Update on ATAD III and its implementation

The directive was initially intended to go into effect on 01 January 2024, after required ratification by all EU members. However, ongoing discussions with EU members have resulted in some key relaxations to the proposed legislation, and the implementation of ATAD III has been now been postponed to 01 January 2025.

Proposals under ATAD III

The principal objective of ATAD III was to eliminate the misuse of shell entities to prevent cross-border tax fraud practices. The directive will be applicable to EU-resident entities, which may include small and medium enterprises (SMEs), trusts and partnership ventures, as well as entities with additional legal arrangements that may claim the benefits of double tax treaties and other EU directives. 

The EU’s intention in implementing ATAD III is to introduce indicators of ‘minimum substance’ that legal entities in the EU must adopt and with which they must be compliant in order to gain entitlement to tax treaty benefits and tax benefits based on EU directives. 

The ATAD III directive outlines gateway indicators that help to determine whether any business undertaking is at risk of being considered a shell company. In other words, it sets a certain set of guidelines or directives to ensure an entity is doing business legally, and is meeting minimum substance requirements.

Excluded entities

There are certain types of entities that should be excluded from EU tax reporting requirements. These include regulated financial undertakings such as alternative investment funds (AIFs), alternative investment fund managers (AIFMs), undertaking for collective investment in transferable securities (UCITS) funds, as well as EU securitisation special purpose entities, and domestic holding companies.

Entities affected – the ‘Gateway’

ATAD III will be applicable to an entity, regardless of its legal form, if it is resident in an EU member state, and meets the following three cumulative conditions:

1.  Passive income
   More than 65% (previously 75%) of the entity’s revenue in the preceding two tax years qualifies as ‘relevant income’ under ATAD III. The definition of relevant income primarily looks at passive income and includes, among other factors: interest, income generated from financial assets (such as crypto assets), royalties, dividends, income from financial leasing, immovable property, and some movable property. In certain instances, it is not necessary for relevant income to have accrued to the entity concerned for this condition to be met.
   
   
2.  Cross-border activity
   More than 55% (previously at least 60%) of the concerned entity’s relevant income is earned or paid out via cross-border transactions. Alternatively, more than 55% (previously 60%) of the book value of its real estate, or other private property of high value, is located outside the EU member state in which the entity has been resident in the preceding two tax years.
   
   
3.  Management and administration outsourced
   Day-to-day administration and decision making on significant functions have been outsourced in the preceding two tax years.
   After publication of the initial version of ATAD III, there were doubts as to whether this condition would be met in cases of intra-group outsourcing.
   The EU parliament has now clarified that this condition requires outsourcing to a third party. This appears to be a welcome change for businesses that have centralised certain functions within the group; although the changed wording still does not completely clarify that outsourcing within the group is allowed.

Annual minimum substance declaration

Where the gateway tests are met, the entity must report on its annual tax return by including documentary evidence to support that it meets the minimum substance indicators.

The minimum substance indicators are that each entity:

• Has its own premises (or has leased premises) for its exclusive use in its EU member state of residence.
• Has its own active EU bank account in the EU through which relevant income is received.
• Has directors or full-time employees where:
• at least one company director is a tax resident in the entity’s EU member state or lives close enough to perform their duties;
• directors or employees are authorised to take decisions regarding activities generating the relevant income. 

An entity which declares that it meets all three indicators and provides the required supporting documentation is presumed to have minimum substance for the tax year.

The presumption of guilt 

In a case where a business entity is required to provide evidence that it meets the set criteria but fails to do so, the entity will be presumed to be a shell company according to the definition provided in ATAD III.

However, a company will be given an opportunity to counter this presumption if it manages to provide enough evidence of genuine and valid reasons why the company should not be treated as a shell company.

Tax implications 

A company structure that does not meet the ATAD III standards will be presumed to be a shell company and will be subject to extensive tax consequences within the EU. 

Shell company structures resident outside the EU will not be subject to this EU directive. 

Conclusion

As the ATAD III directive is likely to be implemented on 01 January 2025, it is paramount that companies in the EU take steps to comply with this new legislation as assessments of shell companies will be based on circumstances during the last two tax years.

Before ATAD III comes into effect, the directive requires ratification by all EU member states, and the legislation will need to be adopted by each member state in its respective national legislation.