INSIGHT: Getting to Grips with the EU’s New Disclosure Directive

The European Commission published an amendment to the Directive on Administrative Co-operation in June 2018 imposing mandatory reporting by intermediaries (e.g., accountants, lawyers and tax advisers) and potentially taxpayers of various cross-border arrangements to their respective member state tax authorities.

Tax authorities will in turn automatically exchange the information obtained to each other, on a quarterly basis.

Key Points

New rules will apply to reportable arrangements where the first step takes place on or after June 25, 2018.
Although these are EU regulations member states, including the U.K., will have to transpose it into domestic legislation by December 31, 2019.
New arrangements entered from July 1, 2020 must be disclosed to the relevant tax authorities within 30 days.
Arrangements entered from the date the Directive took effect must be disclosed in August 2020.
Cross-border arrangements are reportable if they fall within one of the five categories of hallmarks.
New rules likely to impact taxpayers using reportable arrangements as much as they impact intermediaries.
Advisers will need to review any cross-border arrangements to ensure any advice given does not trigger notification.

The Directive

The new directive (2018/882/EU) amends the 2011 Directive on Administrative Cooperation in the field of taxation (2011/16/EU), generally known as “DAC 6.”

Informed by Action 12 of the OECD’s base erosion and profit shifting (“BEPS”) project and not dissimilar to the U.K.’s disclosure rules (Disclosure of Tax Avoidance Schemes, “DOTAS”), the directive provides for the mandatory disclosure of information on “schemes that are considered potentially aggressive” by intermediaries; or, if there is no intermediary or the intermediary is protected by privilege, the disclosure obligation falls to the taxpayer.

The rationale for the disclosure rules are to:

provide the tax authorities of EU member states with early notification of potentially aggressive tax arrangements to facilitate targeted interventions and propose changes to legislation
encourage behavioral change by imposing reporting requirements intended to deter promoters of aggressive tax planning and potential users; and
foster effective co-operation between EU member states tax authorities to combat tax avoidance and evasion.

Intermediaries and the Obligation to Report

Responsibility for reporting arrangements that fall within the hallmarks is, in the first instance, the responsibility of an intermediary. Intermediaries are broadly defined, as follows:

Main category—any person that designs, markets, organizes, or makes available for implementation or manages the implementation of a reportable cross-border arrangement.
Subsidiary category—any person that knows or could be reasonably expected to know that they have undertaken to provide, directly or by means of other persons, aid, assistance or advice regarding the design, marketing, organization, making available for implementation or managing the implementation of a reportable cross-border arrangement.

The subsidiary category will need to be able to show that they did not know and could not be reasonably expected to know that there was a reportable cross-border arrangement.

A person will only be an intermediary where one of the following applies:

tax resident in a member state;
have a permanent establishment (“PE”) in a member state through which the services relating to the arrangements are provided;
incorporated in or governed by the laws of a member state; or
registered with a professional association related to legal, taxation or consultancy services in a member state.

Intermediaries will report to the member state in question. They do not need to report if in their jurisdiction the advice they provide attracts legal professional privilege though they are required to notify any other intermediaries involved and the taxpayer, thereby passing on the burden of reporting.

Neither will intermediaries need to report arrangements where they can show that the arrangement in question has already been reported in another member state by another intermediary or taxpayer.

As well as catching accountants, lawyers and tax advisers the definition of intermediaries is sufficiently wide to catch banks, fiduciary services businesses and potentially the relationships between companies within the same multi-national group, e.g., where a group company has a holding or treasury function relationship with other companies in the group.

Taxpayers and the Obligation to Report

Crucially, where there is no EU intermediary involved then the obligation to report shifts to the taxpayer in the following circumstances:

the intermediary involved is not based in the EU;
the intermediary is EU based but prevented from reporting by legal professional privilege; an
the arrangements are planned and implemented by the taxpayer in-house.

