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Thursday, 10 February 2022

Proposal for new European directive: the end of entities with little substance?

On December 22, 2021, the European Commission published a potentially far-reaching proposal for a new directive. The aim of this proposal is to "tackle the misuse of undertakings that do not perform any actual economic activity". The directive itself uses the term "shell entities". If an entity is targeted, the application of this directive can have a significant administrative and tax impact on the entire structure. The current proposal potentially affects a large number of taxpayers in different sectors, from private estate structures, internationally active groups with intermediate holding companies to certain fund or financing structures (e.g. private equity, venture capital,...). We discuss the proposal briefly here below. For more details, we encourage you to access the Newsflash of the European Tax Law Center of WTS Global, the international network of which Tiberghien is a member, and co-authored by our colleague Rik Smet.

Undertakings “presumed not to have minimum substance”

First of all, the draft directive tries to identify, based on a number of indicators (in the directive referred to as ‘gateways’), which entities are presumed to have limited substance and therefore, according to the draft, are at risk of being misused for tax purposes (for the time being, only entities that are tax resident in the EU fall within the scope of the directive). The relevant criteria are as follows:

  • More than 75% of the income (or of certain assets) of the undertaking consists of "passive income" in the preceding 2 years (i.e. interest, royalties, dividends, capital gains on shares, real estate income, other income from private assets worth more than EUR 1 million);

  • The majority of the relevant income originates from cross-border transactions (60% of revenue streams or of certain assets); and

  • The undertaking has outsourced the administration of day-to-day operations and the decision-making on significant functions in the preceding two years.

When an entity meets these cumulative criteria, it will become subject to certain additional reporting obligations. The entity will have to indicate in its annual tax return and demonstrate with supporting documents / evidence (i) whether it has its own premises or premises at its exclusive use for its activities in its residence state, (ii) whether it has at least one own and active bank account in the EU and (iii) whether it has directors and/or employees fulfilling a number of criteria (including being resident in, or close to, the resident state of the entity). The directive provides for a fine equal to at least 5% of the turnover of the entity if it fails to comply with this reporting requirement. Information obtained by a Member State as a result of an entity meeting the aforementioned criteria will be automatically exchanged between Member States.

If the entity cannot provide sufficient proof it is presumed to be an “undertaking not having minimum substance". The entity can rebut this presumption either by disclosing more detailed documentation and information (listed in the directive) or by demonstrating that the structure does not reduce the tax liability of the beneficial owners or of the group as a whole. If the presumption cannot be rebutted, the characterization as an “undertaking not having minimum substance" can have significant tax consequences (see below).

The directive explicitly excludes a number of undertakings from its scope. Important in this respect is that entities with at least 5 own full-time employees or staff members cannot qualify as “undertakings presumed not to have minimum substance”, provided that these people are exclusively carrying out the activities generating the relevant income. Certain holding structures within the same Member State are not targeted either. In addition, the draft directive provides for a whole series of specific exclusions, mainly for the financial sector (banks, insurers, listed companies, pension funds, etc.). UCITS and AIF funds are also excluded.

(Tax) Consequences of qualifying as an “undertaking not having minimum substance”

Qualification as an “undertaking not having minimum substance" has important tax consequences:

  • Member States, other than the Member State of the entity, should refuse the tax advantages that might otherwise be granted in transactions with the company under a double tax convention, under the Parent-Subsidiary Directive or under the Interest-Royalty Directive (e.g. exemption from, or reduction of, withholding taxes).

  • If the shareholders of the entity are tax resident in an EU Member State, the income of the company has to be taxed directly in their hands (some sort of CFC approach), with a credit/deduction for the tax paid in the Member State of the entity.

  • The Member State of the entity will be obliged to deny a request for a certificate of tax residence (or provide an amended one), meaning, inter alia, that double taxation conventions between this Member State and other states can (in most cases) no longer be invoked.

This far-reaching tax impact could make working with entities meeting the above-mentioned criteria disadvantageous and/or burdensome. We therefore recommend to thoroughly examine existing group structures and analyse the potential ATAD 3 impact.

Entry into force

The current version of the proposal foresees an implementation in national law by June 30, 2023, and an entry into force on January 1, 2024. It remains to be seen whether this proposal, in its current form, will be accepted by all Member States, and whether this deadline will be met. Please note that, if these deadlines are indeed met, the currently existing characteristics of an undertaking can be relevant for determining whether or not it falls within the scope of the directive, given that several criteria take into account the characteristics of the entity in the “two preceding years”. We will of course keep you informed on further developments.


For more information, please do not hesitate to contact us.

Matthias Vekeman - Associate (Belgium) – (

Rik Smet - Associate (Belgium) – (