In Part I of this series, I looked at the key proposed amendments to the Parent-Subsidiary Directive and the Interest and Royalty Directive and in Part II, I turned to the Merger Directive and the proposal to align EU tax law with company law. Part III turns to ATAD, which may be the most sensitive part of the EU Tax Simplification Package.
With ATAD, the European Commission is not merely addressing tax friction. It is tweaking part of the post-BEPS anti-avoidance architecture. ATAD was adopted in 2016 as a common minimum set of rules against base erosion and profit shifting. That made sense in 2016. But the context today is different. The question is not whether Europe has enough anti-avoidance rules, but whether Europe has too many overlapping defensive layers.
Proposed ATAD amendments
- The Interest Limitation Rule. The proposal would make the 30% EBITDA threshold mandatory, introduce a mandatory EUR 3 million de minimis threshold, remove the standalone entity exclusion, create a carve-out for certain low-risk third-party loans, require group escape and carry-forward mechanisms, broaden the public-benefit project exclusion, introduce a safeguard for significant EBITDA downturns, and temporarily exclude certain defense-related borrowing costs.
- The CFC rules. The proposal would reduce the overlap between CFC rules and Pillar Two. Companies within the scope of the Pillar Two Directive would generally be exempt from CFC rules for low-taxed subsidiaries, subject to limitations. The proposal would also introduce a useful SME carve-out and move towards a single CFC model by removing the Model B transactional approach and fully adopting Model A.
- The GAAR. The proposal would broaden the scope of the GAAR so that it applies consistently to direct taxes, including withholding taxes and Pillar Two top-up taxes.
- Hybrid mismatches. The proposal would remove the imported hybrid mismatch rules, while leaving the main hybrid mismatch rules in place.
- R&D allowance. The proposal would introduce an EU-wide immediate expensing regime for certain R&D capital expenditure. The allowance would apply to qualifying plant, machinery and tangible assets used directly for R&D or for R&D facilities.
Key Takeaways
- ATAD simplification is more difficult than withholding tax simplification. Removing withholding tax friction sounds like promoting competitiveness. Simplifying ATAD may sound like scaling back anti-avoidance. That is why the EU Commission opted for a more targeted approach. Companies operating across the EU do not deal with one ATAD system. They deal with 27 national variations, with different options, carve-outs, thresholds and administrative approaches. That is not a single market solution. It is coordinated fragmentation resulting from the EU tax unanimity limitations. The proposal moves slowly in the right direction by reducing optionality and making certain rules like interest barrier mandatory.
- The Interest Limitation Rule (ILR) needs to be updated for the real economy. The ILR was designed to prevent excessive debt financing and base erosion. That remains a legitimate objective. But the economic context changed. ATAD was adopted in an era of low interest rates and abundant liquidity. Today, businesses face higher financing costs and major investment needs from infrastructure and real estate to scale-up financing. A strict ILR can limit genuine third-party financing instead of intra-group debt. Ultimately most corporate tax systems may still favor debt over equity and the current package does not fully solve the equity incentive side (included in the separate DEBRA Directive). If Europe wants more equity financing, deeper capital markets, stronger scale-ups and more innovation financing, ILR simplification is only part of the answer.
- The mandatory 30% EBITDA threshold as useful step. This is perhaps the flag proposal to reduce fragmentation where Member States apply stricter limits. The mandatory de minimis threshold is also welcome. Keeping the threshold at EUR 3 million may limit the real simplification effect. If the objective is to remove ordinary businesses from unnecessary compliance, the question is what is the right threshold for the current financing needs?
- The third-party debt carve-out is an important ILR change. The proposal recognizes that bank debt or market debt used to finance the borrower’s own business is not the same as profit shifting through related-party financing. This should be particularly relevant for capital-intensive sectors such as real estate and infrastructure groups as well as EU based start-ups looking to expand worldwide. But the drafting is likely to generate significant interpretative questions. Concepts such as "own activities", indirect financing and the prohibition on funding equity contributions are likely to be tested in practice, particularly in acquisition financing structures. The public-benefit and defense exclusion are understandable but appear narrow and time-limited.
- The CFC changes are conceptually important because CFC rules and Pillar Two overlap. CFC rules were designed to counter profit shifting to low-taxed controlled subsidiaries. Pillar Two creates a global minimum tax for large groups. The two regimes are not identical, but they may produce overlapping compliance and functions. The proposal to carve out Pillar Two groups from CFC rules therefore recognises that CFC rules should not become a parallel minimum tax regime.
- The proposed SME exemption for CFC is very welcome. SMEs are rarely the source of sophisticated cross-border tax avoidance, but they can still face disproportionate compliance costs when required to analyse rules designed for multinationals. This begs the question that if SMEs are considered sufficiently low-risk to justify an exemption, and very large multinationals are already disciplined by Pillar Two, who exactly are the CFC rules now targeting?
- The R&D allowance is interesting but oddly placed. ATAD was created as a defensive directive. An R&D allowance is an investment incentive. Including it within ATAD suggests that EU tax policy is no longer only about preventing avoidance, but also about supporting competitiveness. That is positive. But the measure appears limited because it focuses on tangible capital expenditure used for R&D or R&D facilities. It may not cover staff costs, consumables or intangible R&D inputs, which are often the most relevant cost components in technology, software, life sciences and innovation businesses. Many Member States already have wider R&D tax credits, enhanced deductions, patent boxes or innovation incentives. The EU minimum standard may therefore add very little to the R&D space until a real level playing field is achieved.
- The GAAR broadening creates a paradox. Applying the GAAR more consistently across direct taxes, including withholding taxes and Pillar Two top-up taxes, may create a broader and more coherent anti-abuse framework. But a broader GAAR without clearer interpretative discipline can also increase uncertainty. A genuine and bolder simplification exercise could also have harmonized the interpretation of the GAAR across EU direct tax legislation, rather than simply extending its scope.
- The Exit Tax and the notable omission. Surprisingly, Article 5 on exit taxation remains untouched. This is one of the most administratively burdensome provisions of ATAD, requiring complex valuation exercises, deferred payment mechanisms and ongoing compliance obligations. The proposal also misses the opportunity to clarify its interaction with the new cross-border conversion rules, provide greater certainty around the concept of market value and develop common EU principles to limit individual shareholder tax consequences of corporate migrations.
- The removal of imported hybrid mismatch rules. These rules are extremely difficult to apply because they require taxpayers and tax authorities to trace mismatches through multi-layered structures. Their removal is an implicit admission that some post-BEPS rules may have exceeded their practical usefulness.
Conclusion
The ATAD amendments may be the most difficult part of the EU Tax Simplification Package because they reopen, even if only partially, the post-BEPS anti-avoidance discussions. Even if the direction is welcome, it is important to recognize that the patchwork of anti-abuse rules has become somewhat excessive and applied in different ways and forms by each Member State. The hardest simplification exercise of all is to fight tax avoidance without making normal business investment unnecessarily difficult.
