December 4, 2025 — Substance is the word that has done the most analytic work in international tax law for the past decade. It appears in the OECD Transfer Pricing Guidelines, in the European Anti-Tax Avoidance Directives, in the Pillar Two Model Rules, in the Common Reporting Standard's documentation requirements, and in the case law of essentially every major jurisdiction. The word, however, is doing different work in different contexts. The substance test that the French Direction générale des finances publiques applies in a corporate tax audit of a French parent's foreign subsidiary is not the same substance test that the United Kingdom's HM Revenue and Customs applies in a personal tax audit of a UK departer's foreign residency claim. Both differ from the substance test that the Italian Agenzia delle Entrate applies in a transfer pricing audit and from the test that Germany's Bundeszentralamt für Steuern applies in a controlled foreign corporation review.

The variation matters operationally. A multinational group or a cross-border individual whose substance position would withstand audit in one jurisdiction may not withstand audit in another, even where the underlying facts are the same. The practitioner who works across multiple jurisdictions must understand the specific substance test that applies in each and must build positions that satisfy the relevant tests rather than a generic notion of substance. This article reads the audit practice of the four principal European jurisdictions as it stood at the end of 2025 and identifies the points of convergence and divergence.

The general framework: why substance matters

The intuition underlying the substance concept is simple. Tax law contains incentives that depend on the location of activities, persons, or assets. A tax law that grants a benefit to operations in country A creates an incentive to characterise operations as occurring in country A regardless of where they actually occur. Substance is the legal concept that requires the characterisation to track the underlying reality.

The concept is older than the OECD's BEPS project. National tax authorities have applied substance-based reasoning, under various names, for the entirety of the modern income tax era. The post-BEPS development has been the codification and expansion of substance requirements: the addition of substance criteria to specific regimes, the strengthening of substance-based audit programmes, and the international coordination of substance assessments through the OECD's framework for Harmful Tax Practices.

The four jurisdictions examined in this article each apply substance reasoning in multiple contexts. The contexts include: domestic anti-abuse provisions; transfer pricing analysis; controlled foreign corporation regimes; participation exemption qualification; access to bilateral tax treaty benefits; and the determination of individual residence. The audit practices differ across these contexts and across jurisdictions.

France: DGFiP and the substance vocabulary

The French DGFiP applies substance reasoning under multiple legal vehicles. The principal corporate vehicles are the abus de droit doctrine, the acté anormal de gestion concept, the Article 209 B regime governing French parent companies' foreign subsidiaries, and the substance requirements within Article 119 ter and the participation exemption regime. The principal individual vehicle is the application of Article 4B's professional activity and economic centre criteria to claims of non-residence.

The DGFiP audit practice has, in the post-2018 period, intensified the substance dimension of corporate audits. The 2018 introduction of the abus de droit élargi extended the historical abus de droit doctrine to operations where avoiding tax was a principal motive, even if not the exclusive one. The provision applies to operations occurring after January 1, 2020, and has produced a body of administrative practice that the French courts are continuing to develop.

In transfer pricing, the DGFiP has integrated the OECD's DEMPE framework into its examination procedures. A French operating subsidiary that pays a royalty to a foreign intangibles holder is examined for the consistency between the royalty rate paid and the residual return that the holder's DEMPE function performance would justify. The audit practice has produced material adjustments in cases where the foreign holder's substance was found insufficient, with the principal targets being holders in low-tax jurisdictions where DEMPE functions were performed elsewhere.

For individual residence, the DGFiP applies Article 4B's criteria with increasing aggression in audits of high-net-worth departers. The audit practice focuses on the foyer criterion, the activité professionnelle principale criterion, and the centre des intérêts économiques criterion. The evidentiary record required to defend a non-residence claim has expanded substantially, with the administration now routinely requesting calendar evidence, evidence of foreign foyer establishment, evidence of professional activity displacement, and evidence of economic centre migration.

An additional French feature is the role of the Comité de l'abus de droit fiscal, which provides advisory opinions in disputes involving the abus de droit. The Committee's opinions are not binding but carry significant weight in subsequent litigation. The Committee has, in recent years, issued a series of opinions involving cross-border structures that have become reference points for practitioners.

United Kingdom: HMRC and the post-Brexit substance landscape

HMRC's substance practice operates under a different legal architecture from the French. The UK has historically relied on common-law anti-abuse doctrine supplemented by specific anti-avoidance rules, with substance reasoning embedded in the case law rather than codified to the same extent as in France. The post-2010 reforms introduced the General Anti-Abuse Rule, which provides a statutory anti-abuse mechanism applicable to abusive arrangements. The post-2020 period has produced additional specific rules, including the diverted profits tax and various sector-specific provisions.

