Bulgaria: Unmasking the World of Corporate Shell Companies

Shell companies have always held a mystique for entrepreneurs, offering a legitimate cover for various financial and business maneuvers. The European Union has been diligently working on regulatory measures to monitor the operations of these enigmatic entities.

ATAD 3 and the Dawn of Transparency

The European Union has taken a significant step towards regulating shell companies through the Third Anti-Tax Avoidance Directive (ATAD 3). This directive imposes “minimum substance requirements” on these elusive legal structures.

The implications are profound, potentially jeopardizing the advantages shell companies once enjoyed under double tax treaties and EU directives. Member States will now have the authority to tax shareholders based on a transparent evaluation of the entity’s operational activities.

It’s essential to note that this directive exclusively targets entities resident in the EU. Non-compliance with ATAD 3 substance reporting requirements or submitting inaccurate substance declarations could result in penalties of at least 2% to 4% of the entity’s annual revenue.

Exemptions and Scrutiny Criteria

Certain entities are exempted from the purview of the EU Directive, including regulated financial institutions, companies with transferable securities listed on regulated markets, and domestically domiciled holding corporations. Scrutiny is based on three specific criteria: passive income, cross-border activities, and outsourced management and administration.

1. Passive Income Criterion

This criterion is applicable when an entity’s financial operations reveal that over 65% of its revenue in the previous two fiscal years comes from income sources categorized as relevant. These sources include interest, earnings from financial assets (including cryptocurrencies), royalties, dividends, income from the sale of shares, financial leasing, immovable property, and select movable assets. Furthermore, this criterion is met if more than 75% of the entity’s asset value consists of real estate or if more than 75% of its assets are in the form of shares.

2. Cross-Border Involvement

When over 55% of the entity’s income is derived from international transactions or if more than 55% of its real estate assets are located outside its jurisdiction in the preceding two years, it triggers a closer examination.

3. Outsourced Management and Administration

If the entity has entrusted day-to-day administration and decision-making processes to a third party over the past two years, it falls under scrutiny. However, it’s essential to note that the specific delineation of “day-to-day” operations and decision-making functions within the entity remains ambiguous.

Disclosure and Documentation

If an entity satisfies the above criteria, it must disclose relevant information in its annual tax return. Moreover, comprehensive documentary evidence supporting the declaration is required if the minimum substance indicators are met.

The “Magical Three-Criteria” Rulebook

A company meeting all three criteria and providing the necessary documentation is considered to have satisfied the minimum requirements for the tax year.

Consequences of Violating the Three-Criteria Rulebook

Violating these criteria can have significant repercussions. Local tax authorities may withhold certificates of tax residency, leading to the forfeiture of double tax treaty (DTT) privileges and EU directive benefits. Furthermore, EU tax authorities gain the ability to share information about the entity with other EU member states, which may result in local withholding of taxes or taxation of the entity’s income at the EU shareholder level.

The Countdown to ATAD 3

ATAD 3 is expected to come into effect on January 1st, 2023, although there is anticipation that it might be postponed until January 1st, 2025. The implementation process involves bureaucratic steps and aligning with the local legislation of EU member states.

What adds to the intrigue are the meticulous examinations of the preceding two fiscal years, which might shed more light on taxation requirements concealed behind cryptic terminology.

Eurofast team present in over 23 countries of Europe and in the Middle East, provides thorough expertise on latest EU legislation that may affect businesses on the local and European levels.

For further information, feel free to contact our office in Sofia at sofia@eurofast.eu

Pantelis Papadopoulos
Manager Outsourcing Services
Eurofast Sofia