The end of the world of shell companies?

On December 22, 2021, the European Commission presented a key initiative against shell companies, which are created for tax avoidance purposes. The Unshell proposal is intended to ensure that legal entities which provide neither a real product nor an actual service to customers in the European Union cannot benefit from tax benefits and do not be an unreasonable financial burden on taxpayers.

First of all, what the concept means?

A shell company is a business created to manage the financial transactions of another organization. Unlike traditional companies, shell companies do not have, for example: employees. Shell companies provide neither a real product nor an actual service to customers.

Shell companies are often used for tax planning or tax evasion purposes. Businesses move cash flows through shell companies to countries where taxes are extremely low or where taxes can be easily circumvented.

The proposed new measures set transparency standards regarding the use of shell companies. Which make it easier for tax authorities to detect abuse of right. The proposal will use three indicators to help national tax authorities detect companies that only exist on paper.

The proposal introduces a screening system for companies that fall within its scope, which must meet certain indicators. These levels of indicators form a kind of “points”. The proposal defines three aspects. If all three aspects are true for a company, it will have to report more information to the competent tax authority through its tax return.

Indicators

The first aspect of the indicators looks the activities of companies based on income. The condition applies to the company if more than 75% of the company’s total revenue achieved in the previous two tax years does not come from the company’s commercial activities, or if more than 75% of its assets are real estate or other particularly valuable private assets.

The second aspect requires a cross-border element. If the company derives the majority of its income from transactions related to other jurisdictions. Or transfers this income to another company located abroad, the company moves to the next aspect.

The third aspect focuses on whether management and administration services related to the company are managed in-house or outsourced.

If all three aspects prove to be true for the company, then the company must declare in its tax return. E.g.: information about the company’s location, bank accounts, and the tax status of its directors and employees.

All statements must be supported by documents

If a company is considered a shell company, it does not have access to tax allowances and the benefits of tax treaties concluded by its Member State. The Member State in which the company has the registered headquarter either refuses the shell company to provide proof of tax identity, or the certificate issued by it states that the company is a shell company. A company classified as a shell company needs to present additional evidence. E.g.: detailed information about the commercial reason for their establishment in the given Member State and their employees.

Member States’ authorities automatically exchange information on all entities covered by the directive, regardless of whether they are shell companies or not.

Most importantly, the proposal allows Member States to request another Member State to conduct a tax audit of any entity.

The directive will enter into force on January 1, 2024.