The European Commission adopted, on 25 November 2013, a proposal for a Council Directive amending Council Directive 2011/96/EU of 30 November 2011 on the common system of taxation applicable in the cases of parent companies and subsidiaries of parent companies and subsidiaries of different member states (Parent Subsidiary Directive) to close the loopholes in the Parent Subsidiarity Directive that have been exploited by some companies to avoid paying any taxes at all.

The revision of the Parent Subsidiary Directive is one of the measures announced in the Commission's Action Plan for a more effective EU response to tax evasion and avoidance, which was adopted by the Commission on 6 December 2012. The adoption of this Action Plan was the second response to the European Council request of March 2012 "to rapidly develop concrete ways to improve the fight against tax fraud and tax evasion, including in relation to third countries" (see Legal update, European Commission adopts package of measures to strengthen fight against tax evasion and aggressive tax planning). The first response to this request was the adoption, on 27 June 2012, of a Commission Communication on concrete ways to reinforce the fight against tax fraud and tax evasion including in relation to third countries (see Legal update, Tax fraud and evasion: European Commission adopts Communication on concrete ways to reinforce the fight against tax fraud and evasion).

To assist the Commission with the drafting of the proposal amending the Parent Subsidiary Directive and in addition to the consultation work done within the context of the Code of Conduct Group and the public consultation launched by the Commission on double non-taxation in 2012 (see Legal update, Double non-taxation: European Commission publishes feedback to public consultation on factual examples and possible ways to tackle double non-taxation cases), the Commission held technical meetings with member states and with stakeholders in April 2013.

The proposal amending the Parent Subsidiary Directive is accompanied by a Commission Impact Assessment document, an Executive Summary of the Impact Assessment document and an Implementation Plan. The Impact Assessment looked at different options for amending the Parent Subsidiary Directive which were compared with the "no action" or "status quo" scenario. It was found that counteracting double non-taxation deriving from hybrid financial arrangements and aggressive tax planning will have a positive impact on the tax revenue of member states otherwise affected from the overall reduction of taxes paid by the parties involved and by the additional tax deductions of the costs for tax planning and relevant arrangements.

The legal basis for this proposal is Article 115 of the Treaty on the Functioning of the European Union (TFEU) under which the Commission may issue Directives for the approximation of provisions of the member states as directly affecting the functioning of the Internal Market.

The proposal's objective is to tackle hybrid financial mismatches within the scope of application of the Parent Subsidiary Directive and to introduce a general anti-abuse rule in order to protect the functioning of this Directive.

In order to satisfy this objective, the proposal aims at modifying the Recitals, Article 1, Article 4 and to update Annex I Part A of the current Parent Subsidiary Directive. The modifications and update are contained in Article 1 of the proposal.

The proposed amendments to the Parent Subsidiary Directive would:

According to the Commission, the proposal will affect any company that has worked to reduce its tax bill by using artificial arrangements involving profit distributions/ dividend payments between a parent company in one member state and a subsidiary in another. It will also create a disincentive for companies to set up subsidiaries in another member state purely to avail of mismatches in national tax laws. More specifically, a cross-border group of parent and subsidiary companies using hybrid loan arrangements will be denied a tax exemption in the parent company's member state if these payments are deductible in the subsidiary's member state.

Next steps: The proposal falls under the consultation procedure. The consultation procedure is a special legislative procedure, whereby the European Parliament (EP) is asked for its opinion on proposed legislation before the Council adopts it. It is established by Article 289 of TFEU. Under this procedure, the EP may approve, reject, or propose amendments to a legislative proposal. The Council is not legally obliged to take the EP's opinion into account, but in line with the case-law of the Court of Justice, it must not take a decision without having received it.

Background: The issue of corporate tax avoidance is very high in the political agenda of many EU and non-EU countries, and the need for action to combat it has been highlighted at recent G20 and G8 meetings. On 6 December 2012, the Commission adopted a package of measures to strengthen the fight against tax evasion and aggressive tax planning in the EU (see Legal update, European Commission adopts package of measures to strengthen fight against tax evasion and aggressive tax planning). This package of measures is the second response to the European Council's request of March 2012 "to rapidly develop concrete ways to improve the fight against tax fraud and tax evasion, including in relation to third countries". The first response to this request was the adoption, on 27 June 2012, of a Commission Communication on concrete ways to reinforce the fight against tax fraud and tax evasion, including in relation to third countries. The Communication also announced that the Commission would come forward with an Action Plan before the end of 2012, along with specific ideas on how to better tackle tax havens and aggressive tax planning.

The Parent Subsidiary Directive was designed to eliminate tax obstacles for profit distributions between parent companies and subsidiaries based in different member states. While the Parent Subsidiary Directive's purpose is to avoid companies from suffering from double taxation on the Single Market, the Commission found that there are many cases where it is being abused by companies to avoid paying taxes in any member state. The Commission therefore wants to close loopholes being used for a particular tax planning arrangement (hybrid loan arrangements) and to introduce a general anti-abuse rule so the Directive is not exploited by tax avoiders.

Hybrid loan arrangements have been identified as a tax planning tool that can specifically exploit provisions of the Parent Subsidiary Directive to minimise or avoid taxes. Hybrid loan arrangements are financial instruments that have characteristics of both debt and equity. Due to this, member states may give different tax qualifications to hybrid loans. Some member states will treats them as simple loan, while other member states regard them as equity. As a result, cross-border hybrid loans may be treated as a tax deductible expense (interest) in the member state of the payer (subsidiary) and as a tax exempt dividend in the other member state (that of the parent company). This results in a deduction in one member state followed by exemption in the other member state.

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