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December 22, 2021

European Commission publishes draft Directive for preventing the misuse of shell entities (UNSHELL)

Executive summary

On 22 December 2021, the European Commission (the Commission) published a legislative proposal for a Directive setting forth rules to prevent the misuse of shell entities for tax purposes (the draft Directive, UNSHELL, is also referred to as ATAD III). This initiative was announced by the Commission in its Communication on Business Taxation for the 21st century published in May 2021.1

The draft Directive aims at introducing a European Union (EU)-wide “substance test,” including a reporting obligation for taxpayers, to assist Member States in identifying undertakings that are engaged in an economic activity but which do not have minimal substance and, in the view of the Commission, are misused for the purpose of obtaining tax advantages (shell companies). In addition, the Commission proposes to attach consequences to the qualification of a company as a shell company for tax purposes. It also envisages automatic exchange of information by amending the Directive on administrative cooperation in the field of taxation (Directive 2011/16/EU or DAC) as well as a potential request by one Member State to another for tax audits.

The draft Directive will now move to the negotiation phase among Member States with the aim of reaching a final agreement. In the EU, adoption of tax legislation generally requires unanimity between all 27 Member States. The Commission proposes that the Member States shall transpose the Directive into their national laws by 30 June 2023 for the rules to come into effect as of 1 January 2024.

Detailed discussion


On 18 May 2021, the Commission published the Communication on Business Taxation for the 21st Century (the Communication) that sets out the Commission’s short-term and long-term vision to provide a fair and sustainable EU business tax system and support the recovery.2 Among the corporate tax reforms proposed in the Communication, the Commission also had announced its plans to table a legislative proposal in Q4 2021 setting out EU rules to “neutralize the misuse of shell entities for tax purposes.”

Following that, on 4 June 2021, the Commission launched a public consultation on such proposal in the form of the questionnaire. According to the explanatory memorandum to the draft Directive, the Commission has concluded from the feedback provided that all respondents acknowledge that - in spite of the recent EU anti-tax avoidance measures - the problem of tax avoidance and evasion persists, including through the misuse of shell entities. While some respondents welcomed new targeted measures to tackle abuse in the tax area, others considered that they were potentially premature.

According to the Commission, the fact that shell entities continue to pose a risk of being used for improper tax purposes, such as tax evasion and avoidance, was also confirmed by recent media revelations (the OpenLux investigation and, more recently, the Pandora Papers).

The draft Directive

While the draft Directive is consistent and interlinked with other EU initiatives, including the proposals for minimum tax rules, there are key differences between the draft Directive and the draft Pillar 2 Directive in terms of objectives and scope, as also highlighted in the explanations to the draft Directive. The Pillar 2 Directive essentially seeks to establish a minimum level of taxation for large multinational enterprises. The purpose of this Directive is to address tax avoidance in the area of direct taxation conducted through the use of low-substance entities. In short, the draft Directive therefore establishes a minimum level of substance and does not contain measures linked to a minimum level of taxation. Another key difference between the draft Directives is that this draft Directive applies to all corporate tax residents of Member States without any materiality threshold.

Seven-step approach

With the draft Directive the Commission proposes a seven-step approach which is summarized below. This step plan should be followed for each entity which is resident for corporate income tax purpose in a Member State.

For each undertaking it is assessed whether the entity is at risk of falling in scope of the aim of the draft Directive. An undertaking is an entity engaged in an economic activity, regardless of its legal form, that is a tax resident in a Member States (hereafter referred to as “entity”). The Commission proposes that the tax authorities in the Member State in which the entity is resident shall make an assessment of the information provided by the entity.

Step 1: Gateway

The first step entails three cumulative “gateway” criteria. An entity passes the gateway if it:

Engages in cross-border activities
This criterion contains an asset test and an income test of which only one test needs to be met in order to qualify under the gateway criteria:

  • If more than 60% of the book value of certain assets held by the taxpayer (such as immovable property) is located outside the Member State of residence the asset test is met.

  • If more than 60% of the entity’s “relevant income” is derived from abroad, the income test is met. Such relevant income generally consists of passive income such as interest and other financial income including crypto assets, royalties, dividends and other share income, and income from leasing, insurance and immovable property.

Which are geographically mobile
This criterion would be generally met if more than 75% of the entity’s income in the preceding two years qualifies as relevant income.

Has (partly) outsourced its own administration
The draft Directive does not elaborate the requirements of this criterion. Based on the explanatory memorandum enclosed with the draft Directive it seems that this criterion specifically targets entities which have outsourced their administration to professional third party service providers (or equivalents thereof).

Step 1 includes several carve-outs and exceptions, for example for listed entities, specific regulated financial entities, certain holding entities of operational businesses in the same Member State and entities with at least five own full-time equivalent employees exclusively carrying out the activities generating the relevant income.

If no exception applies and the gateway criteria are met, an entity is considered to be at risk for purposes of the draft Directive and a reporting obligation arises.

