of tax avoidance and tax evasion, certain categories were carved out in order not to unnecessarily involve these businesses as these are not the ones targeted. For example, listed companies are subject to important transparency obligations already. Therefore, they are assumed to pose a relatively low risk of being exploited as shell entities for tax purposes. Equally, a low risk seems to arise with those holdings located in the same jurisdiction as their shareholder. Similar carve-outs are used by a) the Code of Conduct Group when it verifies regimes including substance requirements in Member States and in third countries and b) the OECD Forum for Harmful Tax Practices which has a similar task at international level. These have been verified against and enhanced with the input from the public consultation, where contributors were asked to indicate specific structures that should be carved-out because they do not raise tax risks but are put in place for good commercial reasons, such as joint ventures.

However, carve-outs are general rules and might not preclude a genuine business from falling in scope of the initiative. Such business should be given the chance to evidence that lack of tax motives in its structure and obtain an exemption. An exemption mechanism should therefore complement the carve-outs. The exemption shall apply both for the required reporting and the tax consequences of the initiative. Entities that pass the gateways and/or do not have the minimum substance can choose to apply for an exemption. As the gateways provide further focus on the type of activities/income it is expected that the entity will be pre-dominantly involved in intra-group transactions, an exemption should then only be granted if the interposing of the entity does not provide for a lower overall tax burden for the group of companies it is part of. Carve-outs envisaged in Option 2 (I)Companies of which the principal class of shares is regularly traded on one or more recognised stock exchanges. (II)Regulated financial undertakings. (III)Businesses whose main activity is holding shares in operational businesses in the same Member State while their beneficial owners are also resident for tax purposes in the same Member State. (IV)Undertakings with at least 5 own full time employees exclusively involved with the activities generating the relevant income and having the necessary qualifications. 5.2.2.2 A gateway to focus on the highest risk Entities not carved out and not exempt otherwise would have to fulfil certain requirements or “gateways”. These requirements have been chosen on the basis of evidence according to which shell entities typically do not produce goods nor provide services. Therefore it can be expected they mainly earn passive income, are used as part of tax structures involving several jurisdictions, do not employ staff or do not have offices, etc. To reflect these characteristics, the gateways of Option 2 include: 1.The first gateway looks at the type of income to single out entities with geographically mobile activities. The latter means essentially that the entities that earn more than 75% of their income in the form of passive income (such as interests, royalties, dividends, rents or similar) would pass this gateway. 2.The second gateway seeks to identify a cross-border element as tax risks from shell entities are expected to arise in situations involving more than one taxing jurisdictions. 3.The third gateway focuses on the (lack of) resources necessary to carry on a business activity, i.e. staff, premises, equipment and singles out entities in need to rely on outsourcing of core activities (corporate administration and management or). Entities and arrangements meeting all the three gateways should report to the tax administrations on whether they meet a set of substance indicators and provide evidence. The key policy rationale for including gateways are part of the regulatory option is the attempt at a balancing act between on the one hand the policy objective of tackling tax avoidance and tax evasion through shell entities on the one hand; and, on the other hand, the attempt at avoiding a disproportionate burden on the private sector. 5.2.2.3 Minimum substance After an entity has crossed all the gateways, such entity would be asked to: a) run a self-assessment about whether it meets basic minimum substance criteria; b) to report to the tax administration where it is resident for tax purposes the results of such self-assessment. It is challenging to define what substance amounts to. Option 2 proposed here would include the following substance indicators: 1.The entity has own premises in the Member State where it is resident for tax purposes. 2.The entity has at least one own bank account in the EU. 3.One or more directors of the entity are resident for tax purposes in the same Member State of the undertaking, or close enough to ensure they are able to fulfil their duties, and are qualified and authorised to take decisions in relation to the activities that generate relevant income for the undertaking. In selecting the specific substance indicators, existing international and EU standards on assessing substantial economic presence for tax purposes have been taken into account. The latter have been developed and are applied by the OECD Forum on Harmful Tax Practices and the EU Code of Conduct Group. These standards focus on the existence of staff, premises and equipment that are essential to perform an activity. Given the geographically mobile nature of the activities in scope, equipment could be a non-appropriate requirement. At the same time, it is recognised that lack of own bank account is a key feature of shell entities used for evasion and avoidance of taxes, as also indicated by the results of the public consultation for this initiative. 5.2.2.4 Tax consequences Where an entity reports that it does not have the substance indicators set above, tax consequences would be triggered, to be specified under this option. Consequences would be triggered only if the entity fails to meet all minimum substance criteria. The indication of specific tax consequences is a new feature that complements existing EU anti-tax avoidance rules regarding a lack of substance situation. In addition to the interplay of carve-outs, gateway and substance indicators that would allow authorities to identify only those entities that are shells misused for tax purposes, taxpayers identified as shells should still be able to provide counter-evidence through a rebuttable presumption before consequences apply. This would allow the tax administration to make an individual assessment based on the facts and circumstances of each case. Should a tax administration ascertain that the taxpayer has substantial presence despite indications to the contrary, it would be able to certify so and relieve the taxpayer from the consequences.

