August 2023

Tax Alert: Understanding the Unshell Directive

The European Union’s “Unshell Directive” was originally slated for implementation across all EU member states by the conclusion of June 2023, with its enforcement commencing on the 1 January 2024. Although the initial deadline was not met, it is imperative that we neither dismiss it nor underestimate its profound impact on cross-border capital groups.

Conceptual Overview

The “Unshell Directive” or more formally, ATAD 3, centred around the establishment of a shared framework to ascertain what constitutes “insufficient substance” and to delineate the precise tax repercussions that follow. Disparate jurisdictions exhibit varying criteria for companies in the realm of business substance. The Directive is set to define the baseline standards applicable throughout all EU states.

Draft Beginnings

The draft of the Directive operated on the foundation of an evaluation designed to pinpoint entities lacking substantial business foundations. The foremost criterion seeks to recognise “high-risk” entities. This criterion is based upon three key factors: (i) a notable proportion of “passive” revenues, (ii) the transnational nature of the business, and (iii) the outsourcing of critical business administration and decision-making processes.

Entities designated as “high-risk” are required to pass a basic business substance test contingent on stipulations such as: (i) maintaining a bank account within the EU, (ii) owning premises for exclusive use, and (iii) engaging a “local” director or employees. Failing to satisfy these prerequisites results in the presumption of the entity as a shell company, which consequently incurs unfavourable tax implications.

Making Changes

Revisions to the draft directive have been endorsed, notably involving the relaxation of criteria for identifying “high-risk” entities. The threshold for “passive” revenues has been revised downward from 75% to 65%. There has been a decrease in passive income arising from cross-border transactions, now standing at 55% from the previous 60%. Correspondingly, the valuation of assets generating passive income positioned outside the entity’s country of residence has been similarly decreased.

Furthermore, a specific criterion has been heightened, mandating the outsourcing of business administration and decision-making functions to third-party entities. These adjustments will potentially encompass a broader array of entities classified as “high-risk,” compelling them to divulge indicators of minimum business substance. In terms of substance, the prerequisite for sole ownership of premises has been eased, permitting premises to be shared among other group entities.

Preparation Period

The deferred Directive encompasses a retrospective 2-year period, signifying that the identification of “high-risk” entities and validation of their minimum business substance will be executed based on data from the preceding 2 years leading up to its enforcement. Even if this timeline is pushed to the middle of 2024 or early 2025, the data from the current year (2023) will assume paramount significance.

Written by Penteris Head of Tax Piotr Prokocki, the full article was originally published 23.08.2023 in prawo.pl