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European Commission proposes to amend the Parent Subsidiary Directive
 
On 25 November 2013, the European Commission adopted a proposal for a directive amending the Parent Subsidiary Directive (Directive 2011/96/EU) to eliminate abuses of the directive such as hybrid loans and letterbox companies without any substance.

The Parent-Subsidiary Directive was designed to eliminate tax obstacles for the distribution of profits between subsidiaries and parent companies based in different Member States.  The Directive must eliminate the risk of double taxation of dividends and other profit distributions paid by subsidiary companies to their parent companies, first in the Member State of the subsidiary and then in the Member State of the parent company.  The Directive gives a tax exemption for such profit distributions.

The original directive dates back to 23 July 1990, it has been amended several times, mainly following the accession of new Member States. A major change occurred in 2003, with a progressive reduction of the shareholding percentage requirements, and the elimination of double taxation for subsidiaries of subsidiary companies. In November 2011 the Directive was recast as Council Directive 2011/96/EU.

This proposal is part of the Commission's action plan to strengthen the fight against tax fraud and tax evasion, in response to the Base Erosion Profit Shifting (BEPS) discussion.  The Commission had announced a review of anti-abuse provisions in the corporate tax directives, including the Parent Subsidiary Directive, to implement the principles underlying its recommendation on aggressive tax planning.

The proposal will not only introduce a general anti-abuse provision, but will specifically disqualify hybrid loan instruments.

1. General anti-abuse provision

The current text of the Directive allows a Member State to introduce provisions, either in its domestic legislation or in agreements with other States, for the prevention of fraud or abuse. This requirement is deemed to be too restrictive and will be replaced by the requirement that these provisions are adopted for the prevention of tax evasion (article 1 para 2 of the Directive).

The Commission proposes to introduce its own anti abuse provision that would achieve a common standard. A new article 1a would allow Member States to withdraw the benefit of the Directive in case of an “artificial arrangement” put into place for the essential purpose of obtaining an improper tax advantage under the Directive and which defeats the object, spirit and purpose of the tax provisions invoked.

An artificial arrangement consists of a transaction, a scheme, an action, operation, agreement, understanding, promise or undertaking that does not reflect “economic reality”.  Alternatively, a series of arrangements can also be deemed artificial.

The Proposal specifies the elements a Member States should analyse to determine whether an arrangement is artificial:
-- the legal characterisation of the individual steps of the (artificial) arrangement  is inconsistent with the legal substance of the arrangement as a whole;
-- the arrangement is carried out in a manner which would not ordinarily be used in a reasonable business conduct;
-- the arrangement includes elements which have the effect of offsetting or cancelling each other;
-- the transactions concluded are circular in nature;
-- the arrangement results in a significant tax benefit which is not reflected in the business risks undertaken by the taxpayer or its cash flows.

One of the arrangements the Commission is considering is the situation where the subsidiary is located in a Member State that charges withholding tax on dividends to a parent company outside the EU. Tax planners eliminate this withholding tax by diverting the dividend via an intermediate subsidiary in a second Member State that would not charge withholding tax on dividends to a parent company outside the EU. The Directive does not allow the first Member State to withhold tax on a profit distribution paid to the intermediate subsidiary in the second Member State.

If the insertion of the intermediate company in the second Member State is a wholly artificial arrangement set up with the essential purpose of avoiding the withholding taxes in the first Member State, the new anti-abuse rule could be applicable in the first Member State.  If the intermediate company is e.g. a letterbox company with no substance, the benefits of the Directive would be denied and the withholding tax would be due to in the first Member State.

2. Hybrid loan instruments.

The Commission also wants to deny the tax benefits of the Parent Subsidiary Directive to companies that use hybrid loan instruments.

Hybrid loan instruments have characteristics of both debt and equity so that in a cross border situation the parent and the subsidiary can achieve double non taxation because the two Member States give the hybrid loan a different tax qualification.  For the subsidiary the instrument is debt, and the profit distribution qualifies as tax deductible interest. For the parent company it qualifies as equity, and the Member State must exempt the distribution of profits in accordance with the Parent Subsidiary Directive.

The Directive will be adopted so that the Member State of the payee will only have to exempt these profits “to the extent that such profits are not deductible by the subsidiary of the parent company"

The Commission wants the Member States to implement the amended Directive into their domestic law by 31 December 2014. However, the Council of the European Union still has to approve the Proposal by unanimity before it becomes effective.

Marc Quaghebeur
De Broeck Van Laere & Partners



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