With less than six months to go before ATAD 1 starts to kick in, now may be a good time to test your knowledge of what the EU’s anti-tax avoidance directive has in store. Here's my take on the following 10 questions.
1) A company with net interest expense of EUR4m cannot benefit from the safe harbour exemption (if a Member State opts for it) under the interest limitation rule, true or false?
A. False. The first EUR3m (or lower amount if a Member State so chooses) is deductible whatever the level of the taxpayer’s net interest expense. By way of contrast, under the current German earnings stripping rules, if net interest expense exceeds the threshold, the EBITDA limitation applies to the total net interest expense. The ATAD rule is of course only relevant if the safe harbour amount exceeds the 30% of EBITDA limitation.
2) Member States can use blacklists to implement the CFC rules in relation to entities in a) other Member States, b) third states, c) any state, d) none of these
A. (b). According to recital 12, “It should be acceptable that, in transposing CFC rules into their national law, Member States use white, grey or black lists of third [ital. BL] countries…” Implicitly, therefore, not for EU Member States. Presumably the EU Court of Justice would otherwise have a problem.
3) Where a Member State applies the ‘passive income’ CFC approach (‘Model A’) the low tax test is applied to a) all the entity’s profits, or b) each separate category of ‘tainted’ passive income?
A. (a). The ATAD provides (Art. 7(1)(b)) that the low tax test applies to the entity’s “profits”, irrespective of the approach adopted, i.e. the passive income approach (Model A) (Art. 7(2)(a)), or the ‘transfer pricing’ approach (‘Model B’) (Art. 7(2)(b)). That said, in its draft legislation issued for public consultation last year, the Netherlands proposed applying the low tax test to ‘tainted’ income only under Model A.
4) Under the CFC rules, income to be included in the parent’s tax base is always a) 100% of the CFC’s profits or b) limited to the parent’s participation in the entity concerned.
A. (b). Art. 8(3) provides that the taxable income is “calculated in proportion to the taxpayer's participation in the entity”. No distinction is made for these purposes between the ‘passive income’ CFC approach (‘Model A’) (Art. 7(2)(a)) and the ‘transfer pricing’ approach (‘Model B’) (Art. 7(2)(b)). Interestingly, Art. 8(2) provides that “The attribution of controlled foreign company income shall be calculated in accordance with the arm's length principle”.
5) The ‘switch-over’ rule has completely disappeared from the final ATAD, true or false?
A. Part true, part false. Article 6 of the original draft that contained the switch-over provision was indeed dropped from the final version. However, part of that provision effectively reappeared in a significantly altered form in the CFC provisions of the final ATAD, specifically the part of the switch-over rule that dealt with income from exempt permanent establishments in third countries.
6) The ATAD’s General Anti-Avoidance Rule does not have to be applied in purely domestic situations, true or false?
A. False. This follows generally from the EU fundamental freedoms and Recital 11 confirms this.
7) The interest deduction limitation rule in Article 4 of the ATAD does not apply to the extent the interest is subject to tax in the hands of the creditor, true or false?
A. False: the tax treatment of the creditor is irrelevant under the interest limitation rule.
8) Under the interest deduction limitation rule, Member States can offer taxpayers any combination of the following: a) a carry-forward of excess interest expenses, b) a carry-back of excess interest expenses, and c) a carry forward of unused interest capacity, true or false?
A. Almost true! The permitted combinations are a) excess borrowing costs carry-forward only, or b) excess borrowing costs carry-forward and carry-back, or c) excess borrowing costs carry-forward and unused interest capacity carry-forward. Strictly speaking a combination of all three cannot be offered. However, since carry-back of excess borrowing costs achieves a broadly similar result to carry-forward of unused interest capacity (except as regards timing) this is not as big a disadvantage as it may sound.
9) Exempt dividend income is included in EBITDA under the interest deduction limitation rule, true or false?
A. False. The starting point for EBITDA is “the income subject to corporate tax in the Member State of the taxpayer” (Art. 4(2)). If that wasn’t clear enough the ATAD adds “Tax exempt income shall be excluded from the EBITDA of a taxpayer”. Under their current earnings stripping rules some Member States (e.g. France and Italy) appear to allow exempt dividend income to be included.
10) Under the exit tax rule, a Member State must grant a step-up to market value on the transfer to it of assets or of a company’s residence from another Member State or from a third country, true or false?
A. False. A step-up is only required where the transfer is from a resident of a Member State or from a permanent establishment in a Member State.
Bonus question: How should ATAD be pronounced?
A. “aytad”, “ahtad”, “atad” – take your pick!
A word of caution
There are various reasons why a Member State may, legitimately, deviate from the specific text of the ATAD. This may simply be due to the discretion allowed to Member States in implementing a directive, which allows them to determine the form of the implementation so long as this achieves the intended result. Or it may be because the ATAD only represents a ‘minimum standard’, leaving Member States free to adopt even tighter anti-avoidance rules, subject to respecting other aspects of EU law such as the fundamental freedoms. In some cases Member States may implement the ATAD in a way that exceeds the limits of what is permitted. This may present opportunities and/or risks going forward that taxpayers should evaluate in planning their affairs.