EU reporting rules on cross-border tax planning

New EU rules have been introduced which will require intermediaries or taxpayers to report information in respect of potentially aggressive cross-border tax planning arrangements to tax authorities. The rules also require automatic exchange of these disclosures between EU authorities.

Member States have until 31 December 2019 to implement these amendments to the Directive on Administrative Cooperation in the field of Taxation (known as DAC 6) with the first reports not being due until the latter half of 2020. However, a 'catch-up' provision means it will be necessary at that time to disclose relevant arrangements for which the first step is implemented on or after 25 June 2018. 

For this reason – and despite the fact that the detail of the legislation will not be known until the Member States implement DAC 6 into domestic law - intermediaries and taxpayers will immediately need to begin forming a view as to what arrangements will be notifiable, and keeping appropriate records, so that the future disclosure obligations can be complied with. 

Why are these rules being introduced?

These rules are based on Action 12 of the OECD's Base Erosion and Profit Shifting (BEPS) project, which sets out a disclosure obligation in respect of aggressive tax planning, and also have a marked similarity to the UK's DOTAS (Disclosure of Tax Avoidance Schemes) rules, introduced in 2004.  

The aim is to strengthen tax transparency by requiring intermediaries - those involved in aspects of the design, promotion or implementation of arrangements - or taxpayers to report to tax authorities details of any arrangements that display specified features or characteristics which are considered to be potential indicators of avoidance. The requirement to disclose does not, in itself, mark the arrangements as avoidance but will enable tax authorities of Member States to identify and counter cross-border tax avoidance schemes at an earlier stage. 

What arrangements are in scope?

"Aggressive tax planning"

The Directive does not attempt to define "aggressive tax planning arrangements". Instead, cross-border arrangements (those that involve at least one EU Member State) will be notifiable if at least one of a specified list of "hallmarks" is present. The hallmarks are intended to capture characteristics or features which are indicative of a potential risk of tax avoidance. This is a concept very familiar to UK intermediaries and taxpayers and, indeed, many of the hallmarks closely reflect those in the UK rules.

It is worth reiterating at this point that there is (currently) no downside, other than the administrative inconvenience, to reporting arrangements. It is an information gathering exercise only and reporting per se implies no wrong-doing on the part of the taxpayer.

That said, this was also the initial position with the UK DOTAS rules and it was therefore customary for advisers to err on the side of caution and, if in doubt, disclose. However, in more recent years, notifiability under DOTAS has become a trigger for application of more penal measures such as the accelerated payments regime and the Serial Tax Avoiders rules which can give rise to higher penalties and increased reporting obligations. There is no indication of this in the Directive itself, but it cannot be ruled out that some jurisdictions may in the future choose to use notifiability under DAC6 as a criterion for application of their domestic anti-avoidance or penalty regimes. 

"Main benefit" test

The DAC 6 rules include a "main benefit" test so that, in respect of certain hallmarks, disclosure will not be necessary until obtaining a tax advantage is the main benefit or one of the main benefits that might be expected to arise from the arrangement.

The UK DOTAS regime contains a virtually identical threshold requirement but the key point to note in the context of the new European rules is that the main benefit test applies in conjunction with only some of the hallmarks. Therefore, in some circumstances purely commercial non-tax driven arrangements may be inside the scope of disclosure. In any case, it would be unwise to rely on this main benefit test if more than minimal tax advantages were expected to arise.

The lack of a main benefit test will be particularly noticeable in respect of certain cross-border transactions and the transfer pricing hallmarks. Depending on the exact wording of national legislation and any accompanying guidance, these hallmarks could be extremely broad; without any filter for genuine commercial arrangements, a potentially large number of arrangements currently considered to be inoffensive for tax purposes could be reportable. For example, the transfer pricing hallmark applies whenever there are cross border arrangements involving hard to value intangibles regardless of whether or not there is any tax avoidance motive.

The "hallmarks"

The hallmarks fall into a number of categories but can be summarised as follows.  We have also included in the list below examples of situations falling within the Hallmarks which have been given based on examples by the EU Commission to the Working Party on Tax Questions (WK 9981/2017 INIT).  These were developed before the DAC 6 rules were finalized but give some insight into the EU Commission's view of the scope of the regulations.

