Economic substance is the real economic activity behind a company — office, staff, decisions taken on site — as opposed to its mere legal existence. A registration certificate, a domiciliation contract and a nominal director prove the company exists; none proves it does anything. In modern tax law, the second is what decides.
A client once brought me, in one file, what he called "the structure's documentation": the registration certificate of a company in an EU Member State, a domiciliation contract with a corporate-services provider, the mandate contract of a local director paid a few hundred euros a month, and the tax-residence certificate issued by that state's administration. His question was: "What more does the tax authority want?" The uncomfortable answer: almost everything that was not in the file.
The first practical difficulty is that economic substance has, in Romanian and European law alike, no unified definition, no single test and no closed list of conditions. It is a concept built from several normative and case-law sources, each with its own logic. Whoever looks for "the article on substance" will not find it. Whoever understands the mechanism will recognise it in at least five places — and these apply simultaneously, not in the alternative.
This is also the difference between the line between lawful tax planning and an artificial arrangement and a mere matter of formal compliance: substance is not a document you obtain, but a reality you prove.
Each has its own scope and its own consequences. Together, they form the test we call, in shorthand, "substance."
The general anti-abuse rule of domestic law: the tax authority may disregard a transaction with no economic purpose, adjusting its tax effects, or recharacterise the form of a transaction to reflect its economic content. In return, it must reason its decision, indicating the elements as to the purpose and content of the recharacterised transaction and all the evidence considered. Not a formality — it is the ground of the defence.
Distinct from art. 11, the chapter on rules against tax-avoidance practices contains a general anti-abuse rule of its own for corporate income tax, transposed from the ATAD Directive: an arrangement not put in place for valid commercial reasons reflecting economic reality cannot produce the tax advantage sought.
The founding reference (12 September 2006). A restriction on freedom of establishment can be justified only by countering "wholly artificial arrangements" devoid of economic reality. The criterion: whether the company corresponds to a real establishment carrying on genuine economic activities, verifiable through objective factors ascertainable by third parties — premises, staff, equipment.
The Grand Chamber of the CJEU, in C-115/16 (interest and royalties) and C-116/16 (dividends): the prohibition of abuse of rights is a general principle of Union law, applicable even absent an express domestic rule. The indicia of a conduit company: near-total onward transfer of income shortly after receipt, a minimal margin, absence of staff and of genuine activity. Detailed in the analysis on the beneficial-owner test and the Danish cases.
The closest legal wording to a definition of substance in Romanian tax law: "a substantive economic activity supported by staff, equipment, assets and premises, as evidenced by relevant facts and circumstances." Four pillars and a facts-and-circumstances standard of proof — but with a geographical limitation few point out.
The functional analysis — functions performed, assets used, risks assumed — is the tool by which the remuneration an entity deserves is determined. Anyone who has ever prepared a transfer-pricing file has performed, without naming it as such, a substance analysis.
The geographical limitation almost nobody points out. The exception in art. 40⁵(4) — the substantive-economic-activity exception in the CFC rules operates only for entities that are tax-resident in, or located in, an EU Member State or a state party to the European Economic Area Agreement. A company in a third state — the UAE, Switzerland, the United Kingdom, the United States — does not benefit from this exception in relation to the CFC rules, however real its activity, however much staff and premises it has. Substance, however well documented, does not save the structure outside the EU/EEA perimeter under this text in particular.
Here is what is looked for, in the order in which it is looked for.
A domiciliation contract with a provider that hosts a few hundred companies at the same address is not a seat. A seat is a space at the company's disposal, suitable for the declared activity, with market rent, with utility bills that vary with use. The mental test: if someone rang the doorbell during working hours, would someone who works for the company answer?
It is not the number that counts, but the fit between competence and the declared function. A company that claims to manage intellectual property yet has no employee capable of valuing, developing or protecting that property does not perform the function it invoices. A nominal director who cannot explain the activity of the company they head is not staff — they are a signature.
Here the bulk of the evidence concentrates: where the management bodies meet and whether they meet at all; minutes, dated and correlated with real physical presence; the correspondence showing who proposed, who analysed, who decided; where the contract was negotiated and signed; who talks to the bank and from where; who has power of disposal over the accounts.
What the company owns, what it invests its resources in, what ownership risks it bears. An entity with no assets, no working capital of its own and no capacity to bear a loss cannot justify a return.
Risk is proved by the financial capacity to bear it and by control over it. Contractual risk on paper, borne by an entity that could never cover it, is reallocated.
Here substance meets transfer pricing. A company that performs no functions, uses no assets and assumes no risks deserves no profit. It is the simplest formulation of the whole subject.
Domiciliation with mail forwarding. It proves someone receives your envelopes, not that someone works there for you.
A local resident who signs the documents sent from another country and takes no part in forming the decision. They do not exercise management; they attest to it.
Minutes drafted afterwards, signed by courier, without anyone having ever met. They are the first evidence to fall on a check of travel records.
Opened in the state of incorporation but operated exclusively from Romania. IP addresses tell the whole story.
Who merely records the documents received from elsewhere. They keep the books of an activity carried on somewhere else.
It attests that the state concerned considers you resident. It does not attest to substance and does not, by itself, oblige another administration to grant the benefits of double-taxation treaties. That was one of the lessons of the Danish cases.
