EU drops controversial 'switchover rule' from final anti-tax avoidance law

Out-Law News | 22 Jun 2016 | 10:31 am | 2 min. read

A controversial proposal designed to prevent 'double non-taxation' of certain dividends, capital gains and profits has been dropped from the final form of the EU's planned anti-tax avoidance directive (ATAD).

The so-called 'switchover rule' would have allowed tax authorities in EU member states to deny EU tax exemptions on dividends, capital gains and profits from permanent establishments which enter the EU from non-EU countries, had that income been taxed at a very low or no rate in the third country.

ATAD was designed partly to ensure consistent implementation within the EU of the measures recommended by the Organisation for Economic Co-operation and Development (OECD) in its base erosion and profit shifting (BEPS) project. The switchover rule was not one of the OECD's recommendations, and had been opposed by a number of member states during the EU's legislative process.

Member states will have until 31 December 2018 to transpose most of the provisions of the directive into their national laws. They will have until 31 December 2019 to transpose the new exit taxation rules included in the directive.

Tax expert Heather Self of Pinsent Masons, the law firm behind said that the Commission's announcement contained some "interesting hints" about its intentions.

"It is good to see that the most controversial element of the initial proposals, the so-called switchover rule, has been dropped," she said. "This rule would have gone beyond the BEPS proposals, and its impact was hard to predict."

"The EU's decision to adopt a common approach to implementing the BEPS proposals is welcome, although a considerable amount of work remains to be done on the details," she said.

The Commission published its proposal for the directive in January. Once implemented, ATAD will introduce restrictions on interest deductibility, controlled foreign company (CFC) rules and an exit charge to prevent companies shifting company residence or assets, such as intellectual property, to low tax jurisdictions. CFC rules are designed to prevent corporate groups from diverting their profits to low tax jurisdictions where no genuine economic activity takes place in order to avoid tax.

The directive also includes a rule to prevent 'hybrid mismatches'. These are arrangements which allow companies to exploit the differences between the tax rules applicable in different countries in order to avoid paying tax in either country, or to obtain more tax relief against profits than they are entitled to. The directive provides that, where EU countries treat the same income or entity differently for tax purposes, the legal characterisation given to the hybrid instrument or entity by the country where the payment originates will apply.

ATAD is part of a wider anti-tax avoidance package developed by the Commission, which also includes a revision of the Administrative Cooperation Directive to require country-by-country reporting between the tax authorities of different member states on certain tax information about multinationals operating in the EU. This part of the package was agreed in March, and will initially apply to tax years starting on or after 1 January 2016. Member states have also backed a proposal for automatic exchange of information relating to tax rulings, which will come into force on 1 January 2017.

EU tax commissioner Pierre Moscovici said that the agreement "strikes a serious blow against those engaged in corporate tax avoidance".

"For too long, some companies have been able to take advantage of the mismatches between different member states' tax systems to avoid billions of euros in tax," he said. "I congratulate our member states who are now fighting back and working together to make the changes needed to ensure that these companies pay their fair share of tax."