ATAD III: Is the tide turning on shell companies?

4 min read

The European Commission (the "Commission") published a draft Directive on 22 December 2021, known as the anti-tax avoidance Directive III ("ATAD III"), aimed at preventing the use of shell companies for tax evasion and avoidance in the European Union ("EU"). ATAD III proposes the introduction of a "minimum substance test" and reporting requirements to identify shell companies, and could have serious consequences for investment structures that do not perform "actual economic activity".



ATAD III follows two previous iterations of EU-wide anti-tax avoidance legislation. In January 2016, the Commission proposed the Anti-Tax Avoidance Directive ("ATAD"), in order to "create a level playing field for all businesses in the EU",1 and to implement the OECD's base erosion profit shifting ("BEPS") measures across Europe. ATAD II was subsequently introduced in January 2020, broadening the original scope of ATAD to tackle the issue of hybrid mismatches and provide protection against mismatch outcomes.

Whilst these Directives are seen to have developed measures aimed at tackling perceived tax avoidance and evasion in EU Member States, the existing legislation is not considered to have adequately addressed the issue of entities with minimal substance or economic activity, known as shell companies, being used within the EU. As such, the Commission has determined that further legislation in the form of ATAD III is required in order to "create a fair and effective taxation system in the EU".3 


What is ATAD III proposing?

ATAD III seeks to address the misuse of investment structures that "do not perform any actual economic activity", commonly known as shell companies.4 The draft Directive focuses specifically on legal entities involved in cross-border activities which are "presumably engaged with an economic activity", but in reality do not conduct economic activity.The draft Directive outlines gateway indicators which help determine whether an undertaking is "at-risk" of being a shell company. If these indicators are met, the undertaking will be considered "at-risk", and be subject to further reporting to determine that it meets "minimum substance" requirements.

What are the minimum substance requirements?

An entity will be considered "at-risk", and subject to further reporting requirements if it meets the following conditions:

  • More than 75 per cent of revenue in the preceding two tax years is relevant income (broadly, royalties, dividends and income from assets)
  • The undertaking is mainly engaged in cross-border activity
  • The administration of day-to-day operations and decision-making is outsourced.6 

"At-risk" entities must then report whether they meet the following indicators of "minimum substance" on their yearly tax return:

  • Individual premises in a Member State
  • An active bank account in the EU
  • At least one local director who is exclusive to the undertaking, or full-time local employees.7 

Consequences for not meeting the minimum substance requirements

If an undertaking does not meet these requirements, it would be treated as a shell company for the purposes of ATAD III. The relevant Member State in question would then be able to take action against the shell company, including denying them a certificate of tax residence and restricting treaty freedoms. In practice, this means that certain tax benefits may be denied, and shell entities may be unable to claim double tax relief in other jurisdictions.

Exemptions and the right to rebuttal

Certain undertakings are excluded from the proposal as they are considered to be at low risk of lacking the necessary economic substance, due to already being subject to significant scrutiny. These include companies listed on regulated markets, regulated financial undertakings and undertakings with at least five of their own full-time equivalent employees or members of staff carrying out the activities which generate the relevant income.

The draft Directive also includes a right to rebuttal if an undertaking is assumed to be a shell company. For example, the taxpayer is offered the opportunity to provide concrete evidence of the economic activities the supposed shell company performs, and to prove that genuine commercial reasons exist for setting up and maintaining the entity.9 



ATAD III is currently a proposal, and has not yet been adopted by Member States. Should this happen, the current timeline suggests that the proposed Directive should be implemented into Member States' national laws by 30 June 2023, and come into effect from 1 January 2024.

Businesses should take a critical look at their structures in order to identify any undertakings that may be considered to lack economic substance and be impacted by the implementation of ATAD III. It is important to note that ATAD III will only be legislated by EU Member States.

It is also worth noting that the ATAD III substance test includes a look-back period of the preceding two tax years, meaning that should the Directive come into effect in 2024, an undertaking's compliance as of January 2022 may be taken into consideration. As such, it is imperative that action is taken now to avoid any unforeseen compliance issues.


1 European Commission, Taxation and Customs Union "Anti Tax Avoidance Package", January 2016. 
2 Proposal for a Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries, dated 17 February 2017.
3 Proposal for a Council Directive 2021/0434 (CNS), 22 December 2021, p. 1.
4  Ibid.
5 Ibid, p. 8.
6 Proposal for a Council Directive 2021/0434 (CNS), 22 December 2021, p. 25.
7 Ibid, p. 29.
8 Ibid, p. 26.
9 Ibid, p. 11.


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This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.

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