International Legal Instruments established to fight shell companies
The OECD Model Tax Convention on Income and Capital, 2017 1 and The UN Model Double
Taxation Convention between Developed and Developing Countries, 2017 were adopted as a means
to promote the cooperation in taxation between countries in order to address the gaps relating to taxation.
It is a model for countries concluding bilateral tax conventions. It aims to remove tax-related barriers to
cross-border trade and investment. The convention forms the basis for negotiation and application of
bilateral tax treaties, assisting businesses through the guidelines while giving minimum standards to be
met in order to prevent tax avoidance and evasion. These conventions were developed due to the rapid
digitization of systems and therefore, the increase in cross-border trade, investments, and businesses. 2
The Action Plan on Base Erosion and Profit Shifting 3 is a set of 15 action plans that aim to equip
governments with domestic and international rules and measures to address and prevent tax avoidance.
The action plans ensure that profits are taxed where economic activities that generate the profits are
conducted and where value is created.
In January 2016, the EU launched the EU Tax Avoidance Package, which aimed to promote a simpler,
more effective, and more fair method of corporate taxation. The directives entered into force as of 1 st
January 2019, and they contained 4 legally binding instruments. The first legal instrument in the EU Tax
Avoidance Package was the Council Directive (EU) 2016/1164 4 which addressed the main rules against
tax avoidance practices that directly affect the functioning of the internal market. Upon the realization that
the initial directive had some gaps with regard to third countries, the EU adopted the Proposal for a
Council Directive Amending Directive (EU) 2016/1164 and the Commission Staff Working
Document which aimed to neutralize the effects of hybrid mismatches with third countries. Hybrid
mismatches exploit differences in the tax treatment of an entity or instrument under the laws of two or
more jurisdictions to achieve double non-taxation.
The National Defense Authorization Act 5 was adopted by the US Congress, and it aims to effectively
ban shell companies. It was noted that many shell companies are anonymous, meaning that one opens a
company existing only on paper with no employees, activities, and revenue, and is only made up of bank
details and assets. 6 Its ownership is also unknown as a result of the corporate governance rule on the veil

1 Fair Taxation: Commission proposes to end the misuse of shell entities for tax purposes within the EU
2 Department of Economic & Social Affairs, United Nations Model Double Taxation Convention between
Developed and Developing Countries, 2001
3 BEPS, Inclusive Framework for Base Erosions and Profit Shifting,
accessed 1 May 2022
4 Council Directive (EU) 2016/1164, 2016
5 The National Defense Authorization Act 2022

of incorporation, an environment is created where money laundering and tax evasion and avoidance are
conducted. Due to this reality, the act makes provisions requiring any shell companies to provide
ownership details or some basic form of identifying information in order to promote tax compliance.
The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion
and Profit Shifting is an international multilateral instrument that allows governments to modify existing
bilateral tax treaties in a synchronized way. It will update international tax rules and close loopholes for
tax avoidance schemes. 7 This will result in more certainty and predictability for corporations.
1.2 Relevant Measures introduced so far in the United States and the Netherlands and how
effective they have been in detecting and combating shell entities
The EU directives implemented various measures to prevent tax avoidance. Among the measures
highlighted were:
The rule on hybrid mismatches, whereby differences can arise from the manner in which an entity is
characterized under the tax laws of states and thereby generating an advantage in terms of tax or an
outcome that is a mismatch. 8 The effect of such mismatches is often a double deduction (i.e., deduction in
both states) and a deduction of the income in one state without inclusion in the tax base of the other. The
anti-hybrid rules make it so that there is no mismatch in the laws of the two countries by making domestic
law changes and by harmonizing and coordinating domestic laws. One of the two jurisdictions in a
mismatch should deny the deduction of a payment that would lead to such an outcome. This closes the
gaps, therefore, preventing arrangements that exploit the differences in the tax treatments of entities in
two or more jurisdictions.
The Controlled Foreign Company Rule which prevents the artificial diversion of profits from the
controlling/main company to offshore entities situated in low-tax or no-tax jurisdictions to avoid taxation.
It ensures the taxation of certain categories of companies (mainly subsidiary companies and controlled
companies) in the jurisdiction of the parent company in order to prevent offshore arrangements that result
in no or indefinite deferral of taxation. 9 The CFC rules do not aim to prevent the shifting of profits to
other jurisdictions but rather, aim to put taxation procedures in place, even when the company shifts its
6 Schwartz, Moshe, and Heidi M. Peters. "Acquisition Reform in the FY2016-FY2018 National Defense
Authorization Acts (NDAAs)." (2018).
7 Malherbe, J., 2018. A New Tax Treaty for a new world: The Multilateral Convention to implement tax treaty-
related measures to prevent base erosion and profit shifting. In A New Tax Treaty for a new world: the Multilateral
Convention to implement tax treaty-related measures to prevent base erosion and profit shifting (pp. 9-41). CSA-
Casa Editrice Università La Sapienza.
8 Fibbe, G.K. and Stevens, T., 2017. Hybrid mismatches under the ATAD I and II. EC tax review, 26(3).
9 Egger, P.H. and Wamser, G., 2015. The impact of controlled foreign company legislation on real investments
abroad. A multi-dimensional regression discontinuity design. Journal of Public Economics, 129, pp.77-91.