For corporate substance, HMRC's principal audit themes are the pricing of intra-group transactions and the location of economic activity. The transfer pricing audit programme has been built up substantially since 2015 and now operates at a level of analytical sophistication comparable to the OECD's most active tax authorities. The DEMPE framework has been integrated into HMRC's examination procedures, and HMRC has been active in challenging royalty rates, intangibles location, and intra-group financing arrangements.

The diverted profits tax, introduced in 2015, applies a higher tax rate to profits diverted from the UK through arrangements lacking economic substance. The provision operates as a deterrent to substance-deficient structures and has been applied in a series of high-profile cases. The tax has been credited with influencing multinational behaviour beyond the cases in which it has been formally applied.

For individual substance, HMRC applies the Statutory Residence Test as the principal residence determination. The substance dimension of the SRT operates through the sufficient ties test, where the accommodation tie, the work tie, and the family tie each test for substantive connections to the UK. HMRC has built audit capability around the SRT and routinely audits high-net-worth individuals' residency claims when the day-count is close to thresholds or when the ties analysis is contested.

The UK has additionally implemented its own platform reporting framework aligned with DAC7 and operating from January 1, 2024. The data has been used in HMRC audits of individuals whose declared income did not match the platform-reported figures. The audits are ongoing.

Italy: Agenzia delle Entrate and the esterovestizione doctrine

The Italian audit practice on substance is characterised by a specific doctrinal device that has no direct equivalent in the French, British, or German systems: the doctrine of esterovestizione. The doctrine applies to entities that are formally incorporated abroad but that are managed and operated from Italy. Such entities are treated as Italian tax residents under the Testo unico delle imposte sui redditi, regardless of their foreign incorporation.

The Agenzia delle Entrate has applied the esterovestizione doctrine in a series of cases involving Italian-resident individuals or groups that established foreign holding entities. The cases that have reached the Corte di Cassazione have generally favoured the administration where the foreign entity was found to lack genuine foreign management and substance. The doctrine has been applied to entities incorporated in low-tax jurisdictions and, in some recent cases, to entities incorporated in EU Member States.

For transfer pricing, the Agenzia delle Entrate has integrated the DEMPE framework but has emphasised, more than other administrations, the test of whether the legal owner of an intangible is genuinely capable of performing the DEMPE functions. The capability test has been applied in cases where the foreign entity had legal title but lacked the operational capability to perform the relevant functions.

For individual residence, the Agenzia delle Entrate applies the criteria of Article 2 of the TUIR, including the iscrizione anagrafica test, the domicilio test, and the residenza test. The administrative practice has been to scrutinise AIRE registration and to test the displacement of personal and economic centre. The audit programme on individuals claiming foreign residence has been particularly active in respect of relocations to the UAE, Switzerland, Monaco, and Portugal.

An additional Italian feature is the new article on residence introduced through Legislative Decree 209 of December 27, 2023, which modified the residence test for individuals from January 1, 2024. The reform retained the historical criteria but adjusted certain interpretive elements, including the treatment of presence and the definition of domicilio. The administrative practice under the new article is still developing.

Germany: Bundeszentralamt für Steuern and the substance question

The German substance practice operates through several legal vehicles, including the Außensteuergesetz controlled foreign corporation rules, the substance requirements for participation exemption qualification, the abuse-of-law provisions in the Abgabenordnung, and the substance criteria within specific anti-avoidance rules.

The post-2022 reform of the German CFC rules tightened the substance criteria for foreign subsidiaries. A foreign subsidiary of a German parent is subject to CFC inclusion if it derives passive income that is taxed at less than fifteen percent in its jurisdiction, unless the subsidiary can demonstrate substantive economic activity in that jurisdiction. The substantive economic activity test requires premises, qualified personnel, and operational capability commensurate with the activity. The 2022 reform increased the granularity of the test and produced administrative guidance that has been actively applied since.

For transfer pricing, the German Bundeszentralamt für Steuern has integrated DEMPE into its examination practice. The administration has been particularly active in challenging royalty rates and intangibles location in cross-border arrangements involving the historical low-tax holding jurisdictions. German Federal Tax Court decisions in 2021 and 2023 incorporated DEMPE-influenced reasoning and have provided benchmark cases for subsequent practice.

