Macfarlanes tax risk experts explain the EU's new Directive on Administrative Cooperation, and how private equity firms can prepare for compliance and manage tax risk.
Reducing instances of perceived tax evasion and tax avoidance is becoming increasingly important for tax authorities. The EU Directive on Administrative Cooperation, or "DAC6" as it is commonly referred to, is another in a number of initiatives that have been introduced recently. DAC6 legislation follows on from a number of other measures such as the UK's Corporate Criminal Offence and the Organization for Economic Co- operation and Development's Base Erosion and Profit Shifting initiative that have come into effect in recent years, indicating that managing tax risk is high up on the lawmakers' agenda and therefore the business agenda too.
While DAC6 has been framed as a measure to address potentially aggressive tax planning, it can also catch arrangements with no obvious tax motivation.
DAC6 provides for two things: (i) a notification obligation on intermediaries (in most cases this is likely to be your advisors but in certain cases it could be the taxpayer) to report certain cross-border arrangements that meet specific hallmarks, and (ii) the exchange of that information between EU member states. The purpose is to allow tax authorities in member states to be aware, at an early stage, of arrangements that indicate potential tax avoidance.
The biggest strain on resources comes from the reporting timeframes and how private equity firms will want to coordinate with their various advisors. First, there is a historical reporting period for cross-border arrangements entered into on or after June 25, 2018. Second, once the ongoing reporting commences, there will be a rolling 30-day deadline. And third, while the European Commission has offered a concession with a six-month delay to reporting deadlines due to covid-19, it has been introduced on an optional basis. This means that some key territories like Germany are operating on the original timetable (first reports due by July 31, 2020) while others, such as the UK, will not require first reports to be made until January 31, 2021.
In addition to variable timelines, local country legislation and its interpretation can differ. Poland, for example, has expanded the scope of the taxes covered and, alongside Portugal, has also included domestic transactions within the scope of DAC6. This means that where businesses are operating in a number of jurisdictions it will be important to understand what the local differences are and how they might impact their operations.
The scope of these rules is wide and a large number of transactions will need to be examined to determine whether or not they are reportable. Potentially reportable arrangements could include transactions involving the transfer of functions or assets cross-border or business-as-usual deductible interest payments made to the Channel Islands under existing transfer pricing methodologies. It is important that businesses understand exactly how entities within the group may be affected.
We have summarized below some of the key actions private equity businesses are undertaking to mobilize and ensure that not only are they in a position to be DAC6 compliant by the new go-live date, but also better placed to manage their organization's tax risk more widely.
Raise awareness within the organization
Businesses are ensuring that the people within the organization who need to know are aware of the rules through training and debriefing sessions.
This involves the allocation of internal roles and responsibilities to ensure that when arrangements are being put in place that could have a DAC6 impact, staff are appropriately informed how best to identify them and escalate as necessary.
Identify and document in-scope arrangements
One of the key steps to compliance can involve the undertaking of an impact assessment to understand what historic transactions may be reportable during the two-year look-back period. As a part of this analysis, it will also be important to understand what activities might give rise to reportable arrangements on a go-forward basis and require reporting under the very tight 30-day rolling deadline.
Identify relevant intermediaries and relevant taxpayers
Given that the private equity sector often engages with a number of different third-party service providers to provide advice or financing, it is important to identify who might need to report, where reports may need to be filed, and the information to be reported. In this context, it will be important to understand whether any of your entities may be considered relevant taxpayers, and therefore reportable under these rules. And while the primary reporting obligation under DAC6 is with intermediaries, as a part of good stakeholder and tax risk management, you will want to know what is being reported, by whom and why. Investors will also want to know if and when their information will be passed on to relevant tax authorities.
Additionally, some jurisdictions, including the UK, have introduced a secondary reporting requirement for relevant taxpayers to include the reference number of any previously reported arrangements on their tax return, and so they will need this information in order to be able to comply.
Communication with key stakeholders
Once intermediaries, relevant taxpayers and potentially reportable arrangements have been identified, as indicated earlier, it will be important for businesses to coordinate reporting requirements with service providers and ensure that it is clear where any reporting responsibilities may lie. This applies with respect to arrangements executed within the two-year lookback period and also in respect of ongoing and future arrangements. It is important that any offering letters, SLAs and engagement letters have the necessary wording or disclosures that outline what the responsibilities are for each party in relation to DAC6. And some businesses may wish to have a degree of involvement and input into what is reported by an intermediary, in which case a timetable for this will need to be agreed to in advance. A clear timetable will be especially important once the 30-day reporting regime in underway.
Documentation of updated policies and procedures
Given the broad scope of the DAC6 rules and their complexity, organizations will want to document related policies and procedures, perhaps as part of a wider tax risk management policy. Where DAC6 is included within its scope, relevant procedures will need to be capable of update or amendment, as necessary, to deal with any changes in DAC6 practice or interpretation. In any event, a clear and robust tax risk management policy will be a strong indicator of a business's approach to tax risk and tax compliance, and may provide helpful evidence of good intent in the context of a penalty regime such as DAC6.