A mechanism to monitor implementation of the measures in Member States (via reporting by Member States to the Commission) should also be envisaged. This is particularly important because the identification of shell entities and the application of consequences lies with the Member State of tax residence of such entities. As, in many cases, the Member States whose tax bases are eroded through the use of shell entities are different from those where the shell entities are tax resident. A monitoring mechanism should thus provide incentives for all Member States to apply the measures appropriately. 5.2.3 Option 3: EU wide common substance requirements accompanied by provisions for administrative cooperation 5.2.3.1 Overview This option would build on the previous one. However, on top of option 2, it would envisage an EU wide mechanism for administrative cooperation and automatic exchange of information between tax authorities. Since 2011 and the adoption of the Directive on Administrative Cooperation (DAC), the EU has made large progress in the field. While there remains scope for improvement, administrative cooperation and in particular exchange of information has empowered tax authorities with a key resource – information – needed to ensure cross-border tax compliance in a highly dynamic and integrated economy as the EU internal market. The administrative cooperation element of this option would build upon, and complement, existing DAC mechanisms and tools. Currently, Member States can use the DAC to check the status of entities which are tax residents in other Member States but such mechanisms are not automatic. A Member State needs to ask another Member State for information. This is referred to as exchange of information on request. The requested Member State has up to six months for answering. In practice, responses are far from immediate and in some cases provided later than six months. This option would push administrative cooperation one step further by obliging tax authorities to automatically inform each other about whether entities in scope which are tax resident in their jurisdictions fulfil the substance requirements or not. The basic flow of information would work in two steps: first, the entity will send its self-assessment (about whether it fulfils substance requirements or not) to the tax administration of the Member State where it has its tax residence. Second, the tax administration will upload the self-assessment, including its conclusion (whether an entity fulfils or not substance requirements) in a shared directory for all other tax administrations to be able to read. By introducing automatic exchange of information mechanisms, this option would enable all Member States concerned, e.g. because they are the place of tax residence of an entity belonging to the same group of the one having sent its self-assessment, to have information available on a timely basis in order to apply correctly the envisaged tax consequences. In addition, this could encourage Member States’ tax administrations to implement properly and timely the obligations envisaged by the new initiative. 5.2.3.2 Ensuring effective cooperation Effective cooperation, including information exchange, between tax authorities would be ensured first of all by checking that data exchanged is accurate, complete and sent within the deadlines. Moreover, it is essential for effective cooperation that Member States make use of the information they receive. However, effective cooperation does not depend only on Member States. The Commission has a role to play. The Commission is responsible to check the correct legal transposition of provisions concerning administrative cooperation, among others. Furthermore, it is the Commission that needs to monitor how the system of information exchange is implemented and how effective it is in practice. As part of the monitoring of tax cooperation between Member States, and separately from this initiative, the Commission is planning to conduct on the spot visits in the Member States to monitor effectiveness. The initiative will include specific monitoring provisions, as outlined in Chapter 9. Effective cooperation will also depend on the quality and quantity of resources allocated. A regulatory intervention is expected to provide a strong incentive (and stronger than in the case of a soft-law option) for Member States to ensure that adequate resources are dedicated to effective cooperation. Monitoring by the Commission will allow to assess to what extent resource allocation is fit for meeting the objectives of the intervention and whether its implementation leads to effective cooperation, including effective and useful information being exchanged. 5.2.3.3 Information exchange and personal data Information exchanged will consist in the information reported by entities to tax administrations through their self-assessment of minimum substance. It will comprise primarily information about the entity. However, Member States will also receive personal data, i.e. only what is necessary to identify the beneficial owner(s) of the entity. Interference with the fundamental rights to privacy and to the protection of personal data must be necessary and proportionate. Personal data are protected under the General Data Protection Regulation (GDPR). The processing of personal data must comply with the applicable data protection legislation (including with principles such as legality, data minimisation and purpose limitation, security etc.). The Directive on Administrative Cooperation includes specific provisions and safeguards on data protection. However, any legal intervention based on further amendments to this Directive will have to comply with GDPR. Each time personal data is processed, there is a risk of a data breach, e.g., a data leak or an unauthorised disclosure. The most efficient way to reduce such risks is to reduce the amount of personal data processed (data minimisation principle). This is also the approach followed by this intervention. The vast amount of data exchanged within the meaning of this Directive will concern legal entities and not individuals. Personal data will represent only a small fraction of the exchange of information flow. Member States will also have to comply with GDPR with regards to the processing of data in their national systems. As data controllers they will have to implement appropriate technical and organisational measures to ensure and to be able to demonstrate that processing is performed in accordance with the GDPR. The exchange of the data will occur through a secured electronic system that encrypts and decrypts the data and, in every tax administration, only authorised officials should access the information. 