European Parliament revises gateway tests in Unshell Directive

Following a review of the proposed “Unshell directive” (also referred to as “ATAD3” and published by the European Commission on 22 December 2021), the European Parliament Committee on Economic and Monetary Affairs agreed on changes to the directive, in particular to the “gateway” rules (for prior coverage, see our article published in February 2022).


The revised version lowers the thresholds below which an entity is not subject to reporting requirements. The European Parliament adopted the European Commission proposal (with the proposed changes) and calls on the European Council to adopt the proposed amendments by the European Parliament Committee on Economic and Monetary Affairs.


Background and changes to the Directive

The Unshell Directive sets out rules to prevent the misuse of shell entities for tax purposes and expand the scope of the EU Council Directive on administrative cooperation. The essential purpose of the Unshell directive is to thwart the use of intermediary companies in the EU that purportedly engage in an economic activity but, in reality, do not conduct any economic activities and do not have minimal substance. Such intermediary companies are often used to enable certain tax advantages to flow to their beneficial owners or to the group to which they are members. To prevent abuse of these structures, the directive contains measures that would disregard entities that are considered “shell entities” for cross-border purposes.


Introduction of "substance test"

The Unshell Directive would introduce an EU-wide “substance test,” as well as a reporting obligation for taxpayers, the latter of which would result in the disallowance of any tax advantages to EU entities that are deemed to have no or minimal economic activities. Although the directive targets certain low-substance shell entities, implementation of the Unshell directive would lead to additional compliance obligations for many entities.


Directive's seven-step approach

The directive sets out a seven-step approach for the tax authorities to identify entities that lack minimum substance and that are being used improperly to obtain tax benefits. The Unshell provisions would apply to all entities, regardless of their legal form, that are engaged in an economic activity and that are considered to be tax resident and eligible to receive a tax residence certificate in an EU member state. The directive also would capture legal arrangements, such as partnerships, that are deemed resident for tax purposes in an EU member state. The proposed directive would not apply to entities in third countries, although another proposed directive, called SAFE (Securing the Activity Framework of Enablers), which would target the use of shell entities from third countries is expected mid-2023.


The first of the seven steps is to identify entities lacking substance by checking three “gateways” and this is where the proposed directive is being amended through the lowering of the thresholds:

  1. Type of revenue: More than 65% (previously 75%) of the entity’s revenue in the preceding two tax years consists of relevant income (primarily passive income) such as dividends, interest, royalties and income from crypto assets, insurance and immovable property. This requirement also would be met if more than 65% (previously 75%) of the assets consist of assets that generate such passive income;
  2. Cross-border element: Either more than 55% (previously 60%) of the book value of “passive income assets” was located outside the undertaking’s member state in the preceding two years, or more than 55% (previously 60%)  of the entity’s relevant is earned or paid out via cross-border transactions; and
  3. Management and administration: In the preceding two tax years, the entity has outsourced the administration of its day-to-day operations and decision-making to a third party (bold is added in the proposal).


An entity that meets all three gateway tests would be deemed to be “at risk” and would be required to report on its substance in its tax return to assess whether it would be presumed to be a shell entity.


Consequences of being deemed to be a shell entity

An entity that is deemed to be a shell entity and that does not provide rebut the presumption of a lack of substance would not be eligible for application of the EU Parent-Subsidiary and Interest and Royalty Directives (which grant withholding tax exemptions for dividends, interest and royalties), nor would it be eligible for benefits under applicable tax treaties concluded by the member state in which the entity is resident. Moreover, information on EU shell companies would be exchanged automatically through an EU-wide central directory. Member states also would be able to request another member state to launch a tax audit if they have reason to believe that an entity potentially lacks minimum substance.


If an entity responds affirmatively to all three tests, it would be subject to new tax reporting obligations related to economic substance, specifically with respect to its premises, whether it has its own active bank account in the EU and the tax residence of its director(s) and the majority of its full-time employees. If an entity lacks substance based on one or more of these indicators, it would be presumed to be a shell entity for purposes of the directive and would not be eligible for benefits under the above directives or applicable tax treaties and no tax residence certificate would be issued. Failure to comply with the rules would result in a penalty of at least 5% of the entity’s turnover for the relevant year. Regardless of whether the entity qualifies as a shell entity, the information reported would be exchanged automatically.


An entity still would be able to rebut the presumption of shell company status by providing additional evidence at least on the commercial rationale for the undertaking.


BDO insights

The same day the European Commission published the proposed Unshell directive, it also published a proposal for a directive that would implement the Pillar Two GloBE rules (see the tax alert dated 21 December 2022). Both initiatives demonstrate that the EU is stepping up its fight against tax avoidance. By the end of 2023, the Commission intends to publish a new framework for business taxation in the EU, which may result in more initiatives.


The Unshell directive requires unanimity in the European Council for its adoption, following the consultation with the European Parliament. If adopted, the Unshell directive would have to be transposed into national laws of the EU member states by 30 June 2023 and would be effective as from 1 January 2024.


However, since there is a two-year look-back period in determining whether the economic substance indicators are met, the directive would—in a sense—apply retroactively as from 1 January 2022. In any case, given the ongoing negotiations at the level of the European Council (including the lookback period and implementation), the effective date of the Unshell directive may be postponed.


Adoption of the proposed directive would mark a significant step in direct taxation within the EU as it is the first harmonisation of minimum substance criteria for tax purposes. Although it remains unclear whether member states will embrace the Commission’s initiative, potentially affected companies should consider undertaking an analysis of their corporate structures based on the current draft of the Unshell directive.


How can BDO assist you?

The proposed rules are extremely complex and there is no doubt there will be much debate on the rules in 2023. We look forward to contributing to this debate and keeping you updated on this topic.  

Reach out to our Tax Team at to discuss any questions you have.

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