• General hallmarks linked to the "main benefit" test, i.e. a main benefit that a person may reasonably expect to derive from an arrangement is the obtaining of a tax advantage.
• A confidentiality condition requiring a participant not to disclose how the arrangement could secure a tax advantage vis-a-vis other intermediaries or the tax authorities
  
  Example: a promoter would not want to disclose new and innovative elements to competitors to retain a competitive advantage.
• A fee fixed by reference to the amount of the tax advantage or contingent on the advantage being obtained
  
  Example: a fee arrangement where the taxpayer pays no upfront costs until they obtain the tax benefit, but on receipt of the benefit pays a percentage of the tax benefit.
• Substantially standardised documentation and/or structure without the need for substantial customisation before use by different taxpayers
  
  Example: is a general scheme that is not tailored to only meet the needs of the taxpayers or is only slightly modified to suit the circumstances each time.  The value of take-up or manner in which the scheme is made available is considered irrelevant. 
• Specific hallmarks linked to the "main benefit" test.
• Contrived steps consisting of acquiring a loss-making company only to use those losses to reduce tax liabilities and involving the discontinuance of the loss making activity.
  
  Example: a profitable company buys another company which maintains a loss-making PE to offset against their profits in future years.  This example was based on an earlier draft of this hallmark and it is unclear whether this is still applicable given that such steps would not generally be considered 'contrived' and do not involve the discontinuance of the loss making activity.
• Arrangements with the effect of converting income into capital, gifts or other categories of revenue taxed at a lower level
  
  Example: a CEO is given shares as part of a remuneration package in a group company that is tax resident in a jurisdiction where dividends are not subject to withholding tax and the CEO is tax resident in a jurisdiction that provides a full exemption from tax for foreign dividends paid to individuals.
• Circular transactions resulting in the round-tripping of funds, through interposed entities with no commercial functions, or transactions that offset or cancel each other
  
  Example: a local business invests capital in a foreign subsidiary, disguising it as foreign capital and return it to fund local investment to take advantage of preferential treatment that is only available to foreign investors.
• Specific hallmarks related to cross-border transactions, including deductible cross-border payments between associated enterprises where the recipient pays a low rate of tax or benefits from a preferential regime (the "main benefit" test must also be met in relation to this hallmark), double deductions for depreciation, or double relief for the same item of income or capital in more than one jurisdiction.
  
  Example: a company is tax resident in a high-tax jurisdiction and licensed to use IP, which was given via an MNE group, tax resident in a country with 0% corporate tax.  To avoid paying withholding tax, the group sets up a NewCo in an EU Member State where there is a tax treaty which provides a full exemption from withholding tax.  The company will then pay royalties to NewCo under a tax treaty and the NewCo will pay no withholding tax as it is abolished on outflows.
• Specific hallmarks concerning automatic exchange of information and beneficial ownership, e.g. arrangements to avoid reporting obligations under agreements on automatic exchange of information, or those involving non-transparent legal or beneficial ownership chains with the use of entities in jurisdictions other than that of the beneficial owner, where the beneficial owner is made unidentifiable or that do not carry on substantive economic activity supported by adequate staff or assets.
  
  Example: the salary of employees is partly given in form of shares in bonds in that company; the income will not be captured by the automatic exchange of information and there will be no reporting obligations under the CRS.
• Specific hallmarks concerning transfer pricing, such as the use of unilateral safe harbour rules, transfer of hard to value intangibles and intra-group transfers of functions, assets or risks where this leads to a 50 per cent decline in a taxpayer's projected annual EBIT over the initial three years. Unless exceptions and/or clear guidance is introduced, these hallmarks are highly likely to result in a large proportion of these categories of transactions being disclosed.
  
  Example: an advance cross-border ruling under DAC 3 concerning the tax affairs of a natural person exclusively, which will not be required to be reported or exchanged.

