English
SpanishIncreasing regulation and enhancing harmonisation within the European Union
Introduction
The financial sector in the EU has seen a lot of new legislative texts and one of the main challenges institutions face is regulatory change. According to statistics since the establishment of the EU in 1957, more than 100,000 legislative acts have been adopted. Of course not all of these necessarily concern the financial sector but there is a general sentiment that there are evermore rules to be assessed and analysed potentially requiring implementation or changes to the way business is currently conducted. We see a trend within the EU to develop and maintain an attractive and competitive business environment and ensuring a common and harmonised approach across the Member States. At the same time combating tax evasion and fraud and ensuring that clients and customers are adequately protected.
Initiatives in the field of tax
Over the past ten years, numerous tax scandals in Europe have led to a public wave of discontent targeting harmful tax practices. In the eye of public opinion, tax evasion and fraud were identified as primarily responsible for budgetary constraints, both at national and European levels.
Although tax policy remains a national duty, EU is responsible for combatting tax evasion and tax fraud. Thus, the EU is committed to the promotion and the strengthening, both internally and internationally, of mechanisms ensuring good tax governance, tax fairness and tax transparency. To achieve this objective, the EU has adopted a proactive stance, setting up several anti-tax commissions and adopting and implementing numerous directives.
Amongst these directives which aim to increase cooperation in tax matters and tax transparency, reference can be made to the recent Central Electronic System of Payments directive (CESOP) and to the most recent set of Directive on Administrative Cooperation (DAC, i.e. DAC 6, DAC 7 and DAC 8), which are part of an overall drive to develop the legal tools available to Member States to reach these objectives.
With respect to tax evasion, two specific directives, known as ATAD 1 and ATAD 2, have been implemented in all Member States in 2018 and 2019 to in particular limit the deduction of financial charges, introduce general anti-abuse clauses, identify and sanction hybrids, etc. A third round of this set of anti-abuse directives, also known as ATAD 3, was proposed by the European Commission at the end of 2021 to provide minimum substance requirements for companies, although this has not been voted on so far.
Given the global nature of tax evasion, the EU also had to tackle third countries indirectly affecting the Member States’ tax bases. The EU has drawn up a list of territories that are considered to be non-cooperative for tax purposes. This list includes countries that do not comply with their commitments to respect good tax governance criteria within a given timeframe but also countries that have refused to comply with them. The subsequent black and grey lists have already had a beneficial impact, with dozens of countries abolishing their harmful tax regimes and bringing so-called “tax havens” in line with international standards of transparency and fair taxation.
Despite these developments, the European Commission recognises that there is still a long way to go, particularly with respect to large digital companies and certain multinationals. Some of them, for instance, remaining taxed effectively at half of the rate of traditional companies in the EU.
“Although tax policy remains a national duty, EU is responsible for combatting tax evasion and tax fraud. Thus, the EU is committed to the promotion and the strengthening, both internally and internationally, of mechanisms ensuring good tax governance, tax fairness and tax transparency. To achieve this objective, the EU has adopted a proactive stance, setting up several anti-tax commissions and adopting and implementing numerous directives.”
One of the EU’s current key focuses is on large digital companies and multinationals and in 2018 the European Commission unveiled its plans for a Digital Services Tax (DST). The idea was to tax the revenues at a rate of 3% – and not just the profits generated by certain digital activities realised in the EU. The tax was intended to apply to very large digital companies with annual worldwide sales in excess of €750 million, of which €50 million would be taxable in the EU. However, the EU27 failed to reach a compromise for the DST.
However, this aborted idea was replaced recently by a broader project of a minimum tax for multinationals. Thus, in December 2022, the EU adopted the minimum tax directive, aimed at ensuring a minimum level of worldwide taxation for multinational groups and large-scale national groups, also known as “Pillar 2”. This minimum tax, which entered into force on 1st January 2024, concerns constituent entities that are members of a multinational enterprise group or a large-scale national group, with annual revenue equal to or exceeding €750 million in the consolidated financial statements of its ultimate parent entity for at least two of the four tax years immediately preceding the tested tax year. The aim of the directive is to allow an additional amount of tax to be levied whenever the effective tax rate of a multinational company in a given jurisdiction is below 15%. The “Pillar 2” directive makes it possible to limit the use of low-taxed jurisdictions.