profits to another state. This reduces the incentives of companies to shift profits of a company from the
market jurisdiction to a low or no-tax jurisdiction. Therefore, any profits shifted to another jurisdiction
shall still be subject to EU taxation. 10
The Exit Taxation provisions that aims to prevent companies from avoiding tax when relocating assets. 11
The rules provide for an “exit tax” on unrealized capital gains. 12 This is seen mainly when a company,
after developing a new product, moves it to a low-tax or no-tax country before it is finalized and
launched, therefore, making the company pay less tax on the profits of the products. With the rules on exit
tax, member states can impose a tax on the value of the products before they were moved out of the state
and the EU’s jurisdiction. 13
The Switch-over rule which prevents double non-taxation of certain income. 14 In many circumstances, an
EU-based company invests in another company situated low-tax or no-tax country outside the EU.
Dividends and profits are then paid to the EU-based company, where member states presume that the
proceeds have been properly taxed in the third country, but in many cases, the third country presumes that
the proceeds will be taxed in the EU-based company’s jurisdiction. With the implementation of
switchover rules, the EU member states will have to monitor the taxation of dividends and profits by
having the company lodge taxation documents from the third country and where it is deemed that no tax
was paid in the third country, then the EU member states will be at liberty to tax the dividends and profits.
Interest Limitation rule that discourages artificial debt arrangements designed to minimize taxes. 15 In
many cases, a company based in the EU sets up a subsidiary in a low-tax country which furnishes the
parent company, or another subsidiary of the company based in the EU with a loan to be repaid in high
interest with tax-deductible payments. Multinational groups achieve favorable tax results by adjusting the
amount of debt in a group entity. 16 This can be done in three distinct methods: by placing higher levels of
third-party debt in high tax countries, by using intragroup loans to generate interest deductions in excess
of the group’s actual third-party interest expense, or by using third-party financing to fund the generation
10 Controlled Foreign Company Rule, accessed 1 May 2022
11 Peeters, S., 2017. Exit Taxation: From an Internal Market Barrier to a Tax Avoidance Prevention
Tool. EC Tax Review, 26(3).
12 Tijms, H.C. and van der Duyn Schouten, F.A., 1978. Inventory control with two switch-over levels for a
class of M/G/1 queueing systems with variable arrival and service rate. Stochastic Processes and Their
Applications, 6(2), pp.213-222.
13 Ibid
14 Resch, R.X., 2007. The new German unilateral switch-over and subject-to-tax rule. European taxation, 47(10),
15 Pivoňková, A. and Tepperová, J., 2021. Interest limitation rule under ATAD: Case of the Czech
Republic. Danube, 12(2), pp.121-134.
16 Dourado, A.P., 2017. The Interest Limitation Rule in the Anti-Tax Avoidance Directive (ATAD) and the Net
Taxation Principle. EC Tax Review, 26(3).

of tax-exempt income. The Interest Limitation Rule aims to link an entity’s net interest deductions to its
level of economic activity within the jurisdiction measured using taxable earnings. This will in turn limit
the amount of interest that a company can deduct, therefore increasing the amount of tax payable.
The Income Inclusion Rule 17 whereby the state where the parent company is situated imposes a top-up
payment on the entity in respect of the low-tax advantage gained by the subsidiary company in a low-tax
country. This ensures that the loophole with regards to companies in low/no-income states is closed,
therefore making the company pay the required amount of tax as compared to its activities. 18
The General Anti Abuse Rule that aims to counteract aggressive tax planning, even when other rules do
not seem to apply. This general rule closes all loopholes that may be used by companies to avoid tax. 19 It
gives the EU the mandate to tackle and prevent aggressive tax planning by companies even where there
are no specific rules covering a specific action. 20
In the US, there have been rules adopted that require entities to disclose beneficial ownership information
that shall be stored in a central database, where the information will not be public but rather, will be
available to law enforcement agencies and financial regulators in order to promote transparency in matters
regarding shell companies. This will enable easier regulation and follow-up on the companies’ activities,
therefore, preventing tax evasion and avoidance.
Domestic general anti-avoidance rules (GAARs) of the Member States already target shell companies and
transactions. In fact, they are patterned according to Article 6 of the Anti-Tax Avoidance Directive
(ATAD) 21 , which has to be interpreted in light of the existing case law of the CJEU on abusive practices
(as far as its concepts stem from EU law). 22 Said case law unequivocally considers potentially abusive (i.e.
wholly artificial) shell entities. 23 The Netherlands has certain minimum substance requirements for
intermediary holding companies that were introduced, requiring, inter alia, a minimum amount of labor