5.2.4 Option 4: EU wide common substance requirements accompanied by provisions for administrative cooperation and a common sanctioning framework This option would build on Option 3 with the addition of one more element: a common sanctioning framework, targeting non-compliance by the entities in scope. Given that the initiative establishes reporting obligations for entities and relies on the actual reporting of these entities for its effective implementation, it is important to ensure that such entities do report. This option would be enhanced in this direction, compared to the other two regulatory options. It would define specific, monetary sanctions that Member States’ tax administrations would apply to entities that do not properly comply with their obligations. Having a basic, common EU sanctioning framework would provide a better guarantee that sanctions are dissuasive and proportionate, while maximising certainty for taxpayers. Any sanctions should be proportionate and non-discriminatory under EU law. 5.3 Options discarded at an early stage As part of the process for identifying options, some alternatives have been considered and discarded upfront, for different reasons.

The introduction of a ban to shell entities was discarded almost at the start for the following key reasons: first, as said also earlier in this impact assessment, shell entities and the lack of a universal definition of what is a shell entity are not problems per se. Problems emerge from a tax perspective when they are used for tax avoidance and evasion purposes. It is evident that there are legitimate reasons why entities, including legal arrangements may exist without conducting any substantial economic activity. As pointed out by one stakeholder: “ (…) there are good commercial reasons for the use of special purpose vehicles, in particular in secured lending, securitisation, insurance-linked securities and similar transactions.” An EU-wide prohibition of shell entities would be a disproportionate and potentially costly measure, which could also be contrary to the fundamental freedoms, and in particular the freedom of establishment, in the single market. Secondly, the political and legal feasibility of such a ban appears thin. The option of regulating intermediaries, such as in particular trust and company service providers, who enable the set up and maintenance of shell entities is another measure considered, as alternative or complementary. Such measure could function to discourage, in an indirect manner, the creation and maintenance of shell entities. However, action in this direction was discarded for three main reasons. First, as an EU-wide measure, this would regulate only intermediaries / service providers with a link to the EU but would not prevent the use of third country persons. Second, groups of enterprises would still be able to use associated enterprises in the role of intermediaries / service providers and would not need to have recourse to external, regulated persons. Third, such measure could risk being disproportionate in relation to its objective: it would be too broad a solution for a specific problem. Furthermore, this assessment has also discarded options focussing on corporate tax rates or VAT, as put forward, for instance, by respondents to the publication for feedback on the inception impact assessment. Namely, one respondent suggested to harmonise and to lower the corporate tax rate (the contribution is not specific here, the assumption is that reference is made to the corporate tax rate) in order to reduce, arguably, incentives for tax avoidance and risks of non-compliance by taxpayers. Leaving aside considerations of legal feasibility, this option seems in any case disproportionate to the specific problem at hand, that is to say the misuse of shell entities for tax purposes. Another respondent called for introducing one single corporate tax rate and to use turnover as tax base. In the same vein, the option to harmonize withholding taxation (WHT) on outbound payments from Member States has been discarded. The lack of harmonized WHT was in particular cited in the context of the public consultation by the IBFD as one of the drivers for the use of shell entities in the internal market for tax abuse. Yet, a measure towards harmonization of WHT would imply a significant intervention in the freedom of Member States to define their tax rules, which would be disproportionate solution to the problem at hand. Another discarded option from the feedback on the inception impact assessment, would entail stricter regulation and oversight of e-commerce. While sales via e-commerce contribute to certain companies’ profits, such option is not directly relevant to tackle the problem at hand, namely the misuse of shell entities for tax avoidance or tax evasion. 6.What are the impacts of the policy options? 