Is the European Union finally trying to make a real end to the embarrasing fiscal constructs, which rob countries from their desperately needed tax yields? New tax regulation offers a glimmer of hope.

A good friend of mine, Roustam Vakhitov, is a renowned lawyer and fiscal expert with respect to tax payments and tax regulation in the European Union. 

A few days ago, he sent me a paper, that contained his research with respect to the new corporate tax regulations, deployed by the European Union. These regulations will come into effect on 1 January 2016.

What these tax regulations should achieve, is the following:

• Genuine, financial cross-border traffic between holdings, international head offices and executive subsidiaries in different countries, with the purpose of normal business execution and cash management, should remain possible at fair tax rates within the European Union, as such that companies will not get taxed twice or will get taxed with higher than necessary rates;
  
• International fiscal constructions, however, which are solely deployed with the purpose of tax avoidance/evasion, should be made impossible. 

The following snippets come from the article of Roustam and his partner Dmitriy Mikhailenko. Some will be accompanied by my comments:

30 January 2015 Anti- offshore changes to the EU Directive on Parent and Subsidiary companies: what will change as of 2016

The  important changes to the Council Directive of the European Community "On the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States" (Council Directive 2011/96 / EU, hereinafter - the Directive).

In accordance with the Directive the subsidiaries are effectively exempt from withholding taxes on dividends and taxes on profit distributions in case of making payments to the parent companies. This option was misused sometimes to minimize taxation.

For example, a Russian or Ukrainian beneficiary may own an operating company in his jurisdiction through the Dutch, Latvian or Luxembourg holding company and an offshore company on top of it. In case of payment of dividends from Luxembourg / Latvia / the Netherlands directly to offshore, such dividends shall be subject to a withholding tax at the rate of 15%.

To reduce the tax burden, some consultants recommended to interpose over the Luxembourg, Dutch or Latvian company a Cyprus, Malta or another holding company in the country, in which the dividends are tax exempt if paid to the offshore.

In this case, dividends from Latvia, the Netherlands and Luxembourg to Cyprus would be tax exempt according to the rules of the Directive on parent and subsidiary companies, and from Cyprus such payments would be tax-exempt in accordance with the local legislation.

One could call these blatant fiscal constructs ‘tax porn’: the creation of artificial companies and holdings – mainly on paper – with the sole purpose of reducing tax payments, for executive companies and subsidiaries, virtually to nought.

Such fiscal constructs are very disruptive for all tax-receiving countries involved, as these constructs rob the countries from their desperately needed tax yields. 

Besides that, such fiscal constructs are also devastating for the unity and trust between countries in large multinational entities, like the European Union. The Netherlands, Ireland and Luxembourg are examples of such countries with "antisocial" tax laws, which could be used for tax avoidance (or evasion).

(Corporate) taxes by themselves are a drag, but they are used by governments to pay for unemployed people, healthcare and elderly care, roads, infrastructure and development, as well as many, many more purposes.

When large companies make use of such infrastructures and facilities in countries, but refuse to pay even the tiniest amount of money for it, it means that all tax payments in such countries should be coughed up by private citizens and small and medium enterprises.

Besides having to pay more than their fair share of taxes, these SME companies see their competitive powers dramatically decrease, in favour of the already powerful large companies with their tax advantages. 

These tax advantages for large companies make a level playing field in such countries impossible, as they act as EPO-dopage in the ‘Tour de France’ or steroids in baseball.

In order to prevent such practice, on January 27, 2015 the following changes to the Directive were adopted:

• The above-mentioned tax benefits under the Directive shall not apply if the arrangement is recognized as not genuine;
  
• The arrangement is presumed not to be genuine if its only purpose is to obtain tax benefits (i.e., there is no other economic feasibility of operations than obtaining tax benefits);
  
•  Unreality of the arrangement is identified through a complex study of all the facts and circumstances of its functioning;
  
• Not the whole arrangement may be admitted as not genuine, but only some of its elements (along with application of the negative effects exactly to such elements); 

In plain English, this means that companies may use foreign subsidiaries or holding companies to achieve a reduction of their corporate and withholding taxes, when these companies do a genuine share of the labour, services or production activities in their respective production or value chains.

However, when these holdings or subsidiaries are only created as an ‘administrative entity’, without a real function in the production or value chain, they might not be used anymore for tax avoidance (evasion).

• The Member States may introduce more tough conditions related to payments between subsidiaries and parent companies in their national legislation compared to the Directive.
  
• The EU Member States are obliged to implement the above changes in the Directive not later than 31.12.2015.         

This means that starting from 2016 the tax exemptions on dividends paid to Cyprus/Malta in the example above, or to any other similar jurisdiction shall not be granted if the Cyprus company does not perform the real activity and there is no economic justification of its presence in the arrangement.

The Directive did not forbid the countries to set their own measures to combat tax evasion. In the Netherlands such measures have started to be effectively applied since 2012, and an example of the arrangement 'the Netherlands-Cyprus' is a bit outdated, but now the European Commission obliged all the EU countries to amend their legislation providing for such measures of prevention of the tax evasion.

Several tendencies may be presumed as a result of the above changes.

Firstly, it is unlikely that the taxpayers will massively create genuine activities at every level of the multi-level holdings. Most likely, the structures will be simplified.

Secondly, the taxpayers will be more likely to choose as the main jurisdictions the countries in which there is no withholding tax on payments to non-residents (Cyprus, UK, Malta, Latvia etc.).

Considering the Russian law on CFCs, many Russian taxpayers will put up with the obligation to pay 15% tax, especially since it will be offset against the Russian personal income tax of 13%, and will remove the superstructures over Dutch and Luxembourg holding companies.

For the Ukrainian beneficiaries such dividends shall be subject to personal income tax at the rate of 20%, which also shall not exceed the rate of withholding tax under the payment from the Netherlands, and taking into account the tax paid in the course of the payment will not cause additional taxation in Ukraine.

Thirdly, some countries may abolish the withholding tax on dividends - Luxembourg already does not tax the dividends paid to residents of countries with which there is a tax treaty. It is possible that this tax will be eliminated entirely.

 It can also be assumed that if after the implementation of changes to the Directive the tax authorities of the EU determine that the European arrangements of the Ukrainian or Russian beneficiaries are artificial, the additional taxation is possible. In addition, the practice of obtaining preliminary tax rulings may tighten, and the risk of performing transactions without receiving them shall increase.

Summarized, it might be expected that the aforementioned measures will lead – one way or the other – to both a declining number of artificial fiscal constructs, higher tax yields for individual countries, as well as to a declining amount of money, withheld by companies, through tax avoidance or evasion. That is very good news in my humble opinion. 

Unfortunately, such measures cannot be introduced overnight. This means alas that these measures will only come in effect at January 1st of next year. Of course, that is much too late in the eyes of many people, including myself.