Where are Taxpayers Required to Report?

Where the obligation to report falls on the taxpayer they must report to the member state where they:

are resident;
have a PE;
generate or receive income or profits; and
carry on their business activities.

The list above reflects the order of reporting so if a taxpayer is resident in one-member state but has a PE in another member state then they will report to the member state in which they are resident, i.e., residency trumps PE and the other categories.

From the above it can be seen that these rules impact companies and individuals who use potentially reportable cross-border arrangements, as much as they impact intermediaries.

Cross-border Arrangements

The rules apply to “cross-border arrangements” that concern two member states or a member state and a third country. There is no definition of “arrangements” other than that it can consist of more than one step or part and can also comprise of a series of arrangements and one at least of the following conditions apply:

participants are tax resident in two or more jurisdictions;
one or more participants are dual resident;
the arrangements are part of the business of a PE;
an activity is undertaken in another jurisdiction without a tax presence or PE in that jurisdiction; and
it has the effect of undermining the reporting requirements under automatic exchange of information or Common Reporting Standard (“CRS”) or the identification of beneficial ownership.

The Hallmarks

A cross-border arrangement is only reportable if it meets at least one of the hallmarks set out in the directive. These hallmarks are characteristic of arrangements which the EU considers create a potential risk of tax avoidance. The hallmarks will also be reviewed every two years and some of them only apply where the arrangements satisfy a main benefits test.

The main benefits test will be familiar for those in member states with a main purpose test although arguably it is intended to be broader. The test would be satisfied where having regard to all relevant facts and circumstances the main benefit or one of the main benefits a person may reasonably expect to derive from an arrangement is the obtaining of a tax advantage.

The hallmarks are set out in two tables in the directive and those in Table 1 only apply where the arrangements satisfy the main benefits test and include:

Table 1 (Subject to the Main Benefits Test)

A. — a confidentiality clause
— a success fee dependent on the tax saved and where the documentation or structure is standardized
B. — acquiring a loss-making company and using the loss outside of the business of the acquired company
— the conversion of income into capital or into other categories of income taxed at lower rates
— “round tripping of funds” using circular transactions without substance
C. — cross-border payments between associated enterprises where the recipient is resident in a low or zero tax rate jurisdiction

It should be noted that part of category C above falls into Table 2 and is therefore not subject to the main benefits test.

Table 2 (Not Subject to the Main Benefits Test)

C. — cross-border payments between associated enterprises when the recipient has no tax residence or is resident in a blacklisted “country” (i.e., included in the published EU or OECD black lists as non-cooperative or have not adopted the Common Reporting Standard for the automatic exchange of information)
— relief from double taxation claimed in more than one jurisdiction, deductions for depreciation claimed in more than one jurisdiction
— transfer of assets with a material difference in the price used for tax purposes
D. — arrangements which may have the effect of undermining the reporting obligations under EU law, or equivalent agreements, on the automatic exchange of information or Common Reporting Standard
— arrangements (non-transparent ownership chains) that lack substance and hide beneficial ownership
E. — transfer pricing where unilateral safe harbor rules are used
— arrangements involving transfers of “hard to value” intangibles and cross-border transfers of intragroup functions, risks, or assets where more than 50 percent of the transferor’s income is removed (i.e., profit shifting).

It can be seen from the hallmarks that these rules are very broad in scope and, as they stand, will catch wholly commercial transactions, including intra-group transaction which are not tax driven. It will be interesting to see how member states operate these rules along existing or planned domestic rules, e.g., will the U.K. widen its DOTAS rules to accommodate the EU Directive or operate both independently? From a U.K. perspective it is hoped that when transposing the rules into U.K. legislation full consideration will be given to reducing, as far as will be possible, any unintended compliance burden for those not involved in aggressive cross-border tax avoidance.

What Information must be Reported?