17 Hey, J., 2021. Guest Editorial: The 2020 Pillar Two Blueprint: What Can the GloBE Income Inclusion Rule Do That
CFC Legislation Can’t Do?. Intertax, 49(1).
18 OECD/G20 Base Erosion and Profit Shifting Project Two-Pillar Solution to Address the Tax Challenges Arising
from the Digitalization of the Economy, 2021, <
address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-october-2021.pdf> accessed 1 May 2022
19 Freedman, J., 2014. Designing a general anti-abuse rule: Striking a balance.
20 Debelva, F. and Luts, J., 2015. The general anti-abuse rule of the Parent-Subsidiary Directive. European
Taxation, 55(6), pp.223-34.
21 UK: CJEU, 12 Sept 2006, Case C-196/04, Cadbury Schweppes and Cadbury Schweppes Overseas, EU:
C:2006:544, para. 68
22 Room Document # 3, Working Party on Tax Questions – Direct Taxation, PSD Anti-Abuse rule, 17.09.2014,
Highlights & Insights on European Taxation, H&I 2015/275, p. 45
23 UK: CJEU, 12 Sept 2006, Case C-196/04, Cadbury Schweppes and Cadbury Schweppes Overseas, EU:
C:2006:544, para. 68

costs and office space. 24 Failing to meet these requirements leads to withholding taxes in outbound
1.3 Do the proposed rules in the EU shell directive effectively plug the gaps in the existing legal
framework to tackle shell companies?
The proposed EU directive 25 (Anti-Tax Avoidance Directive III) aims to ensure that companies that have
little or no economic activity will be unable to benefit from tax advantages. The directive also aims to
increase transparency standards around shell entities to enable the easy detection of misuse of the entities
by tax authorities. The EU directive proposes a number of indicators to determine whether a company has
any real economic activity. If a company is found to have all indicators, then it shall be required to
annually report more information than other companies in order to satisfy the requirement during tax
return filing. 26
The indicators consider the entities’ activities as compared to the income they are said to receive. If 75%
of the entity’s overall revenue over the period of the past 2 years is not derived from the entity’s activities,
or if more than 75% of its assets are derived from passive income, dividends, and income from the
disposal of shares, income from financial leasing, immovable property and real estate, income from
movable property, insurance, banking, and other financial activities, as well as income from services
which the entity has outsourced to other associated enterprises then the entity will have been said to have
failed on the first indicator.
Similarly, if the company receives 60% or more of its relevant income through transactions from other
countries or if the company passes 60% of its income to another company situated abroad, then the
company crosses the next gateway. The third indicator is whether corporate management and
administration services are performed in-house or if they are outsourced.
A company with all the indicators will be required to report on information related to matters such as the
premises of the company, its bank accounts, the tax residency of its directors, and that of its employees.
All such information is to be verified by supporting evidence. Should a company fail to provide
information as required, it shall be presumed to be a shell company.

24 P. Mac-Lean, Netherlands – Investment Funds & Private Equity, Country Tax Guides IBFD (accessed 31 July
25 ATAD 3 – European Commission proposal to prevent the misuse of shell entities,
of-shell-entities.html accessed 30 April 2022
26 Ibid

If the company is deemed as a shell company, it shall be unable to access tax relief and any benefits from
the tax treaty networks of any of the EU member states nor will it qualify for the treatment under the
Parent-Subsidiary and Interest and Royalties Directives. The state in which the company is set up shall be
required to deny the shell company a tax residence certificate or the certificate will specify that the
company is a shell company for purposes of future transactions. Further to that, payments by the shell
company to third countries will be subject to withholding tax, and payments made from another state to
the shell company shall be taxed at the state of the company’s shareholder.
This directive provides clear procedures for the adequate monitoring of companies, and it gives three
main indicators to help determine if a company is a shell company. Moreover, the directive also gives
specific action to be taken should a company be deemed to be a shell company. Therefore, the rules are
capable of tackling matters of tax avoidance by the use of shell companies, not only in in-bound situations
but also in cross-border transactions. However, in matters of cross-border transactions, the directive fails
to consider the implications of their laws and directives on non-EU member states. It fails to consider how
compliance with tax obligations shall be ensured if payments are made from another state to the shell

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