However, even if the fight against tax evasion and fraud is at essence in the EU, the continuous issuance of directives could not limit itself to these objectives without risking to discourage investors or impacting Member States in international trade. So, in order to strike the right balance between combating tax evasion and fraud on one hand, and developing an attractive business environment on the other hand, the EU has adopted directives to ease tax obligations of certain companies.
In September 2023, the European Commission proposed the BEFIT directive (Business in Europe: Framework for Taxation), aiming to standardise tax rules for large companies. This would automatically apply to EU-based entities in a group with consolidated financial statements and revenues exceeding €750 million, with an optional application for those below this threshold. The directive would allow groups to file a single tax return for all group members located within a Member State, with an aggregated taxable basis at the European group level and thus reallocated to each company. Member States would then apply their corporate tax adjustments and rates. If approved, EU Member States would have to implement these rules by 1st January 2028 but the adoption of the directive remains uncertain due to previous difficulties faced by similar proposals like the Common Corporate Tax Base (CCTB) and Common Consolidated Corporate Tax Base (CCCTB).
“In order to strike the right balance between combating tax evasion and fraud on one hand, and developing an attractive business environment on the other hand, the EU has adopted directives to ease tax obligations of certain companies.”
The EU also recently proposed the Faster and Safer Relief of Excess Withholding Taxes directive (FASTER) to enhance the business environment by streamlining withholding tax refund procedures. This is in response to the varied and often complex refund procedures existing across Member States that may discourage cross-border investments.
The proposed directive is centred on the following four elements:
- the introduction of a digital residence certificate (“eTRC”),
- two expedited procedures to supplement the existing refund process,
- the mandatory participation of a certified financial intermediary to apply for reduced rates on behalf of the beneficiary; and
- a standardised reporting obligation.
The eTRC will allow investors to submit refund claims digitally, making the process quicker and more efficient. A single eTRC will be sufficient for multiple refunds in a year, therefore benefitting investors with diversified portfolios.
These new reporting obligations will also help tax authorities to obtain complete visibility of the financial chain to verify investor eligibility for reduced rates and ensure an adequate granting of withholding tax refunds, thus preventing tax abuse and strengthening tax transparency.
To summarise, the fight against tax evasion and fraud remains a topical trend for the EU, particularly where multinationals and digital companies are concerned, as it seeks to reconcile this objective with the promotion of an attractive business environment. Recent initiatives demonstrate the EU’s commitment to enhancing tax transparency and fairness, while trying to preserve the region’s economic competitiveness.
While the EU Commission is heavily engaged in the battle against tax evasion and fraud, it also place a high emphasis on preserving the financial stability of the financial sector. This has been a key priority since the financial crisis that occurred in 2008-2009. As part of this effort, the European Commission is set to champion a wide-ranging update of banking and financial regulations, including CRD.
Harmonisation of the third country branch regime
CRD has become a well-known acronym in the banking world. CRD stands for “capital requirements directive”, which as the name suggests is a legislative initiative from the European Commission required to be implemented across the EU27. The first directive dates back to 2006 and we have since seen a number of changes and improvements as the market evolves and products and players become more sophisticated and regulators more keen to protect customers in light economic tumult. Now we have reached CRD 6.0 so to speak, referred to in the legal world as CRDVI. Historically, and whilst mirroring the requirements of Basel II and III frameworks, the texts implement rules around minimum capital and liquidity requirements. However, from an EU perspective, the texts also address areas related to market access of credit institutions.
CRDVI will introduce a number of changes but the one undoubtedly getting the most attention is the harmonisation of the third country branch regime. Although the rules around bank regulation is directed by the European texts, we observe deviations in interpretation and application across the Member States. We have long been engaged in carrying out comparative studies and creating tables and rules of the road covering what a third country entity and its employees are permitted, or not, to do in the various Member States. Financial market players talk about “reach-in” which is not a concept you find in the European texts but rather something that has developed in the market. What is meant by this is offering services or carrying out activities on a cross-border basis, i.e. from one country to clients located in another country by “reaching in” to them. There is no establishment or “boots on the ground” – activities are carried out over the internet or on the phone. There have been concerns that due to the absence of harmonisation within the Union with regard to the licensing requirements and prudential regulation of third country branches, there is a risk for the EU’s financial stability. By way of reminder, “third country” means any country not a member of the EU, including of course also the UK following Brexit.
