The EU member states through the ECOFIN have agreed on far-reaching amendments to the Directive on Administrative Cooperation in the field of Taxation (DAC).
These amendments, known as DAC6, will impose mandatory disclosure requirements on EU-based intermediaries and their clients. The disclosure concerns cross-border (EU-to-EU or EU-to-third country) tax planning arrangements that have certain characteristics known as "hallmarks."
Depending on formal adoption, these rules could become applicable in the EU as early as the second quarter of 2018. While intentionally broad in scope, it remains currently unclear which "arrangements" are effectively covered. Much will depend on how the member states implement DAC6 in their domestic legislation, as the EU Directive merely lays down minimum standards which the member states must adopt.
All enterprises and investors with any EU nexus should be aware, however, that the disclosure requirement will apply to all "intermediaries" and possibly their clients involved in cross-border tax arrangements. This could range from third-party service providers and tax advisors to in-house tax counsel, local directors and other in-house representatives involved in the transaction/arrangement.
DAC6 IN A NUTSHELL: MANDATORY DISCLOSURE AND EU-WIDE AUTOMATIC EXCHANGE OF INFORMATION
On March 13, 2018, the EU Economic and Financial Affairs ministers adopted the European Commission's proposal of June 2017. Pursuant to this proposal, Directive 2011/16/EU as regards mandatory automatic exchange of information in the field of taxation in relation to reportable cross-border arrangements is to be amended with new transparency rules for intermediaries that design, market, sell and/or implement potentially aggressive tax planning schemes with a cross-border element.
The proposal is a double-edged sword since it not only requires all EU member states to impose a mandatory disclosure regime, but also requires member states to exchange the information they receive under the mandatory disclosure regime under the automatic exchange mechanism already in place. These exchanges ensure that all EU member states benefit from the disclosure and increased transparency on planning practices which might possibly be affecting their taxable bases.
Under the new rules, intermediaries will have to report any cross-border tax planning arrangement that they design or promote if it bears any of the features or "hallmarks" listed in the Directive.
There are five categories of hallmarks: Category A through E. Categories A, B and most of Category C only create a reportable transaction if it can be established that "the main benefit or one of the main benefits" of the transaction "having regard to all relevant facts and circumstance" is that the taxpayer may reasonably expect to derive a tax advantage (main benefit test) from entering into an arrangement. Categories D and E render an arrangement reportable whether it yields a tax benefit or not.
Category A lists three "generic" aggressive tax planning hallmarks: (i) confidentiality imposed on clients; (ii) contingent fee arrangements; and (iii) the use of standardized documentation (indicating "sign-on-the-dotted-line," "shrink wrapped" arrangements).
Category B lists "specific" hallmarks relating to the nature of the transaction: (i) planning the use of losses; (ii) conversion of income into an item that benefits from more favorable (or no) taxation; and (iii) circular transactions resulting in the round-tripping of funds which yield a net tax benefit.
Category C lists, inter alia, transactions (i) involving payments to stateless entities, to low / no tax jurisdictions, to non-cooperative jurisdictions and to taxpayers benefiting from exemptions or preferential regimes; and (ii) a wide range of hybrid / dual deduction / double relief transactions.
Category D concerns a wide range of transactions that are by their nature intended to circumvent transparency rules (eg, frustrating application of CRS rules).
Category E considers certain transfer pricing arrangements such as those involving the use of unilateral safe harbor rules, hard to value intangibles and business restructuring (those creating a 50 percent or more decline in a taxpayer's projected annual EBIT) to be reportable arrangements.
WHO MUST REPORT?
An "intermediary" is defined as any person that carries the responsibility vis-à-vis the taxpayer for designing, marketing, organizing or managing the implementation of the tax aspects of a reportable cross-border arrangement provided that the intermediary has a EU nexus, by being either (i) incorporated in or governed by the laws of a member state; (ii) tax resident in a member state; (iii) registered with a professional association related to legal, taxation or consultancy services in at least one member state; or (iv) based (have a permanent establishment) in at least one member state from which it renders its professional services.
The reporting obligation shifts to the taxpayer(s) concerned where there is no tax advisor involved, or the intermediary has no EU-nexus, or the attorney-client privilege applies.
Where there is more than one EU member state where a report must be filed, a certain ranking rule applies (in the given order) and mandates filing/disclosure in the member state: (i) where the intermediary is tax resident; (ii) where the intermediary has a permanent establishment through which the services are provided; (iii) in which the intermediary is incorporated or by whose laws it is governed; and (iv) where the intermediary is registered with a professional association related to legal, taxation or consultancy services.
The foregoing ranking rule also sets the hierarchy where there is more than one intermediary or, alternatively, taxpayer who must report.
WHEN TO REPORT?
The disclosure must be made to the local tax authorities of the intermediary within thirty days of the day that the arrangement is "made available," or is "ready for implementation" or after the first step in the arrangement has been implemented, whichever occurs first. Intermediaries who become involved in part of the arrangement are also independently subject to the disclosure obligation. They must do so within 30 days after becoming reasonably aware of being involved in a reportable cross-border arrangement.
TIMEFRAME FOR EXCHANGE OF INFORMATION
The member state to whom the arrangement(s) is reported must automatically share this information with all other member states every three months through the same centralized database that is already in use for the exchange of information under the Common Reporting Standard (CRS) and the exchange of cross-border tax rulings pursuant to the EU's implementation of BEPS Action 5. The exchange takes place in a designated and standardized format and occurs within one month after the quarter in which the arrangement was reported. The first round of information exchange is envisaged to take place on October 31, 2020.
It was agreed that the new reporting requirements would enter into force on July 1, 2020. There will be a catch-up period with retroactive effect for all reportable arrangements the first step in regard to which was implemented between the entry into force of the Directive (estimated around June/July 2018) and 1 July 2020. Such arrangements will have to be reported by August 31, 2020.
KEY TAKEAWAYS: FAR-REACHING CONSEQUENCES
The approval of DAC6 and its implementation throughout the EU member states will have far-reaching consequences for tax advisors, service providers and taxpayers. One objective of DAC6 is to increase and accelerate the information available to the tax authorities and the legislators with a view to their taking suitable counteraction against cross-border tax planning schemes that raise tax policy and tax revenue concerns. However, the rules are cast so broadly that some member states have questioned whether the information exchanged is sufficiently targeted to be useful.
Another prominent and explicit intention of DAC6 is to deter intermediaries and their clients from engaging in potentially aggressive cross-border tax planning in the first place. In this regard, it is important to note that some hallmarks, such as those relating to transfer pricing arrangements, may not be sufficiently targeted. It is possible that business restructuring where tax mitigation is not an objective could be covered, because the hallmark in Category E focuses on EBIT rather than tax liabilities. At the same time, it is also unclear how bilateral or multilateral Advance Pricing Agreements where countries involved have already agreed to a transfer pricing arrangement fit in with these reporting obligations.
The question over legal privileges is also a tricky one. Some legal tax professionals may be exempt from the reporting obligations, under the DAC6 rules, by claiming legal privileges. In such cases, taxpayers may be required to fulfill the reporting obligations unless another intermediary is required to report. This effect may be contrary to the purpose of legal privileges in many professional standards, which are intended to protect the taxpayers to whom the legal professionals are advising.