6.1.Introduction The section is organised as follows. First, there is a brief introduction on the typologies of impacts considered in the analysis. Second, the impact on SMEs is considered. Third, the impact of each option, including the baseline, is assessed in terms of: a) regulatory charges; b) administrative burdens for businesses; c) enforcement costs for tax administrations; and d) direct and indirect benefits. Certain types of costs as well as the impact on the environment are not assessed, for the following reasons: ·Substantive compliance costs are not assessed because no equipment, labour, materials or external services will be necessary to comply with the intervention. Businesses will incur only administrative burdens or non-substantive compliance costs, due to the nature of the information requested. Requested information should be readily available for them, thus limiting the costs of compliance to processing of information. ·No impact on the environment can be readily identified. The proposal does not have an environmental policy dimension and is aimed at behavioural changes that would affect financial flows. 6.2.Impact on Small and Medium Enterprises (SMEs) The impact on SMEs producing and selling goods and services is expected to be negligible if any. As the definition of SME is based on thresholds of number of employees, turnover and total balance sheet, it would be possible that some shell entities would fall under this definition (e.g. a shell entity with no employee, EUR 50 million turnover and EUR 40 million onto the balance sheet could theoretically qualify as a SME). However, this definition should not be interpreted rigidly: the initiative aims at covering those entities that do not have substance and are set up to avoid or evade taxation.. The criteria that trigger reporting obligations to the tax authority are strictly limited to companies with a high risk of practising tax avoidance or tax evasion, which is expected to cover only a very small proportion of the SME-defined population. The gateway criteria (see section 5 above) are expected to exclude the vast majority of SMEs (e.g. to fall in scope, a SME should have most of its revenues from passive income, be owned mainly by foreign owners and have outsourced essential aspects of its operations). Another possibility is that SMEs use shell entities to carry activities in the EU. The population of SMEs using shell entities is expected to be negligible. In addition, and importantly, it is not possible to assess the specific impact on SMEs given the lack of data. As shown in this impact assessment, the lack of data makes it a complicated and inaccurate exercise to quantify the use of shell entities by businesses in general, and impossible to differentiate between SMEs or larger companies, something this initiative would improve. When it comes to SMEs, also the findings of the public consultation are of limited help in terms of impact assessment. Respondents are divided on how to include SMEs in the scope of a possible regulatory initiative to tackle tax avoidance or tax evasion via shell entities. Eleven respondents indicated that there is no need for specific rules for SMEs, while ten indicated that a threshold could be used to exclude SMEs from the scope. Hence, the negligible impact expected on SMEs, both in terms of SMEs qualifying as shell entities and SMEs using shell entities, and lack of data to allow us to assess the specific effect on SMEs, justify the lack of an in-depth assessment of the specific impact on SMEs. 6.3.Data limitations and assumptions The analysis in this section builds on limited evidence. The initiative addresses a certain type of entities for which there is a severe lack of data. For shell companies, no data is available as such. Indeed and relatedly, there is no universal definition of shell entities and no commonly agreed way of giving them a legal qualification. It is thus difficult to distinguish between entities with substance and actual operations and a “shell”. All this generates a high level of opacity surrounding these entities. Nonetheless, a relatively wide range of data sources is used to try and quantify the impact of the problem. These including: a) international organisations (Eurostat, OECD and IMF); b) commercial databases (ORBIS); c) journalistic sources (OpenLux) and d) academic literature, including contacts with scholars in the field. For a detailed analysis it would be key to estimate the number of entities in scope, i.e. those that will pass the gateway criteria and will have to report and, in a second step, those that could be identified as “shell” as a result of applying the substance test. However, there is no data source available that allows a reasonable estimation of the effect of the gateway criteria and substance test on the number of entities in scope. For this reason, impacts presented in this section will rely often on assumptions, partial data or circumstantial evidence and should be treated with caution. 6.4.Option 0: the baseline scenario (no change)

Tax avoidance and tax evasion through shell entities continue to occur in this scenario. As said, shell entities can take the form of companies, trusts or foundations settled in an EU country with revenues coming in from (or revenues going out to) a third country. Such structures’ main purpose may well be business-related. As already indicated, there are many legitimate reasons why shell entities are set up. However, the end result of having financial flows going through a shell entity may be to decrease its owner’s tax liability, for instance by hiding assets and income from the jurisdiction where owners are tax resident and where tax rates are comparably high. Recent literature shows that MNEs may also use shell entities, mostly finance and holding entities, to decrease their effective tax rate, over and above other (and main) legitimate commercial reasons. As pointed out earlier, DAC and ATAD have tackled some main tax abuse, but there is still a lack of commonly shared substance criteria to ensure that tax advantages are not granted abusively. The ongoing reform of the