National finance ministers meeting on Tuesday (6 May) will move to close a loophole exploited by companies with European subsidiaries to avoid paying tax on profits from hybrid loan arrangements.

Ministers are expected to approve the splitting of a proposed directive on company taxation to stop the practice quicker, according to sources at the Greek presidency of the EU. The presidency is steering the directive through the European Council. Hybrid loans are a financial instrument, which combines debt and equity.

Member states are too divided to agree on other anti-abuse provisions of the revised Parent-Subsidiary Directive which, like all EU tax law, requires unanimous support from member states to become law.

By dividing the amending directive in two parts, progress can be made on the loophole. EU countries have until 31 December 2015 to incorporate its provisions into national law.

The European Commission identified hybrid loan arrangements as a tax planning tool, EU official sources said. They take advantage of certain provisions in the original Parent-Subsidiary Directive, which was meant to ensure cross-border company groups were not taxed twice.

Member states introduced tax exemptions on profits received by parent companies from their subsidiaries in other European countries. This still applies even if the profits are tax deductible in the subsidiary’s country.

Some countries classify profits from hybrid loan arrangements as tax-deductible debt. Other don’t, creating a mismatch in national legislation that is being exploited. Cross-border hybrid loans may be treated as a tax deductible expense such as interest in the subsidiary’s country and as a tax exempt dividend in the parent’s. This can lead to a deduction followed by an exemption. Some cross-border companies have planned their intergroup payments so as to pay no tax at all on the profits.

The practice is called “double non taxation” by the commission, which has not named any of the companies exploiting the loophole. The proposed solution is that if a subsidiary is based in a country where profits from financial instruments with both debt and equity characteristics are tax deductible, those dividends must be taxed by the member state where the parent company is based.

Tuesday’s ECOFIN meeting is also expected to bring a statement of intent from the bloc of euro area nations pressing ahead with a Financial Transaction Tax (read here) but there will no similar agreement on the rest of the Parent-Subsidiary Directive.

Common European anti-abuse rule

Meetings between ambassadors ahead of ECOFIN were arranged by the Greek Presidency. They revealed divisions between member states, which are preventing the adoption of a common European anti-tax abuse rule.

The commission wants member states to introduce a clause in their national laws. It would counteract aggressive tax planning practices which fall outside the scope of their specific anti-avoidance rules.

When first mooted in November last year, Taxation Commissioner Algirdas Šemeta said the clause would ensure the spirit as well as the letter of the law would be respected. Billions of euros were at stake, he said.

The clause reads: “An artificial arrangement or an artificial series of arrangements which has been put into place for the essential purpose of avoiding taxation and leads to a tax benefit shall be ignored. National authorities shall treat these arrangements for tax purposes by reference to their economic substance.”

This could deter new innovative financial instruments, such as hybrid loan arrangements, being exploited before legislation has a chance to catch up.

Member states have different views and concerns on the anti-abuse rule, Greek Presidency sources said. Varying anti-abuse measures are already in place vary across the EU and were designed with national concerns in mind. More technical work is needed before more progress towards unanimity can be made, they added.

The crackdown is being resisted by counties including the Netherlands, Luxembourg and Ireland. All three have a reputation for ‘letter box’ subsidiary companies.

Global solutions needed

Tove Maria Ryding, tax coordinator at the European Network on Debt and Development (Eurodad), a network of 48 non-governmental organisations, said: “While it is positive that EU governments are trying to close the most obvious loopholes in the Parent Subsidiary Directive, they are still trying to patch up an international tax system which is almost 100 years old, and not fit for purpose.”

“The solutions they propose could reduce corporate tax dodging in the EU, but not prevent European companies from dodging taxes in developing countries. What we really need is a common international approach to calculating corporate profits and ensuring that multinational corporations pay their fair share of taxes,” she added.

Campaigners are sceptical that ongoing work on the issue by the Organisation for Economic Co-operation and Development will convince global governments on the need for a common approach.

Schemes used by Starbucks, Apple, Amazon and others, operating within the law to minimise taxes, put aggressive tax planning at the top of the political agenda last year.

The European Parliament has no authority in the legislative procedure on the revised Parent-Subsidiary Directive, as it is a tax law. But it has presented an opinion largely backing the proposal.