INSIGHT: U.K. Final Regulations for Disclosure of Cross-Border Tax Arrangements

The U.K.'s final regulations to implement the EU directive known as “DAC 6,” designed to enable EU tax authorities to share information about cross-border tax schemes, have now been published and include some helpful changes.

The rules will now only apply where there is an EU tax advantage and the penalty regime has been changed so as not to unduly penalize genuine mistakes.

HM Revenue & Customs (HMRC) intends to issue guidance before the rules come into force on July 1, 2020.

The regulations require U.K. intermediaries to report to HMRC cross-border tax arrangements which contain a prescribed “hallmark.” The information received from these reports will be shared with tax authorities in EU member states so that they can identify any potential tax risks in their jurisdictions. EU tax authorities will in turn share the information they receive about arrangements involving the U.K. with HMRC.

The primary reporting obligation will fall on “intermediaries.” This is very widely defined and includes those who design and market cross-border arrangements as well as those who provide aid, assistance or advice in respect of such arrangements. In some circumstances the taxpayer itself will be obliged to make the report.

A consultation on the draft regulations closed in October 2019. The U.K. was meant to have its implementing legislation in place by December 31, 2019, but the dissolution of Parliament and the general election meant this was not possible.

The regulations come into force on July 1, 2020. However, the regime catches cross-border arrangements entered into since June 25, 2018. Reports for arrangements entered into from June 25, 2018 to June 30, 2020 will be due by August 31, 2020.

As well as the final regulations, a summary of responses to the consultation has been published. The main changes from the draft regulations published in July 2019 are to:

• make the penalty regime deter non-compliance but not unduly penalize those who make genuine mistakes;
• limit the scope of “tax advantage” to only cover EU taxes;
• ensure that the same intermediary does not have an obligation to report in multiple jurisdictions;
• ensure that the scope of the U.K. rules is limited to U.K. intermediaries and does not apply to those without a U.K. connection; and
• ensure that the rules are compatible with legal professional privilege.

Territorial Scope

The U.K. government has admitted that the territorial scope of the draft regulations was too wide and has introduced new definitions of “U.K. intermediary” and “U.K. resident taxpayer” to ensure that the regulations do not apply to intermediaries without a connection with the U.K. The regulations also make it clear that an intermediary will only have to report in one country.

Some of the hallmarks are only triggered where the arrangements satisfy a “main benefit” test. This will be satisfied if it can be established, having regard to all relevant facts and circumstances, that the main benefit or one of the main benefits which a person may reasonably expect to derive from the arrangements is the obtaining of a tax advantage.

The U.K. regulations define “tax advantage” so that it will only catch arrangements “where the obtaining of the tax advantage cannot reasonably be regarded as consistent with the principles on which the relevant provisions that are relevant to the reportable cross-border arrangement are based and the policy objectives of those provisions.” HMRC will provide guidance and examples to illustrate where a tax advantage will and will not be consistent with the underlying policy intent.

The draft regulations provided that a tax advantage could be either an EU tax advantage or a non-EU tax advantage. The government has now accepted that the rules should only apply to EU tax advantages.

Hallmarks

Hallmarks which will only trigger reporting if the tax main benefit test is satisfied include where:

• the participant agrees to confidentiality obligations;
• the intermediary’s fees are dependent on success or by reference to the tax saved;
• the arrangement has substantially standardized documentation and/or structure and is available to more than one taxpayer without a need to be substantially customized for implementation;
• the arrangements involve acquiring or generating losses;
• the arrangements involve converting income into capital or into revenue taxed at a lower level or exempt from tax;
• the arrangements involve circular transactions resulting in the “round-tripping” of funds; or
• the arrangements involve cross-border payments between associated enterprises where the recipient is resident in a zero or near zero corporate tax jurisdiction; or the payment benefits from an exemption from tax or a preferential tax regime in that jurisdiction.

There are a number of hallmarks which are not subject to a main benefit test. These catch:

• cross-border deductible payments between associated enterprises where the recipient has no tax residence or is resident in a “blacklisted country”;
• deductions claimed for depreciation in more than one jurisdiction;
• relief from double tax claimed in more than one jurisdiction;
• transfers of assets where there is a material difference in the amount treated as consideration in each jurisdiction;
• arrangements which may have the effect of undermining Common Reporting Standard reporting;
• certain arrangements involving non-transparent ownership chains, using arrangements which lack substance;
• arrangements using unilateral safe harbor transfer pricing rules;
• arrangements involving the transfer of “hard-to-value” intangibles; and
• intra-group cross-border transfers of functions and/or risks and /or assets removing 50% or more of the transferor’s income.