Step 2: reporting

An entity considered at risk under Step 1 has to report on its substance in its tax return. In short, the entity is obliged to confirm whether the following cumulative criteria are met and to provide documentation in support of its position:

  1. The entity has premises available for its exclusive use.

  1. The entity has at least one bank account in the EU.

  1. The entity has at least one director and/or the majority of relevant employees being resident close to its undertaking.

Step 3: shell company

An entity considered at risk under Step 1 which does not meet the three criteria under Step 2 is considered a “shell company” which is in principle in scope of the draft Directive.

Steps 4 and 5: rebuttal of presumption

Step 4 provides an entity considered as a “shell company” under Step 3 with two opportunities to rebut this presumption. The first opportunity is that the entity substantiates that it conducts a genuine economic activity and is therefore not a shell company (in spite of it not meeting the criteria under Step 2). The second opportunity is that the entity substantiates that it does not create a tax benefit. In such case, despite the entity having low substance, it is considered out of scope of the draft Directive as the draft Directive is aimed at preventing the granting of tax benefits through the use of low-substance companies.

Step 6: tax consequences

The Commission proposes a number of tax consequences for a shell company which fails to rebut the presumption under Steps 4 and 5. Firstly, the Member State of residence of the shell company should either deny the granting of a tax residency certificate to the shell company or only provide a tax residency certificate with a warning statement.

Secondly, other Member States should effectively disregard such a shell company for the granting of benefits under the relevant tax treaties between Member States and tax Directives (for example the Interest and Royalty Directive). This means that no benefits should be provided due to the interposition of such a shell company and a “look through” approach is provided taking into account the beneficial owner of the shell company (which may result in a (partial) reduction of the tax benefit obtained through the shell company). This “look through” approach should also be applied where a Member State is the state of the beneficial owner.

Step 7: information exchange

As a final step, the Commission proposes that all Member States shall have access to information on any entities considered at risk under Step 1 even if such entities meet any of the exceptions of the other steps. This information will be exchanged automatically. Furthermore, a Member State would be able to request the Member State of the entity to conduct an audit to a tax resident entity if it suspects that this entity lacks the minimal substance.


Although the draft Directive leaves it to Member States to establish penalties, a minimum penalty for non-compliance is provided consisting of at least 5% of the entity’s turnover.

Next steps

Article 115 of the Treaty on the Functioning of the European Union is the legal basis for the draft Directive. Proposals put forward under this special legislative procedure are subject to the Council’s unanimity, while the European Parliament only has an advisory role.

As with previous Directives with respect to direct taxation, it is expected that many changes will be made on the proposal during the negotiation process. Consequently, the final Directive, if adopted at all, could differ significantly from the current proposal.

Once unanimity is achieved, the next step would be the publication of the Directive in the Official Journal of the EU. The Commission proposes that the Member States shall bring into force the laws, regulations, and administrative provisions necessary to comply with the provisions of the final Directive by 30 June 2023, and that they shall apply these provisions from 1 January 2024. The Commission proposes to submit a report on the application of the Directive by 31 December 2028.


Adoption of the proposed Directive would mark a significant step in the area of direct taxation within the EU as it is a first harmonization of minimum substance criteria for tax purposes within the Union. While the Commission recognizes that tax treaties with third states need to be respected, an indirect effect could be that administrations will use the minimum substance in the draft Directive as a benchmark in the application of the Principal Purpose Test in relation to third countries (both inbound and outbound).

Although the Commission’s initiative is only aimed at certain low-substance shell companies, implementation of the draft Directive would lead to additional compliance obligations for many taxpayers. The proposal also has significant compliance implications for tax authorities in the Member States. For example, the proposals under step 6 are expected to significantly increase the administrative burden with respect to the granting of tax residency certificates. In light of this and since the current proposal raises numerous questions, the draft Directive may be subject to change during the negotiation process.

While it is not yet known whether Member States will embrace the Commission’s initiative, it is recommended that businesses and investors closely monitor the adoption process for any changes/clarifications to the proposal. Businesses that are potentially in scope could already carry out an initial analysis on their corporate structures based on the current draft. After all, the initiative fits into a broader trend towards increased tax transparency in the Union and individual Member States may opt to introduce the rules proposed in the draft Directive unilaterally if the 27 Member States fail to adopt the rules unanimously.


For additional information with respect to this Alert, please contact the following:

EY Société d’Avocats, Paris

Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft, Munich

Ernst & Young Belastingadviseurs LLP, Rotterdam

Ernst & Young Belastingadviseurs LLP, Amsterdam

Ernst & Young SA (Portugal), Porto

Ernst & Young LLP (United States), Global Tax Desk Network, New York



  1. See EY Global Tax Alert, European Commission publishes Communication on Business Taxation for the 21st century, dated 18 May 2021.

  2. Ibid.


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