Anti-Tax Avoidance Directive
The fight against tax avoidance is not new. In fact, it has been around since biblical times. Yet in recent years, multinationals are being faced with mounting pressure to contribute their fair share of taxation in those economies where they are conducting their business activities.
The Organisation for Economic Cooperation and Development (OECD) published its Base Erosion and Profit Shifting (BEPS) action plans in the fourth quarter of 2015, and the EU Commission responded in January 2016 by publishing the Anti-Tax Avoidance Package as part of its agenda for fairer and more effective corporate taxation in the EU. Initially, the Anti-Tax Avoidance Directive was opposed by a number of Member States, yet towards the end of June, after months of negotiations, the Economic and Financial Affairs Council (ECOFIN) reached an agreement.
The approved directive lays down four measures, which as a minimum, Member States should transpose into domestic laws by 2018. A fifth measure, covering exit taxation is to be transposed into domestic law by 2019.
The key provisions of the directive are the following:
The Interest Limitation Rule limits the borrowing costs to 30% of EBIDTA. However, by way of derogation, a taxpayer may be given the right to deduct exceeding borrowing costs up to a threshold of EUR3m or to fully deduct exceeding borrowing costs if the taxpayer is a standalone entity. Under this rule, Member States also have the following options:
- New loans or those loans used to fund long term public infrastructure within the EU may be excluded from this rule;
- To allow taxpayers to deduct in full or in part exceeding borrowing costs subject to the satisfaction of group gearing ratio conditions;
- To carry forward or backwards exceeding borrowing costs; and
- To exclude financial undertakings from the scope of this rule.
- Under the Exit Taxation Rule, a taxpayer, at the time of exit of the assets from a particular EU member state, will be subject to tax at an amount equal to the market value of the transferred assets less their value for tax purposes. These rules would apply when a taxpayer transfers their tax residence to another Member State or to a third country, or alternatively transfers assets or business between head office and permanent establishment. Member States may give the right to defer the payment of an exit taxation by paying it in installments over five years in specific circumstances, yet such deferment comes at a cost since interest may be charged;
- Through a General Anti-abuse Rule, Member States have the right to ignore any arrangements which have been put into place for the main purpose of obtaining a tax advantage that defeats the objects of the applicable tax law and are not genuine;
Through a Controlled Foreign Company Rule, Member States can treat an entity or a permanent establishment as a controlled foreign company, and thus have the right to tax such profits as per domestic tax rules. These rules apply where the following conditions are met:
- The tax payer or together with their associated enterprises hold a direct or indirect participation of more than 50% of the voting rights, capital, or right to profit distribution; and
- The actual corporate tax paid on the profits of an entity or a permanent establishment is lower than the difference between the corporate tax that would have been charged on the entity or permanent establishment under the domestic tax system and the actual tax paid on its profits by the permanent establishment or entity. Member states may apply certain carve outs, such as cases of substantive economic activity and certain de minimis cases.
- Finally, rules addressing hybrid mismatches have also been included, whereby it is stated that deduction shall be given only in the Member State where such payment has its source.
How the above rules will affect Malta and its financial sector is difficult to predict at this stage. It is true that Malta has long had a wide and far reaching general anti-avoidance measure in the income tax act, similar to the proposed General Anti Abuse Rule and thus this rule should not come as a shock to practitioners. Moreover, the concept of arm’s length invoicing has also long been advocated by practitioners in financial services and the above rules do also clearly imply the need for this. Transfer pricing assignments will probably be a certainty for Maltese companies in the coming years.
One may also contend that EU case law has long questioned the legality of introducing exit taxes. It is in fact felt by European Courts that such taxes hinder one of the basic principles on which the EU has been built, being that of a single market avoiding barriers to entry. Introducing a tax barrier simply because one opts to move his assets from France to Malta, for example, would seem to erode the basic fundamentals of a single market. Other points to make focus around substance and the need to create much more real value in companies established in Malta. In recent years, locally, there has indeed been an overall general improvement in this area.
The interest rate rule is also interesting and one which will strive to ensure that low capital, shareholder financed groups rethink their financial strategy. This gives rise to the need for financial practitioners to advise their clients accordingly.
In conclusion however, and quite importantly, these rules are not expected to adversely affect Malta’s Full Imputation Tax System, a methodology unique to Malta to eliminate double taxation.