Multinationals Should Beware New European Tax Rules on Horizon

Small and medium-sized businesses that own holding companies and other legal entities registered in European Union member states need to prepare for the prospect of paying significantly higher tax rates on dividend income.

However, companies that examine the composition of their European corporate structures may be able to avoid some of these higher tax rates if they begin aligning their operations to reflect the guidelines set forth in a proposed directive.

The pending tax rule—known in EU parlance as the third Anti-Tax Avoidance Directive 3, or ATAD 3—passed the European Parliament in January. If unanimously approved by the Council of the European Union, ATAD 3 will add complexity—and potential accounting and compliance costs—to already cumbersome tax reporting requirements for multinational companies, regardless of domicile, industry, and conformity to the pending measure.

Companies in the software and technology, pharmaceutical, and finance sectors should pay particular attention to these new rules. Their ability to operate with a light physical footprint makes them prime targets for national authorities looking to crack down on tax abuse by holding companies.

Crackdown on Holding Companies

ATAD 3 targets the misuse of holding companies that take advantage of tax treaty networks or other legal mechanisms, such as the EU’s Parent-Subsidiary Directive, to obtain lower rates on dividend income. For multinationals, ATAD 3 would amount to a substance-oriented inquiry to determine if a holding company maintains sufficient on-the-ground operations within the jurisdiction where it’s registered, and can enjoy lower rates on dividend income.

The measure may take effect as early as Jan. 1, 2024. However, companies with holding company structures in the EU need to be aware that the directive allows national tax authorities to penalize companies if they’re out of compliance in calendar years 2022 and 2023. Businesses may avoid penalties if they start now to conform with the pending rules by substantively transforming their operations.

New Inquiries From Tax Authorities Likely

To avoid surprises, cross-border businesses that leverage holding companies for their corporate structures within the EU should immediately examine how they may be affected by ATAD 3. In particular, companies with holding companies in jurisdictions known for their friendly treatment of dividend income, such as the Netherlands, Luxembourg, Switzerland, and Ireland, should determine whether they have sufficient on-the-ground operations within that specific country to pass any ATAD 3 inquiries by national tax authorities.

Consider a multinational that established a Dutch holding company that owns separate French, German, and Italian operating companies. The operating companies in each respective region pay dividends into the Netherlands-based holding company. With ATAD 3’s expected rules, the Dutch holding company should ensure it maintains sufficient on-the-ground operations within the Netherlands to continue to enjoy lower tax rates on dividend income from its foreign subsidiaries.

Specific Threats to Small Businesses

While many large multinationals likely maintain, or can swiftly establish, sufficient on-the-ground operations in countries where they register holding companies, small, medium, and less-resourced enterprises may find it challenging to meet ATAD 3’s expected standards.

Sufficient on-the-ground operations may include the ongoing employment of at least one person and physical presence, such as the renting and operation of an office, in the same country where an EU-based holding company is officially registered. In the age of remote and hybrid work, many national tax authorities may deem the use of an employee’s home to constitute sufficient physical presence.

Small and medium-sized businesses often struggle to navigate unfamiliar employment and commercial real estate markets when expanding abroad. ATAD 3 will add new burdens to these challenges, as the rule will force less-resourced companies to spend more time and money reporting on their on-the-ground operations in countries where they maintain holding companies.

Multinationals that flout or can’t meet these expected tax rules for holding companies likely will incur a hefty tax bill. If national tax authorities find that a company’s holding company fails to maintain sufficient on-the-ground presence based on the rules set forth in ATAD 3, the multinational will be forced to forgo any preferential treatment on dividend payments. Given that some jurisdictions offer rates as low as 0% for dividend payments into a holding company, company cash flows may take a significant hit if they are found to be out of compliance. In fact, some multinationals may face dividend tax rates at or near 25% to 30%.

Corporate Restructuring Considerations

Another alternative to ensure ATAD 3 compliance is corporate restructuring, especially if it isn’t feasible to establish on-the-ground operations in EU member states where holding companies are registered. Though this can be costly upfront, it may be easier to realign operations where it is easier or justifiable to employ workers and maintain a physical presence.

For companies operating on the European mainland, the Netherlands and Luxembourg are attractive for establishing holding companies for EU operations. Not only do both countries offer a network of tax treaties that favorably treat dividend income paid to holding companies, but they are also centrally located, easing logistical challenges. Even though it’s no longer an EU member, the UK also offers an attractive place to set up a holding company to receive dividend income, especially for companies wanting to compete in the British market.

Though multinationals need to closely examine their corporate structuring and operations in the EU to prepare for ATAD 3, it’s not all doom and gloom. Many firms will continue to find exciting opportunities in the EU marketplace, and the implementation of new tax rules shouldn’t detract from the growth potential of expanding internationally.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Bill Henson is a partner in Plante Moran’s international tax services group. He has 34 years of experience in international tax advisory and in-house roles with a focus on manufacturing and oil and gas.