EU public consultation on the Anti-Avoidance Directive

The European Commission recently ran a call for feedback on the EU Anti-Tax Avoidance Directive (2016/1164), also known as ATAD 1. This directive is a key instrument in the fight by the European Union against tax avoidance by multinationals corporations, as it sets out minimum standards for a number of anti-avoidance measures that have to be adopted by the EU member countries.

Using data from the latest edition of the Corporate Tax Haven Index, we submitted our response, urging the EU Commission to strengthen the Directive’s Controlled Foreign Company (CFC) rules, make the limitations on the deduction of interest more watertight by abolishing the legacy debt loophole, and include limitations on the deduction of royalties and service payments in its updated version.

The Directive

In 2016, the European Council adopted Directive 2016/1164, the Anti-Tax Avoidance Directive (ATAD) in an effort to implement some of the policy recommendations made under BEPS 1.0. The Directive provides a set of minimum norms which must be transposed by EU countries into their domestic legislation, although on various aspects EU countries are allowed to make certain choices or use certain optional clauses.  The Directive includes minimum rules on five important measures aimed at stopping corporate tax abuse:

• limits on interest deductions to prevent tax avoidance through artificial debt;
• exit taxes to block asset relocation for tax avoidance:
• a General Anti-Abuse Rule (GAAR) to disregard non-genuine arrangements;
• Controlled Foreign Company (CFC) rules to combat profit shifting to low-tax jurisdictions, and;
• a switchover rule to prevent double non-taxation.

Since January 2019, these measures became mandatory to all EU countries and the Directive has since received the status of ‘full transposition’ in all countries.

Needless to say, getting the Directive right is crucial, as it sets the minimum standards for a number of crucial measures in the fight against corporate tax abuse. Non-EU countries sometimes also look to the Directives for inspiration for the design of their own regulations.

Recently, we updated the anti-avoidance indicators of our Corporate Tax Haven Index. These indicators monitor a set of anti-avoidance rules that should be adopted by countries to make them tax-abuse proof. These rules partly overlap with the ones included in the ATAD. While reviewing countries’ legal frameworks, we identified several flaws and loopholes in national legislations. As it turns out, many of these imperfections can be traced back to shortcomings in the Directive itself.

We therefore welcome the EU Commission’s initiative for a review of the ATAD and its public call for evidence. The Tax Justice Network was one of the few civil society organisations to submit feedback in a public consultation otherwise dominated by the business sector. The inputs gathered during the public consultation will be used by the Commission to evaluate and possibly to propose a revised version of the Directive in the third quarter of 2025.

Our submission is available here.

Much more than a ranking

The data used for our submission comes from the recently updated Corporate Tax Haven Index. The Corporate Tax Haven Index ranks countries based on their complicity in helping multinational corporations underpay corporate income tax. However, the Index is more than just a ranking. Underneath its surface, it stores extensive legal research on national tax laws and the opportunities for tax abuse the rules fail to address. This research is captured in a country’s Haven Score in the Index, which is then combined with the country’s share in global foreign direct investment (or its ‘Global Scale Weight’) to provide a realistic picture of the actual risk of tax abuse each jurisdiction is creating.

In this new launch, we have adopted a new strategy, whereby updates of the Index are undertaken on a rolling basis and focus only on a limited number of indicators per update. The reasons behind this change in approach are closely related to the fact that international tax policies are undergoing shifts at a faster pace, and the rolling updates allow us to be more responsive to such dynamics.

In this first update, we reviewed the anti-abuse indicators which substantially overlap with some of the measures covered by the ATAD. These included the index’s indicators on Deduction Limitations of Interest Payments and on Controlled Foreign Company Rules.

We also updated the indicators on deduction limitations of intra-group payments of Royalties and Service fees. These type of ‘defensive measures’ are currently not covered by the ATAD but have been adopted by many EU countries and are frequently discussed in the EU context by the EU Code of Conduct Group on Business Taxation. As we explained in our submission, we believe these measures should be covered by the Directive.

What needs fixing

Elsewhere, we’ve written about the process behind the research and the development that goes into an Index indicator. Often, a tax rule seems effective on paper but in practice, the same rule leaves plenty of room for companies to exploit loopholes and for countries to implicitly continue to condone such practices. In our submission, we identified some of these loopholes in the ATAD itself and in the implementation of the directive in certain EU countries.

One issue we highlighted involves the Controlled Foreign Company (CFC) rules. The directive currently lets countries choose between two approaches: transactional rules (Model B) and non-transactional rules (Model A). As we explain in the submission, we recommend that the revised directive eliminate the transactional approach. We argue that the transactional approach does not go beyond the mere application of the arm’s-length principle for pricing of intra-group transactions. In fact, transactional approach relies on a highly subjective method for attributing income to a CFC, and for this reason they are not adequate mechanisms to curtail tax abuse.

The non-transactional approach is more effective at achieving CFC rules’ purpose of avoiding base erosion and limiting the deferral of taxes. Non-transactional CFC rules attribute pre-defined categories of income derived by the CFC to the parent company.  The application of such rules is a mechanical process and does not involve any tax authority discretionary power.

The non-transactional CFC rules in the ATAD are not without issues, however. In the directive, these rules come with a mandatory substance carve-out which turn off the CFC rules when a taxpayer can show substance. The need to include such a substance carve-out is a given, as it is based on prior jurisprudence by the Court of Justice of the EU. However, the ATAD currently lacks clear, standardised rules for determining when a company has genuine economic activity. This leaves the implementation of the substance carve-out completely up to the discretion of the tax authorities. As a result, the effect of these type of CFC rules across EU countries is far from harmonized. We therefore suggest tightening these rules by providing clear guidelines to identify real business operations, rather than allowing too much flexibility, which can be abused.

Regarding the interest limitation rule, the current Directive allows interest costs to be deductible up to 30% of a company’s EBITDA (earnings before interest, tax, depreciation, and amortization), which is a rather high threshold. The Directive also allows countries to opt for a group-ratio rule which allows individual companies to deduct interest beyond threshold based on the indebtedness of the overall group at worldwide level. Allowing both a high individual threshold and the benefit of a group-ratio threshold makes the deduction limitation lose a large part of its effectiveness. For this reason, such a combination of rules also goes against international recommendations on the matter made during BEPS.

If countries decide to adopt the 30% threshold, this should be paired with other restrictions, like removing the group ratio rule or adding more limits on interest deductions. We propose either lowering the 30% threshold or making it conditional on additional restrictions. Moreover, the Directive’s exemption for legacy loans under the optional grandfathering clause should be abolished, as it’s becoming a permanent loophole in some countries.

Lastly, limiting (or prohibiting) deductions on intra-group payments like royalties and service fees is a powerful tool to prevent tax abuse in the form of base erosion and profit shifting. So-called ‘defensive measures’ to limit deductions in certain instances are already used by many EU countries, as pointed out by the EU Code of Conduct Group. To make this approach consistent across all EU members, we believe that harmonized anti-avoidance measures on these types of deductions should be included in the directive.

Instead of what EU countries are doing today, which is to limit payments to countries appearing on a list of non-cooperative jurisdictions (which is ineffective and often leads to unfair practices of blacklisting), these limitations to deductions should be based on objective criteria to the risk of base erosion at hand. We would like to see the blunt practice of blacklisting abolished and propose alternative policy options that the Directive could employ to avoid base erosion through the excessive use of intra-group payments of royalties and service fees.

Check our full submission here.