The respective member states who will introduce legislation to give effect to the directive will no doubt determine the precise scope of the information that must be reported and likewise the format for the provision of that information. To ensure a degree of uniformity across the EU it is hoped that this will closely follow the information prescribed by the EU, as follows:

details of the intermediary or taxpayer including name, place of birth (for individuals), jurisdiction of residence and tax identification number
the hallmarks that are met;
a summary of the arrangements, including any commonly known name and a description off the business activities;
date on which the first step in implementing the arrangement was or will be made;
value of the arrangement;
domestic legislative provisions forming the basis of the arrangements;
EU member state of the taxpayer and other EU member states likely to be affected by the arrangement; and
persons likely to be affected by the arrangement and the EU member state to which they are linked.

There is concern that the rules lack precision in prescribing what must be reported leading to inconsistency with the interpretation and implementation of the rules across member states. Neither is it clear what is meant by the value of the cross-border arrangement, i.e., is it the overall monetary value of the transaction or the purported tax saving? It is hoped that member states will provide detailed guidance in support of their domestic legislation to give effect to the rules.

The U.K. authorities (“HMRC”) are well placed to do so as they produced extensive and helpful guidance for the Disclosure of Tax Avoidance Schemes (“DOTAS”) rules and, as mentioned, the EU rules are similar, particularly with the use of hallmarks to identify reportable arrangements.

Timing for Reporting

Member states must transpose the requirements of the directive into domestic legislation by December 31, 2019. New arrangements entered into from July 1, 2020 must be reported to the respective member states tax authorities within 30 days:

from the arrangements being made available; or
from the first step in the implementation being taken;
whichever is first.

For intermediaries providing aid, assistance or advice within 30 days:

from the day after they provided the aid, assistance or advice.

As the new rules will apply to reportable arrangement where the first step took place between June 25, 2018 and July 1, 2020 (the date from which the 30-day reporting deadline applies) there is a retrospective effect and such arrangements must be reported by August 31, 2020.

Exchange of Reported Information by Member States

Member states are required to automatically exchange the reported information on a quarterly basis starting from October 31, 2020 and this first exchange will include those arrangements that were caught retrospectively. Importantly the directive makes it clear that just because the member state tax authorities do not react to the reported information does not mean that they have decided the arrangements are acceptable, or in other words the new rules should not be used as an advance ruling or clearance procedure.

Sanctions for Non-compliance

The directive requires member states to introduce penalties for non-compliance and suggests that these should be effective, proportionate and dissuasive so it remains to be seen what sanctions member states impose. As with non-compliance with other statutory reporting requirements non-compliance with these rules will also pose a reputational risk.

How Should Advisers and Clients Respond?

The U.K. government published a policy paper on July 6, 2018, confirming that it will include the enabling powers necessary to allow the Treasury to introduce the new regulations in Finance Bill 2019. Importantly it has also confirmed it will consult on the regulations in 2019. This is to be welcomed as the EU does not generally consult on its directives which is understandable given it is the responsibility of member states to introduce the new disclosure rules.

It should be noted that although it is far from clear what the U.K.’s relationship with the rest of the EU member states post Brexit those hoping that the U.K. will not need to introduce these rules will be disappointed. The U.K. has always supported tax transparency initiatives and is closely involved with the BEPS initiatives and particularly DAC 6 and, as mentioned above, it is very likely its hallmarks-based DOTAS regime has informed the overall shape and design of the regulations.

Given the retrospective effect (see above) the new regulations have been relevant to intermediaries and their clients from June 2018 and those potentially impacted would be ill advised to wait until member states, including the U.K., consult on the rules in 2019 before considering how to respond.

Those intermediaries and taxpayers likely to be impacted should review any advice and existing arrangements to establish whether they are reportable. Likewise thought should also be given now to the design and implementation of procedures and processes that will be required to ensure compliance with the reporting obligations starting in August 2020.

INSIGHT: Getting to Grips with the EU’s New Disclosure Directive—DAC 6