By Jose A Bustos, EY BEPS Tax Desk Leader
After much anticipation and planning, the deadline for implementation of the European Union (EU) Anti-Tax Avoidance Directive (ATAD) is quickly approaching. Depending on where a company operates, the changes could be sweeping or more like business as usual.
While some Member States took quick action or already had many of ATAD’s minimum standard provisions in place in domestic law, others at this time still have no provisions in place. The last few months have seen a flurry of activity, which is expected to accelerate at year-end, with more than 70% of Member States having at least three provisions to implement.
Companies operating in the EU need to be prepared for these new changes, as most of ATAD I is scheduled to be fully implemented and in effect beginning in January 2019. While not as imminent, ATAD II, addressing hybrid mismatches with third countries, is also being implemented and will be in effect as of 1 January 2020.
- ATAD I established a minimum standard for Member States to implement with respect to five areas:
- General Anti-Abuse Rule (GAAR) — applies to arrangements with a main purpose of obtaining a tax advantage that circumvents otherwise applicable tax provisions and are non-genuine when considering all relevant facts and circumstances
- Interest deductibility limits — apply to limit the deduction of exceeding borrowing costs to 30% of taxable earnings before interest, taxes, depreciation and amortization (EBITDA) with several optional provisions such as grandfathering of existing loans and carryforward and carryback options
- Controlled Foreign Company (CFC) rules — apply to attribute certain income to a parent taxpayer when a subsidiary (or permanent establishment) is more than 50% controlled by the parent company and the CFC is in a lower tax regime
- Exit taxes — apply in certain circumstances in which a Member State imposes a tax equal to the market value of the transferred assets, at the time of exit, less their value for tax purposes
- Hybrid mismatch rules — apply when a taxpayer arrangement results in a double deduction or a deduction without income inclusion due to differences in the legal characterization of a financial instrument or entity
ATAD II, a set of additional requirements over and above the original ATAD package, establishes minimum rules to neutralize hybrid mismatches where at least one of the parties is a corporate taxpayer in an EU Member State, thus expanding ATAD to third countries. ATAD II also addresses hybrid permanent establishment (PE) mismatches, hybrid transfers, imported mismatches, reverse hybrid mismatches and dual resident mismatches.
Progress of implementation
The progress of implementation in the region varies, with only two countries, Belgium and Slovakia, fully implementing ATAD I and II to date. At the other end of the spectrum lies the Czech Republic, which has not implemented any ATAD I or II measures and does not have a GAAR in place. Most Member States are somewhere in the middle, with most having three or more measures to address.
Considering implementation by measure, our research shows that:
- A full 50% of Member States have enacted a domestic GAAR that meets or exceeds the minimum standards agreed upon in ATAD I.
- Approximately 20% of Member States have no interest deductibility limitation in place, while 50% have a domestic rule in place that does not fully meet the minimum standards of ATAD I and the remaining 30% have a satisfactory interest deductibility limitation in place.
- Approximately 30% of Member States have no CFC rules in place, while 50% have domestic rules in place that do not fully meet the minimum standards of ATAD I and the remaining 20% have satisfactory CFC rules.
- Member States are split on the imposition of an exit tax, with 30% having no such tax in place now, 45% with a tax not meeting the minimum requirements of ATAD I and 25% with an appropriate tax imposed.
- Implementation of the hybrid mismatch rules really falls behind the other areas, with only 14% (four countries) fully meeting the minimum standards of ATAD I and 32% and 54%, respectively, with no rules in place or rules that do not meet the minimum standard.
Implementation of ATAD II, not surprisingly as it is not due until 2020, lags far behind the other areas with 86% of Member States having no rules currently in place, 3% with something in place and just 11% with ATAD II minimum standards fully implemented.
Timing and impact of implementation
Member States agreed to implement ATAD I, transposing it into national laws and regulations, by 31 December 2018, with the exception of exit taxation rules, which they have until 31 December 2019 to implement. They then have until 1 January 2020, with an effective date of 1 January 2022, to implement ATAD II.
As is observable, for certain Member States the implementation of ATAD I and ATAD II will result in sweeping changes that will be felt by businesses in a myriad of ways. The biggest changes will occur in countries that had none of the provisions previously enacted in domestic law.
The task of implementation may seem daunting at this point, with so many Member States having so much work to do. For many countries, this will be reflected in the issuance of draft legislation in November or December of each year, with a flurry of final votes over the Christmas holiday period in legislative bodies to be certain that laws can be enacted on 1 January for the coming year. As previously mentioned, some Member States already have drafts in circulation that may be added to other impending legislation such as the budget. Other Member States are expected to release draft bills in the coming summer through autumn months. Voting on legislation is expected to occur before year-end.
It is important to note that while Member States are determining their path of implementation and how stringent to make their rules, they do not operate in a vacuum. Member States must consider other factors in the world, such as US tax reform. The combination of lower US tax rates and tighter CFC rules in the EU will result in changing incentives, and companies may no longer flock to certain nations as favored locations for their subsidiaries.
With such large changes occurring across the EU, companies operating there should be prepared for a new dynamic. The level of tax controversy will certainly increase as Member States not only implement ATAD in legislation, but also with more detail to come in regulations. Companies should include these changes in their planning process and be aware of potential structures no longer being available to them. It may behoove companies to seek advance rulings (where still available) from Member States for potential transactions.
Companies operating in the EU need to get ready before these new changes take place beginning in January 2019. Planning processes may be complex, and companies should seek assistance whether entering agreements now that may qualify for grandfathering or requesting advance rulings for structure changes.
As many business structures may be impacted by the ATAD, companies should evaluate their existing financing, IP and supply chain structures as higher effective tax rates may result due to a cap on interest deductions, restricted deductions in hybrid situations, the myriad of CFC rules (completely new to some Member States) and higher tax costs on transfers of assets and migrations within and out of the EU.
All in all, companies should pay close attention to the impending implementation of ATAD I, and to a lesser extent ATAD II, this fall and over the new year.