EU Issues Plan to Target Letterbox Company Tax Avoidance

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By Joe Kirwin

The European Commission wants to prevent firms from using EU single market freedom-of-establishment rules to set up letterbox companies for tax benefits.

The new cross-border company conversion rules will be proposed April 25, part of a legislative package designed to overhaul corporate registration rules in the digital era. A letterbox company seeks to minimize tax liability by establishing domicile with a mailing address in a country that is more tax-friendly, while conducting business elsewhere.

The measures would allow EU member nations to reject a company transfer if it determines an “artificial arrangement” will be set up in the destination country.

“A crucial element of the procedure is that it would prevent a cross-border conversion where it is determined that it constitutes an abuse, namely in cases where it constitutes an artificial arrangement aimed at obtaining undue tax advantages,” according to draft text of the proposal obtained by Bloomberg Tax.

Edoardo Traversa, a corporate law professor at the University of Louvain in Belgium, told Bloomberg Tax the proposal marks an important and controversial legal pivot when it comes to EU single market rules.

“The traditional approach when it comes to company law is that mobility is unconditional,” Traversa said April 24. “Mobility has never been dependent on tax issues. But the efforts to reduce tax abuse,” such as base erosion and profit shifting, “have been taken into consideration with this proposal.”

“There seems to be a recognition that excessive mobility can create imbalances and abuse,” Traversa said.

ECJ Ruling

The European Commission proposal comes in the wake of a controversial European Court of Justice ruling (C-106/16) from October 2017 that struck down a Polish government attempt to restrict a Polish company from moving its company headquarters to Luxembourg.

“The ‘Polbud’ judgment clarified the context for cross-border conversions,” according to the commission proposal. “But the ECJ, being a judiciary organ, may not create any procedure for making such conversions possible or set out the related substantive conditions.”

As for what criteria EU member nations will use for determining whether an “artificial arrangement” is the purpose of a cross-border conversion, the commission proposal refers to the EU Anti-Tax Avoidance Directive approved in 2016. Provisions in the proposal outline rules EU member nations should use to fight abusive tax regimes.

Litigation Likely

Despite that reference, Traversa said inevitably EU member decisions on what constitutes an artificial arrangement—should the proposal become law—will likely lead back to the European court.

“In some member states where tax rulings are issued or where there are clear rules, this issue of what qualifies as an artificial arrangement is less problematic,” Traversa said. “But there are companies in this era that are quite possibly pursuing a cross-border conversion for legitimate, legal economic reasons but the company might have little economic activity in a destination country other than a few employees. These and other kinds of cases will likely end up in court.”

The move away from unconditional EU single market freedom-of-establishment rules has caught the attention of the largest EU business lobby group, BusinessEurope, which represents more than 10,000 companies in the bloc. It warned against a proposal that restricts the movement of companies.

“For decades, companies have been waiting to fully benefit from their fundamental freedom of establishment within the European single market,” BusinessEurope Director General Markus Beyrer told Bloomberg Tax in an April 24 email. He added that it is important to avoid the “creation of additional obstacles for companies” and “overburdening check-ups.”

Trade Union Support

Severine Picard, a labor law expert with the Brussels-based European Trade Union Confederation, told Bloomberg Tax the new proposal on company cross-border conversions is a welcome change in approach.

“Based on the terms of the proposal, this is the first company law legislation that we can support,” Picard said April 24. “But the key question now will be whether or not the EU member states or the European Parliament will try to loosen the terms for company mobility.”

As the commission proposal has EU single market law as its legal base, the European Parliament will have co-decision powers with the Council of Ministers. Just as important, the legislation won’t require unanimous consent by all EU member states in the Council of Ministers, as is the case with EU tax legislation.

Traversa said the upcoming legislative process will likely turn into another battleground between large EU member nations with higher taxes versus low-tax nations such as Ireland, Luxembourg, Malta or Cyprus.

“Certainly, some member states will see this proposal as an effort to stop tax competition in the EU,” Traversa said.

To contact the reporter on this story: Joe Kirwin in Brussels at correspondents@bloomberglaw.com

To contact the editor on this story: Penny Sukhraj at psukhraj@bloombergtax.com

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