On 22 December 2021 the European Commission published a Directive proposal (Anti-Tax Avoidance Directive - ATAD 3) aiming to prevent the misuse of shell entities for tax purposes.

The proposed Directive establishes that entities established in the EU shall annually declare that they meet minimum indicators of substance. Failure to comply with this obligation, or false statements, will be subject to penalty of at least 5 % of the entity‘s turnover in the relevant tax year.

In a nutshell, the obliged entities shall be those (i) which more than 75% of the revenues in the preceding two tax years are "relevant income", as defined in the Directive (e.g. interest or any other income derived from financial assets, including crypto assets, royalties, dividends and income from the disposal of shares or income from immovable property), (ii) that engaged in cross-border activity, as defined in the Directive (e.g. more than 60% of the book value of the entity’s assets were located outside the Member state of the head-office or at least 60% of the relevant income were earned or paid out via cross border transactions) and (iii) that have outsourced the administration of day-to-day operations and the decision-making on significant roles.

Pursuant to the proposal, indicators of minimum substance for tax purposes will be the existence of actual premises in the Member State, or premises for its exclusive use, the opening of at least one active bank account in the EU, and other relating to the management or tax residence of the employees:

- As regards the management, at least one director of the entity (i) shall be tax resident in the Member State, or in a jurisdiction which distance is compatible with the proper performance of their duties, (ii) shall be qualified and authorized to take decisions actively and independently in relation to the activities that generate the relevant income and (iii) shall not be an employee nor director or equivalent in an entity that is not an associated entity.

- As to employees, the majority of employees shall be resident in the entity’s Member State (or sufficiently close to it) and be qualified to perform the activities that generate the relevant income of the entity.

In case the entity does not prove compliance with the minimum substance indicators for tax purposes, the Member State of the tax residency may deny the issuance of the tax residence certificate for use outside the jurisdiction of that Member State, or may grant a certificate of tax residency which declares that the entity is not entitled to benefit from the rights and benefits set out in the agreements and conventions for the elimination of double taxation of income and capital, and those foreseen in the Parent-Subsidiary or the Interest and Royalties Directives.

In other Member States (other than the State of residency) the rights and benefits granted by agreements and conventions for the elimination of double taxation of income and capital, and for the benefits granted by Parent-Subsidiary or Interest and Royalties Directives will be denied to the entity.

Once approved, the Directive shall be adopted and published by Member States at the latest by 30 June 2023 and shall enter into force as from January 1, 2024.

ATAD 3 is another measure against abusive tax practices in the European Union and aims that entities evidence minimum of substance to justify their existence.

Furthermore, the existing structures shall be analyzed and assessed in order to ensure compliance with the minimum substance indicators when the ATAD 3 is transposed and becomes enforceable.