The substance file is not made during an audit. It is built as things happen, because its evidential value lies precisely in being contemporaneous.
Of the premises, with actual payments, at market value, and with proof that the space is used.
Telephone, internet, cleaning — showing a consumption pattern consistent with real activity.
Employment contracts, proof of the declaration and payment of contributions, job descriptions matching the declared functions.
Of the meetings, dated, with the agenda, the supporting materials, the place and the participants, drawn up at the time of the meeting.
Plane tickets, bookings, accommodation notes — confirming that the persons were physically present on the dates in the minutes.
Showing the decision-making process, not just its outcome.
With the negotiation history and an indication of the place of signature.
Who holds the mandate, from where payments are authorised, who deals with the bank.
It costs. A real director, with real competence and a market salary, costs far more than a nominal one. A real office costs more than a domiciliation — and this is, in fact, the real cost of a holding with substance and the economic test of any international structure: if the tax advantage sought disappears once you add the cost of real substance, the structure had no economic sense to begin with — only tax sense. And that is exactly the definition of the thing the anti-abuse rules penalise.
The draft directive known as ATAD 3 or "Unshell", which would have introduced standardised substance indicators, thresholds and automatic consequences for shell entities, was abandoned: ECOFIN closed its work on it in June 2025, in the absence of unanimity. The stated intention was to integrate the anti-shell principles into the regime for reporting cross-border arrangements (DAC6).
On 24 June 2026, the European Commission published the tax-simplification package — the "Taxation Omnibus" and the recasting of the Directive on administrative cooperation (DAC Recast), which codifies the nine successive DAC directives into a single text. The Unshell-type substance tests were not included in the proposal. The reason, explicit in the analyses published just after adoption, is the lesson learned from the failure of Unshell: negotiating precise substance criteria would have delayed the whole package, because Member States would have opposed the wording.
The solution chosen is different: the substance criteria of hallmark D2 are to be developed through a Council implementing act, which the Council is required to adopt within five years of the directive's entry into force. Until then, hallmark D2 remains in force — but without Union-level harmonised criteria on what sufficient substance means.
The practical conclusion does not change, however. The disappearance of a standardised test does not mean the disappearance of the substance requirement. It means only that substance remains assessed through the existing instruments — art. 11, the general anti-abuse rule, CJEU case law, the CFC rules, transfer pricing — that is, through case-by-case analyses, less predictable than a test with thresholds. For the taxpayer, uncertainty is not good news.
The consequences are not theoretical and can accumulate.
If the decisions are effectively taken from Romania, the foreign company may be treated as a Romanian tax resident, with taxation on worldwide income — the mechanism detailed in the analysis on when a foreign company becomes tax-resident in Romania.
The withholding exemption or the reduced rate for dividends, interest and royalties may be refused if the recipient is not the beneficial owner of the income.
With accessories, calculated retroactively, within the limitation period for establishing tax claims.
With adjustment of the tax effects of transactions lacking economic purpose — on the basis of the evidence the tax authority is required to indicate in its reasoning.
If the remuneration does not match the entity's real functions, assets and risks.
If the structure was built precisely to mask these elements, the discussion may shift from tax to criminal. "Reconstructed" documents are the shortest road there.
The position I hold, as a practitioner, is simple: substance is not a compliance cost you add to a structure to make it pass. It is the test that tells you whether the structure should exist at all.
No. The local director and the address are formal elements. The test, as framed as far back as Cadbury Schweppes, concerns a real establishment: premises, staff and equipment, verifiable through objective factors ascertainable by third parties. A director who signs what is sent to them does not exercise management; they attest to it. That difference is exactly what is looked for.
No. The certificate attests that the administration of that state considers you resident under its domestic law. It does not prove substance, does not prove beneficial ownership of an item of income, and does not prevent another administration from examining the merits. The Danish cases settled this point: the certificate is necessary but not sufficient.
There is no numeric threshold in law, and anyone who gives you one is misleading you. The test is one of adequacy: staff, equipment, assets and premises must be proportionate to the declared activity and the profit attributed. A company managing a small portfolio of holdings needs less than one claiming to develop and exploit intellectual property. The right question is not "how many" but "who actually performs what I invoice".
Not under the substance-exception text. The exception in the controlled-foreign-company rules operates only for entities resident or located in an EU Member State or a state party to the EEA Agreement. For a third-country entity, real substance remains relevant to other analyses — tax residence, beneficial owner, transfer pricing — but does not take you out of the CFC perimeter on that ground. It is the most common advisory error on this subject.
Contemporaneous documents cannot be fabricated later without risk — and a reconstructed file is often more damaging than its absence, because it moves the discussion from tax ground to criminal ground. What can legitimately be done is to identify evidence that already exists and was not gathered (correspondence, statements, travel records, banking documents), honestly assess what was real and what was not, and correct the structure for the future. Sometimes the right conclusion is restructuring or closing the entity, not defending it.
Informational material, updated 18 July 2026. It does not constitute legal or tax advice; individual situations must be analysed case by case.
An initial review establishes whether the structure holds up to the substance test, what evidence exists, where the exposure lies, and what can be corrected — before an audit answers the question for you.