EU Directive Targets 'Shell' Companies

On December 22, 2021, the European Commission published proposals for a Directive which targets the perceived misuse of “shell” entities for tax purposes. The draft of the Directive proposes a common minimum substance test across all EU Member States which is designed to identify undertakings (including companies) that are engaged in an economic activity but which fail to have minimal substance and are misused for the purpose of obtaining tax advantages. The Directive identifies such undertakings, using a slightly pejorative (and deliberate) term, as being “shells.”

The focus and objective of the Directive is to identify “shell” entities, and discourage their use. The objective of the proposed Directive is not to raise tax, or impose by itself a penal rate of taxation on the utilization of such entities. Rather, the Directive imposes additional reporting requirements where the entity is deemed to be a “shell” and proposes to deny intra-EU access of a “shell” entity to certain tax benefits – principally those provided by the EU’s Parent-Subsidiary or Interest and Royalties Directives, and (more controversially) the benefits arising any relevant double tax treaty between entities in different EU Member States.

The draft Directive concerns only “shell” entities established in the European Union. An additional proposal relating to the use of comparable entities established in third countries (which would include the UK and the US) is planned by the EU Commission during 2022.

Detailed Proposals in the Draft Directive

The proposed Directive sets out three cumulative gateways, all of which need to be satisfied before any entity can be considered as a “shell” for the purpose of the Directive.

If an entity passes all three gateways, it will be required to annually report additional information to an EU tax authority as part of its corporation tax return and will run the risk of being identified as being a “shell” entity – which has a number of adverse tax consequences.

The three gateways are focused on an entity’s activities. The first gateway is met if more than 75% of the entity’s income is from passive income sources, such as interest, royalties, dividends, rentals from real estate and leasing activities. The second gateway requires a threshold amount of cross-border activity to be met, which will be the case if more than 60% of the entity’s assets are located outside of the Member State of the entity’s establishment or at least 60% of the entity’s income arises from cross-border transactions. The third, and final, gateway requires that day-to-day administration and decision-making on significant functions of the entity is outsourced (which is suggestive of entities which are not actively directed by their own boards).

Once it has been established that an entity satisfies all of the three gateways, the draft Directive requires a number of minimum substance requirements to be met for the entity to avoid being treated as a “shell” entity. Those minimum substance requirements require the entity to demonstrate that it has premises and personnel (such as directors or other employees) in its Member State of establishment, as well as having an active bank account in the EU.

If an entity does not substantively meet these requirements, it will be presumed to be a “shell” entity unless it can demonstrate that one of a series of carve-outs and exemptions in the draft Directive apply to the entity’s activities. Exemptions exist for certain entities, including listed companies, regulated financial undertakings (but not holding companies of regulated entities), entities with listed securities, domestic holding entities, and entities that have at least five full-time employees exclusively engaged on generating income for the entity.

An entity can also request an exemption where it is possible to demonstrate that there is no tax advantage arising from the use of the shell entity, a test which is framed in the context of whether the inclusion of the entity in any ownership structure lowers the tax liability of the beneficial owners of the entity.

Consequences of Being a “Shell” Entity

If an entity is unable to meet the minimum substance requirements and cannot be placed within an exemption, the Directive proposes that the “shell” entity cannot be eligible for the tax benefits provided for in the EU’s Parent-Subsidiary and Interest-Royalty Directives. In addition, the proposed Directive states that the “shell” entity would not be able to obtain benefits under a double tax treaty concluded between EU Member States, although this proposed measure will be challenging to legislate owing to the bilateral nature of such treaties. Other proposals include denying requests by “shell” entities for a tax residence certificate, or ensuring that such a certificate must be provided in a qualified form.

Finally, the Directive proposes that, once identified, a “shell” entity is treated as being tax-transparent, resulting in the entity’s shareholders being taxed on any income as it arises. The effect of this is to introduce a de facto CFC-attribution charge where the “shell” entity and its shareholders are both located in an EU Member State.


The EU Commission’s intention is for the Directive to be introduced with effect from January 1, 2024, but with a retrospective “look back” period of two years – which, effectively, makes the provisions potentially applicable with effect from January 1, 2022. Under EU law, the Directive will need to be adopted by all Member States before it can be transposed into domestic legislation in the EU Member States. However, while some changes might be sought to the draft Directive by both EU Member States and industry bodies, a cautious view (especially given potential post-pandemic European public interest in the prevention of tax avoidance) might be that the Directive is likely to be introduced in near totality. Owing to the retrospectivity of the Directive’s two-year “look back” period, the provisions of the draft Directive are likely to be of considerable interest at the current time to large groups, private equity companies and asset managers.


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