For individual residence, German law applies a residence test based on physical presence and the maintenance of a residence available for use. The test is, in textual form, less elaborate than the French Article 4B framework, but the administrative practice has developed a substantive interpretation that examines the displacement of personal and economic centre in cases of departing residents. The audits of high-net-worth departers have followed a pattern broadly comparable to the French and Italian approaches.

An additional German feature is the role of the binding ruling procedure, which allows taxpayers to obtain advance rulings on substantive issues. The procedure has been used by multinational groups seeking certainty on substance-related questions, and the rulings provide a body of administrative practice that the practitioner can reference in subsequent positions.

The convergence: what is testable across all four

Despite the differences in legal architecture and audit practice, the four administrations apply substantively similar tests to the principal categories of cross-border arrangement. The convergent themes are as follows.

Premises. The foreign entity must occupy genuine premises commensurate with its activities. A foreign holding company with mailbox-only presence is, in essentially every jurisdiction's audit practice, vulnerable. The premises requirement has been interpreted to exclude shared offices used only for registered office purposes, virtual offices that do not host actual operations, and accommodation that is rented but not used.

Personnel. The foreign entity must employ personnel with the qualifications and capability to perform the functions that the entity is purported to perform. A foreign holding company with no employees, or with employees whose qualifications do not match the entity's purported activities, is vulnerable. The personnel requirement has been interpreted to exclude administrative-only staff in cases where the entity is purported to perform substantive functions, and to require senior management presence where the entity is purported to make significant decisions.

Decision-making. The foreign entity's decisions must be made by its own management, supported by genuine deliberation in the foreign jurisdiction. A foreign entity whose decisions are made by parent-company personnel and merely formalised in the foreign jurisdiction is vulnerable to recharacterisation. The decision-making requirement has been interpreted with reference to board minutes, the location of board meetings, the qualifications of directors, and the audit trail of decision-making.

Economic activity. The foreign entity must engage in economic activity that bears a recognisable relationship to the income it derives. An entity that derives substantial royalty income but performs no DEMPE functions is vulnerable. An entity that derives substantial financing income but performs no risk management or financing function is vulnerable. The economic activity requirement has been the principal point of doctrinal development in the post-BEPS period.

Documentation. The foreign entity must maintain documentation that evidences the substance position. The documentation includes accounting records, employment records, premises records, decision-making records, and economic activity records. The documentation requirement has been interpreted to require contemporaneous records rather than retrospective reconstruction, and the absence of contemporaneous documentation has been treated by audit teams as itself an indicator of substance deficiency.

The defensive substance position

The defensive substance position that withstands audit across the four jurisdictions has acquired a recognisable shape. The position rests on five pillars.

The first pillar is genuine premises. The foreign entity occupies premises that are commensurate with its activities, that are used regularly for the entity's business, and that are documented through lease agreements, utility bills, and operational records.

The second pillar is qualified personnel. The foreign entity employs individuals with qualifications relevant to its activities, who are physically present in the foreign jurisdiction for a substantial portion of their working time, and whose employment is documented through employment contracts, payroll records, and social security registrations.

The third pillar is genuine decision-making. The foreign entity makes its own decisions through its own governance, with board meetings held in the foreign jurisdiction, with directors who have the qualifications and capacity to govern, and with documentation that evidences the deliberation.

The fourth pillar is economic activity commensurate with income. The foreign entity engages in operations that bear a recognisable relationship to the income it earns, with the operations documented through transactional records, intra-group agreements, and operational data.

The fifth pillar is contemporaneous documentation. The foregoing elements are evidenced by records created at the time of the activity rather than reconstructed in response to audit. The records are maintained in a form that can be produced rapidly to administrative requests.

The trajectory through the second half of the 2020s

The substance audit practice of the four administrations is on a converging trajectory. Each is becoming more analytically sophisticated, each is integrating data from international information exchange instruments more effectively, and each is approaching the substantive substance question with greater rigour. The differences in legal architecture remain, but the practical operation is converging.

The implications for cross-border structures are clear. A structure that depends on substance must satisfy substantive substance criteria across the relevant jurisdictions, not merely the substance criteria of any one. A structure that operates in a single jurisdiction's audit practice must increasingly anticipate the audit practice of other jurisdictions where the structure has connections. The compliance and documentation burden has expanded accordingly.

The defensive position is achievable. It requires investment, in premises, personnel, governance, and documentation. The investment is generally smaller than the tax advantage the structure provides, but it is no longer negligible. Multinational groups and cross-border individuals operating in the post-BEPS substance environment must increasingly view substance investment as part of the cost of operation rather than as an optional addition. The administrations have made this clear, and the audit practice continues to make it clearer.