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Ivan Fučík | November 17, 2016

New EU Directive Preventing Tax Avoidance

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On 12th July a new directive preventing tax avoidance was approved; this directive is included in the  European packaging which aims to strengthen the rules of fight against tax avoidance by corporate bodies. The measures that are being prepared stem from a suggestion by the OECD (Organization for Economic Co-operation and Development) from 2015 on how to solve the problem of base erosion and profit shifting (BEPS).

Main goals the European Council set for the fight against tax avoidance are:

  1. To prevent aggressive tax planning,
  2. More transparence,
  3. To create a fairer environment for businesses in the EU.

To reach these goals it is necessary, according to the European Council, to set such rules, that will minimize situations, in which groups of companies lower their global taxes using the different national tax systems to their advantage. For this purpose the Anti-Tax Avoidance Directive has been adopted and also to set rules in the following areas: (i) limitations of deductibility of interest, (ii) exit taxation (re-location of assets), (iii) a general rule against abuse of a tax regime, (iv) a rule for controlled foreign companies and (v) a rule addressing hybrid structures (inconsistencies).

Limitations of deductibility of interest

To limit transferring of profits to other countries through debt financing and interest payments the directive relies on the so-called limitation of deductibility of interest. This rule consists of limitations on tax eligibility of interest either of the amount of:

  • 30 % of taxpayer’s earnings before interest, taxes, depreciation and amortization (EBITDA), or
  • 3 mil EUR, where this amount regards the whole group.

However, if a taxpayer who is a member of a consolidated group proves that the ratio of the equity to the total assets is the same as that of the group or higher, the taxpayer has the right to apply interest in full. Similarly, the limitations of tax eligibility of interests are not applied to cases in which the subject stands outside of a group.

Czech tax legislation currently contains a rule which limits the deductibility of interest from the tax base called the thin capitalisation rule. The limitation regards interests payed between connected bodies while the amount of the interest, which may be deduced from the tax base, is limited by the ratio of the number of loans accepted to four times the equity (six times in the case of banks and insurance companies.

Exit taxation

This article is a reaction to the lowering of taxes by relocating assets to a state with a lower tax burden while the owner of assets stays the same. As according to the new rules, such relocation of assets will be viewed as sale, regardless of whether the assets are being relocated to a different member state or to a country outside of the EU. The tax amount calculations will be based on the market value of assets relocated.

General rule against abuse of a tax regime

With this article the EU is trying mainly to prevent big multinational corporations from tax optimization, which is in the words of the EU based on artificially constructed transactions with no economic substance. These operations are often called aggressive tax planning. The aim of this rule lies in the implementation of a general rule against the abuse of the law. Thus, if the main reason for a transaction is only to obtain tax benefits, tax authorities have a right to deny the subject these benefits.

Rule for controlled foreign companies

This regulation is aiming to discourage multinational corporations from artificial transfer of profits into states with low taxes and this way lowering their global tax obligations. The main idea of this regulation lies in assigning the profits of a subsidiary, which is subject to lower taxes, to its parent company. The parent company must then pay the income tax from the assigned income in the state where the head office is situated. The parent company, in this case, is a subject which has - either by itself or with its associates – direct or indirect participation consisting of more than 50 % of voting rights.

Hybrid structures (inconsistencies)

The aim of this regulation is to prevent situations where, thanks to inconsistencies in legal systems of two states, the tax is either deducted in both states (so-called double deduction) or in one state without including the profits in tax base in the other state (so-called deduction without inclusion).

The Anti-Tax Avoidance Directive will come into force on the twentieth day after its issuance in the Official Journal of the EU. The articles of the directive must subsequently be implemented into the tax systems of individual member states by 31st December 2018 the latest, except for the exit taxation rule , for the implementation of which the latest deadline is 31st December 2019.

By: Ing. Štěpán Hrubý