“CRDVI will introduce a number of changes but the one undoubtedly getting the most attention is the harmonisation of the third country branch regime. Although the rules around bank regulation is directed by the European texts, we observe deviations in interpretation and application across the Member States.”
The European Central Bank takes on the direct supervision of the 112 significant banks across[1] EU, whilst the so-called “less significant” institutions are indirectly regulated by the ECB and their direct supervision remains the responsibility of their respective national supervisory authority. We have seen a centralisation of supervision, bringing this to the EU level, very similar to the evolution we are seeing for example for significant investment firms under IRD/IRR or even when it relates to AML and the recent creation of the AMLA (the new single regulator on an EU level for AML).
Still, the absence of a unified approach on prudential regulation of banking services, along with the reality that entities from third countries providing these services are not subject to the oversight of the ECB or national authorities, was seen as resulting in a supervisory shortfall.
The CRDVI Proposal will introduce changes to this and reach-in access will longer be possible in the same way. The Proposal is still in the deliberation phase within the European Parliament, awaiting its final vote before being published in the Official Journal of the European Union, expected for mid-2024. Member States will be given an 18-month timeframe to incorporate CRDVI into their domestic law.
The CRDVI Proposal refers to the “core banking services” which means the activities of:
- taking deposits and other repayable funds;
- lending (including, consumer credit, credit agreements relating to immovable property, factoring, with or without recourse, financing of commercial transactions (including forfeiting)); and
- guarantees and commitments[2].
Third country firms which want to provide, or continue to provide, these services to EU-domiciled customers and counterparts will be required to establish a physical presence in the EU.
This will therefore have a serious impact on how these core banking services can be provided into the EU from firms established elsewhere. It is also significant to note that where a branch is established within a Member State, it will not be permitted to provide those same services in other Member States. There will therefore not be the same concept as the Passport which exist for EU authorised firms.
It is, however, not all bad news. Firms will be familiar with the exceptions and exemptions under MiFID and notably the one relating to reverse solicitation which will also be an option under the new rules. The CRDVI Proposal precises that it is where a client or a counterparty approaches a third country entity at its own exclusive initiative for the provision of banking services, including their continuation, or banking services closely related to those originally solicited. Where this is the case there will be no branch establishment requirement. This of course means that this is properly tracked and monitored. It is worth noting that the prevalent market practice in the EU mandates that reverse solicitation be substantiated by a written request, properly archived to be shown to the national supervisory authority when required. There has been some criticism of this concept under MiFID and the fact that entities may be relying on this too heavily to continue servicing their clients in the EU. It is also important to consider how clients or potential clients are solicited and the marketing or advertisement of services as this may taint the idea that a client has approached at its own exclusive initiative.
Furthermore, banks providing only MiFID investment services or activities will not be caught by the new rules and can continue to rely on what is catered for under MiFID. Intragroup transactions or services will also not trigger this branch establishment requirement.
The many firms established outside the EU impacted by this change will need to take this into account for any future business with EU-based customers. This may entail restructuring of activities within a group, migration of activities and potential relocation of staff. EU clients accustomed to having banking relationships with firms offering attractive solutions from abroad will undoubtedly see changes in the months to come.
The EU talks about harmonisation as a fundamental driver for this change, and there is some sense to that. The EU Single Market seen as one of the EU’s greatest achievements has been built around concepts of level playing field and removing barriers to entry. The absence of a common approach to cross-border banking services provided by third country firms has lead to confusion and an unavoidable risk of non-compliance with the varying local rules.
Conclusion
There is therefore a real trend of addressing inconsistencies through streamlining and harmonising rules across the EU in many different fields especially tax and financial sector. The texts are predominantly linked to protecting customers and the financial markets more generally. To tackle this inevitably means introducing new rules or amending the existing ones which results in the perception of the regulatory tsunami. The rules and requirements are adapting to lessons learnt in the past and it tends to be an exercise of improving existing legislation or adding layers on top. It will be seen if this trend will continue.
[1] Single Supervisory Mechanism (europa.eu)
[2] Point 1, 2 and 6 of the Annex I of the CRDIV.
Authors
Cathrine Foldberg Møller
Partner, Financial Services Regulatory
Simmons & Simmons Luxembourg LLP
Maya Coumes
Supervising Associate, Financial Services Regulatory
Simmons & Simmons Luxembourg LLP
Julie Carbiener
Partner, Tax
Simmons & Simmons Luxembourg LLP
