Moran Harari ■ Intervention at EU Parliament on the Unshell Directive: Full text

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The Tax Justice Network made an intervention at the European Parliament’s Expert meeting on the Unshell Directive on 12 July 2022. The intervention was presented by Moran Hariri, lead researcher indices at the Tax Justice Network, on the behalf of the organisation. The full text of the intervention is shared below.

First of all, we would like to thank you for the invitation to speak at this important meeting and present our views regarding the Unshell directive.

The massive media revelations such as Pandora Papers and OpenLux as well as significant academic literature have clearly demonstrated the way shell entities are widely used to shift and hide wealth and profits in the EU.

The proposed directive is thus an important step to tackle the existence of shell entities and we believe that the framework put in place by the Commission may tackle at least some of the tax abuse created by them.

Predominantly we commend the intention to create a central depository of shell entities for Member States to exchange information and the decision to apply the directive on a broad scope of legal vehicles rather than only on companies.

We also welcome the sanction of disallowing shell entities to use tax advantages derived from double tax agreements and relevant directives, as well as the right for other member states to tax the profits/assets.

However, we at the Tax Justice Network think that shell entities are often the main vehicle for creating complex ownership structures, which constitutes an even bigger problem the Commission should start addressing in this directive. Complex ownership chains may create risks related to three main issues: 1) hiding the ultimate beneficial owner for money laundering and other financial crimes; 2) avoiding tax; and 3) ensuring limited liability by isolating risks for assets within a group of entities.

There is already sufficient evidence which prove that complex chains of ownership are abused for illicit financial flows. In fact, the key method used to hide beneficial ownership involves the use of legal persons and arrangements to distance the ultimate beneficial owner from their assets. 

While it’s absolutely free for an individual to set up a complex ownership chain, the real price is paid by authorities and the public at large. Authorities trying to verify beneficial ownership information or unfold a very complex tax planning, need to spend increasing resources in terms of staff, technology and time to do so.

In light of this view, there are several caveats we would like to point out, mainly regarding the ways to determine shell entities and the consequences of such determination.

We would also like to suggest several recommendations.

A. On how to determine what a shell entity is?

In our view, the current directive proposal is too easy to circumvent.

A few concrete observations:

1) The exclusion of an undertaking which has at least 5 full-time equivalent employees from the initial screen of the gateways test can be simply too easy to by-pass and should be deleted from article 6(2). This is because for undertakings which aim to launder money or to evade tax in large sums, employing 5 people is definitely worthwhile and it would be difficult for tax authorities to monitor this.

2) A similar issue exists in the minimum substance test where the undertaking needs to prove it has a sufficient number of employees who reside close to the entity. Not only does this criterion can be easily circumvented as I explained, but also the requirement to reside close to the entity do not consider the modern business reality of mobile workers, especially after the Pandemic.

3) It is not clear to us why in the first gateway test, the threshold for the revenues accruing passive income by the undertaking should be at least 75% while for the Common Reporting Standard, the threshold for defining a Passive Non-Financial Entity is more than 50%. Unless there is a justified reason to differentiate, we think the lower threshold should be applied for the Unshell directive as well.

4) The incentives and mechanisms for creating shell entities are broader than we currently understand and it’s time for authorities to ask for more information to be able to tackle them. So once a certain undertaking has been filtered through the gateway test and the burden was shifted for it to prove it has a minimum substance, the entity should also be required to disclose its structure, including its number of layers, as well as to justify the need for creating those layers. As a first step, this information will not be considered for the minimum substance test and will be only provided to authorities. At a later stage, however, ideally authorities will have enough data to develop more sophisticated criteria for determining what is a shell entity and to cross- check the information.

B. Regarding the consequences of shell entities that were eventually determined as such- our recommendations are the following:

1) The member state of the shell residence should not have a discretion to either deny its tax residence or to continue considering the shell entity as resident for tax purposes. Such discretion is likely to create a differentiation and attract more shell entities to countries that are inclined not to deny the tax residency of the entity.

2) The shell entity should be required to disclose its beneficial ownership chain upward until the ultimate beneficial owners and downwards until the assets held. Alternatively, the requirement for beneficial ownership registration for shell entities should be subject to a lower threshold than the AML definition of minimum 25% of ownership or control, so perhaps 10% or ideally even less.

3) The central depository of shell entities should – at least at a certain point of time- be open to the public. This way, it is likely to create more deterrence and to enable journalists and civil society organisations to hold governments and entities to account. To sum up, the Unshell directive has the potential to provide authorities with the right tools not only to tackle tax avoidance and evasion but also the greatest risks to society posed by complex ownership chains which are often comprised of shell entities. It would be a missed opportunity not to take these risks on board.

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