Only one of the hallmarks needs be met for the arrangements to be reportable and it can be seen that these are wide-ranging and broad in scope. It should generally be relatively straightforward to determine if either of the first two categories of hallmark are in point, but an analysis of ownership structures, transfer pricing and cross-border deductions will involve greater consideration.  It is worth noting that the last three specific hallmarks do not require that the main benefit of the arrangements is to obtain a tax advantage and therefore disclosure obligations may need to be considered even where no specific tax planning was involved.

Who is required to report the arrangements?

The primary reporting obligation falls on the intermediaries involved in the arrangements.

An intermediary is any person that designs, markets, organises or makes available for implementation or manages the implementation of a reportable cross-border arrangement. It also means any person that, having regard to the relevant facts and circumstances and based on available information and the relevant expertise and understanding required to provide such services, knows or could be reasonably expected to know that they have undertaken to provide help or advice with respect to any of those roles.

Persons who are not incorporated or tax resident in the EU or do not have certain other connections with the EU (such as registration with a legal or taxation professional association in the EU) will not be intermediaries for this purpose. Depending on the final terms of Brexit, therefore, it is possible that purely UK advisers and promoters may be under no direct obligation to report arrangements under the revised Directive, but given the UK's approach to international tax compliance initiatives at this stage that seems unlikely.  

However, where there is no "intermediary", as defined, the "relevant taxpayer", i.e. the person to whom a reportable cross-border arrangement is made available for implementation, or who is ready to implement or has implemented such an arrangement, takes over the reporting obligation. UK advisers and advisers already based solely outside the EU but with EU clients are therefore likely to be called upon to advise whether arrangements with which they are involved fall within the scope of DAC 6, even if they are not ultimately affected by the rules directly.

The "relevant taxpayer" will also have to take over reporting duties in other situations. The Directive recognises that in many jurisdictions, legal professional privilege prevents lawyers from disclosing certain information to third parties, including tax authorities, unless this is waived by the client. To avoid conflict with this principle, lawyers may be exempted from disclosing information that would be privileged under their national rules. There may well be other intermediaries involved with the arrangements who also have an obligation to report but, if not, the client taxpayer must do so and a lawyer asserting legal professional privilege will have a duty to inform his client of the disclosure obligations now falling upon it. The extent of legal professional privilege varies amongst EU member states and ultimately clients will need to clarify this with their advisers in the relevant EU member state.

The client will also be responsible for the closure of any in-house arrangements where no third party intermediary is involved at all.

When must arrangements be reported?

National legislation implementing DAC 6 does not need to be in place until 31 December 2019, with the new reporting requirements applying from 1 July 2020. While this seems some way off, the rules will apply to reportable arrangements where the first implementation step happens on or after 25 June 2018. This information must be filed by 31 August 2020.

From 1 July 2020, the intermediary (or taxpayer where there is no reporting intermediary) must provide information on a reportable cross-border arrangement within 30 days beginning on the day after the arrangement is made available or is ready for implementation or when the first step of such arrangement has been implemented.

Taxpayers will also be required to file information about their use of reportable arrangements in each of the years for which the arrangement is used.
Failure to report arrangements will attract a penalty but it is down to each Member State to determine the appropriate level of this; the Directive only indicates that the penalties must be effective, proportionate and dissuasive.

Member States will then exchange information quarterly, within one month from the end of the quarter in which the information was filed. The first automatic exchange of information will therefore take place by 31 October 2020 and will be carried out through the existing common communication network developed by the EU for other automatic exchanges of information.

Comment

The picture will be clearer once national implementing legislation is published and one would also hope for reasonably detailed guidance. However, this may not be forthcoming for some time yet; HM Revenue and Customs in the UK, for example, has indicated that it is not expecting to release guidance or any consultation on draft legislation until next year.

In the meantime, taxpayers and advisers should address the potential notifiability of cross-border arrangements in real time as a matter of course, and on the assumption that the rules will be as broad as currently appears the case. It will be easier to remove arrangements from the list of those to be reported than it will to go back over two years to identify arrangements that were not originally thought to be in scope.

Whether the rules are sufficiently targeted to achieve the twin aims of deterring taxpayers from cross-border tax avoidance and arming tax authorities with information required to challenge and close down schemes, however, will take far longer to determine.