Two recent trends in international taxation – an increase in taxpayers' obligations to document and share information with tax authorities as well as an increase in substance requirements – have found their way into a new legislative proposal by the European Commission: the Directive regarding so-called "Shell Companies". The proposed Directive will expand the obligations set up by the first and second version of the Anti-Tax Avoidance Directive (ATAD) and has therefore assumed both the nicknames "ATAD3 Proposal" and "Unshell Proposal".

A key element of the Unshell Proposal is a threefold substance test or, in the Commission's words, a threefold "gateway", in order to assess whether an entity shall be deemed a shell company, i.e. an entity without sufficient substance:

• The first "gateway" aims at the source of income. An entity will fail to meet this first substance requirement if more than 75% of its income consists of (i) interest or other income from financial assets including crypto assets, (ii) royalties or other income from intellectual or intangible property, (iii) dividends and capital gains from shares, or (iv) further categories of income from, inter alia, financial leasing, real property, insurance, banking or services that have previously been outsourced to associated enterprises (Relevant Income).
• An entity will fail the second requirement of the substance test if its activities have a cross-border element. This will be the case if the company either (i) receives more than 60% of certain categories of Relevant Income through transactions with one or more other jurisdictions or (ii) passes on at least 60% of such income to entities that are not resident in the same jurisdiction as the entity under review.
• Finally, the third "gateway" requires that the relevant entity has outsourced the administration of day-to-day operations and the decision-making on significant functions within the last two tax years. National implementation and administrative guidelines will need to specify which kind of outsourcing is addressed by this provision.

An entity which fails all three requirements of the substance test needs to declare a minimum level of substance in the Member State where it is tax resident and furnish appropriate evidence. Should the entity fail to meet these obligations, the other Member States shall disregard any double taxation agreements with the Member State of tax residence. For example, Germany could deny the tax exemption or credit provided for in its DTA with the Member State where the entity resides. Additionally, the entity would lose tax reliefs as provided for by the Parent-Subsidiary-Directive and/or the Interest and Royalties Directive. Finally, according to the explanatory notes to the Unshell Proposal, the Member State where the entity resides could apply its national anti-tax-avoidance rules, in Germany most notably section 42 German Fiscal Act (Abgabenordnung), even if the entity succeeds in proving sufficient substance. Given the vast scope of such anti-tax-avoidance rules, this will be a quite cumbersome result of "passing the three gateways" (i.e. failing the three substance requirements).

From a German point of view, implementing the Unshell Proposal may change the range of substance requirements in German (corporate) income taxation. Already today, section 50d paragraph 3 of the German Income Tax Act (Einkommensteuergesetz) sets up quite far-reaching substance requirements. Especially, it will be interesting to observe whether the outsourcing addressed in the third requirement of the Unshell Proposal's test will include intra-group outsourcing and how entities which, by the very nature of their business, require hardly any "substance", would be treated.