Since the hallmarks are set out in DAC 6, their wide ambit has not been narrowed down by the U.K. regulations. However, HMRC intends to issue guidance on when it considers they will apply.

Intermediaries

Responders to the consultation had expressed concerns that the wide definition of “intermediary” and the tight timescales for reporting could lead to significant amounts of duplicate reporting, which would be burdensome for both businesses and HMRC.

There are two different types of intermediary: those who design and market cross-border arrangements (“promoters”) and those who provide aid, assistance or advice in respect of such arrangements (“service providers”). Service providers are only caught if they know or could reasonably be expected to know that they have undertaken to provide aid, assistance or advice in respect of a reportable arrangement.

The consultation document response confirms that intermediaries will not be required to do any additional customer due diligence to work out whether an arrangement is reportable, beyond what they would normally do in the course of their business and in compliance with their existing obligations.

Reporting is usually required within 30 days after the day after the arrangement is made available for implementation, but for an intermediary providing assistance it is within 30 days after the advice or assistance is provided. The government acknowledges that the timescale for reporting as set out in the directive is “potentially challenging,” but will give guidance about where intermediaries will not face penalties for late reports.

In the consultation response, the government agrees that duplicate reporting should be avoided where possible, but that the structure of the rules and the requirements of DAC 6 mean that some multiple reporting is “almost inevitable.” The response document helpfully confirms that where an intermediary who is a promoter has reported the arrangement, an intermediary who is a service provider will be able to rely on that report being complete, without having to verify it directly.

An intermediary who reports an arrangement will be obliged to provide an arrangement reference number (ARN) supplied by HMRC to other intermediaries, but HMRC says it intends that an ARN will be provided immediately upon receipt of a valid report.

Penalties

Intermediaries who fail to comply with their obligations under the rules will be subject to penalties. A significant number of those responding to the consultation said that the rules would be difficult to comply with, and that it was inevitable some mistakes would be made. It was felt by some responders to the consultation that the penalty regime originally proposed, which relied on daily penalties, could operate onerously and with disproportionate effects where genuine mistakes had been made. The government has amended the rules so that the default position will be a one-off penalty of up to 5,000 pounds ($6,500), with daily penalties only applying in more serious cases, and subject to the determination of the First-tier Tribunal.

An intermediary will not be subject to a penalty if it has a reasonable excuse for the failure. Amendments also clarify that where a person has reasonable procedures in place to secure compliance with the rules, this will be taken into account in determining whether they have a reasonable excuse for a failure.

HMRC guidance will provide more detail on how the penalty regime will operate in practice and will provide examples of the situations where different levels of penalty will apply.

Legal Privilege

The rules provide that an intermediary is not required to disclose any information which is protected by legal professional privilege. If information is protected by privilege, the intermediary must tell another intermediary or the taxpayer if there is no other intermediary, who will then need to make the report.

The consultation response says that among the responses that addressed legal professional privilege, there was a strong view that the original draft regulations would be difficult for lawyers to operate and risked threatening legal privilege or putting lawyers in an impossible position where they would either have to fail to comply with the regulations or breach privilege.

The government says it has amended the regulations to address some of these concerns and that it will work with representatives from the legal industry to provide guidance on how the rules will operate.

Brexit

The U.K. is legally obliged to transpose DAC 6 before the U.K. leaves the EU and that obligation will continue during the implementation period, under the terms of the Withdrawal Agreement.

The consultation document response confirms that the U.K.’s commitment to tax transparency will not be weakened as a result of leaving the EU and the government will continue to work with international partners to tackle offshore tax avoidance and evasion. However, the document states that depending on the outcome of Brexit, amendments may be needed to the regulations in due course.

Some Comfort, but HMRC Guidance will be Crucial

The DAC 6 rules will impose a significant compliance burden on financial services and professional services firms in particular. The amendments to the regulations show that the government has listened to the concerns that have been raised, although it is constrained by the fact that the U.K. rules have to accord with the EU directive.

While the consultation response provides some comfort in relation to how the regime will be implemented, businesses will need to rely heavily on HMRC guidance, which has not yet been published. HMRC will be working with industry bodies and other stakeholders to produce the guidance, which will be published before the regulations come into force in July 2020.

Planning Points

Businesses which may be obliged to report under the new regime will need to continue to put systems and processes in place to enable them to comply with their obligations. This will involve ascertaining in which member state they will be required to report, as well as working out what may need to be reported.

The fact that the rules apply to arrangements dating back as far as June 25, 2018 means that businesses should not delay in identifying potentially disclosable transactions, even if final decisions as to what is caught may not be possible until HMRC guidance is available.

Catherine Robins is a Partner with Pinsent Masons.

The author may be contacted at: catherine.robins@pinsentmasons.com

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.