Inspired by the Organization for Economic Co-operation and Development BEPS Action 12, Directive 2018/822/EU (commonly referred to as “DAC6”), is the fifth amendment to the EU Directive on Administrative Cooperation in the Field of Taxation.
DAC6 requires qualifying intermediaries (or in some cases, taxpayers) to disclose certain tax planning arrangements to their tax administration, with information on these arrangements then automatically exchanged among national tax administrations.
This regime generally applies to cross-border arrangements involving one or more EU member states, provided they meet at least one of the hallmarks set out in the Directive. However, as the provisions of DAC6 need to be implemented in each country’s domestic law, some countries, such as Poland and Portugal, have gone further and include domestic arrangements, as well as expanding the tax base to include value-added tax (VAT).
It is also worth bearing in mind that the fact that DAC6 is required to be enacted domestically means that when determining whether an arrangement is reportable, the implementing law of the relevant jurisdiction should be considered.
The hallmarks are characteristics of a transaction which represent the features and elements considered to be indicators of a potential risk of tax avoidance. These are broken down into five categories (A to E). Hallmarks in categories A and B, and certain category C hallmarks, only apply if the main benefit or one of the main benefits of the arrangement is the obtaining of a tax advantage (the “main benefit test”).
This article focuses on the application of the hallmarks in practical terms in specific EU jurisdictions.
For more information about the DAC6 Directive please refer to OnPoint: DAC6—the EU Reporting Rules.
Hallmark A1 applies to an arrangement where a duty of confidentiality has been imposed on the effect of the scheme. Key points to note in relation to this hallmark are:
- this generally applies to confidentiality relating to the tax consequences of the scheme. Therefore, if the duty of confidentiality only relates to other matters, such as confidential stock exchange information or trade secrets, this should not be within the scope of this hallmark;
- the duty of confidentiality applies in relation to other intermediaries and the tax authorities, but not in relation to other taxpayers; and
- this hallmark is subject to the main benefit test.
A Danish tax advisory firm prepares advice for a Danish client. Included in the advice is the following wording: “This memo is for the employer’s own use only, and may not be handed over to others, except for relevant tax authorities, without the adviser’s consent.”
This applies a duty of confidentiality not just to other taxpayers, but also other intermediaries. Denmark would equate a prohibition on handing out the advice with a duty of confidentiality regarding the content of the advice.
If the advice relates to a cross-border scheme, and advises on how the taxpayer can secure a tax advantage, the scheme will be subject to reporting if the main benefit test is also met.
Hallmark A3—Standardized Documentation
Hallmark A3 applies to a scheme where substantially standardized documentation or structures are used and where they are available to more than one relevant taxpayer without having to be substantially customized.
The main target here is clearly ready-made tax schemes which are sold as a package solution, and widely marketed. However, it is worth bearing in mind it does not necessarily just apply to widely marketed, traditional tax planning schemes. In any case, the main benefit test would also need to be met, which is likely to reduce the practical impact for many forms of standardized intra-group documentation.
A Dutch company provides a loan to a foreign group company. The conditions of this loan are in accordance with arm’s-length requirements. All intra-group loans in the group use the same standard loan agreement. The standard loan agreement could qualify as standardized documentation, but in most cases the simple provision of a loan would not mean that one of the main purposes of the scheme is to obtain a tax advantage for the purposes of the main benefit test, unless there were other factors involved.
Hallmark B1—Acquiring a Loss-Making Enterprise
Hallmark B1 applies where artificial steps are taken involving acquiring a loss-making enterprise, discontinuing its main activity and using its losses in order to reduce its tax liability, including through a transfer of those losses to another jurisdiction or by accelerating the use of the losses.
A Dutch parent company has two subsidiaries, one of which is established in the Netherlands and one in another jurisdiction.
The Dutch subsidiary holds the shares in a loss-making Dutch sub-subsidiary. Because the Dutch subsidiary does not have taxable income, the Dutch subsidiary decides to sell the shares to the other foreign subsidiary that can offset the losses of the Dutch sub-subsidiary.
After the transfer, the Dutch sub-subsidiary ceases its activities and is subsequently liquidated. The foreign subsidiary settles the realized book loss with its profit, which reduces the tax payable. Tax laws in the foreign jurisdiction do not fully limit loss set-off.
This arrangement is potentially reportable under hallmark B1 providing the main benefit test is met. Given the sale of the shares in the Dutch sub-subsidiary is for the purpose of offsetting losses to obtain a tax advantage, there is a strong likelihood that obtaining a tax advantage would be viewed as one of the main purposes of the arrangement.
Hallmark B2—Converting Income or Capital
Hallmark B2 applies to an arrangement that has the effect of converting income into capital, or other categories of income which are taxed at a lower level or exempt from tax.
The key aspect of this hallmark is that one type of income or capital is converted into another form of income or capital, which is then taxed at a lower rate or is tax free.
Note that it applies to the conversion of one form of income into a different form of income. Therefore, schemes where business income in one jurisdiction is converted into business income in another jurisdiction, but taxed at a lower rate, should not be caught by this hallmark (although others may apply), as the form of income has not changed.
This hallmark is also subject to the main benefit test.
Parent company A, resident in Finland, converts interest-bearing debt from a nonresident subsidiary into equity of the subsidiary. Rather than taxable interest income, A receives a dividend taxed at a lower rate. This would need to be reported under hallmark B2 if the main benefit test is met.
Hallmark B3—Circular Transactions
Hallmark B3 applies to circular transactions resulting in the round-tripping of funds, through intermediate entities where there is not a key commercial function or where transactions offset or cancel each other.
Company A, established in France, is developing a manufacturing process that it patents. Company A sets up an operating license agreement relating to this technology with company C, established in another EU member state. Due to the non-exclusive nature of the license contract, the amount of the royalty paid by company C to company A is considered low, based on transfer pricing rules.
Company C uses the manufacturing process to manufacture a product and resells it to Company A at a high market price. Company A then resells the finished product with a commercial mark-up. The taxable commercial margin achieved by company A was reduced thanks to the intervention of company C in the manufacturing process, which results in operations which offset each other. Therefore, this arrangement has the characteristics of hallmark B3 and would be a reportable transaction if the main benefit test was also met.
Hallmark C—Cross-Border Transactions
This hallmark relates to cross-border transactions between related/associated parties. It has a wide scope and applies in a variety of different circumstances.
In essence, it applies to:
- deductible cross-border payments between related enterprises, where:
- the recipient is not tax resident anywhere (hallmark C1(a));
- the recipient is resident in a zero-tax country (hallmark C1(b)(i));
- the recipient is resident in a non-cooperating third country (hallmark C1(b)(ii));
- the recipient is entitled to a full tax exemption on the receipt (hallmark C1(c));
- the recipient is taxed under a preferential tax scheme (Hallmark C1(d));
- double depreciation deductions (hallmark C2);
- relief from double taxation on the same income or capital in more than one jurisdiction (hallmark C3);
- differences in the value of consideration for the same transaction (Hallmark C4).
Unlike hallmarks A and B, some of these hallmarks are subject to the main benefit test, whereas others are not.
Hallmark C1(b)(i) applies to deductible cross-border payments made between associated enterprises where the recipient is resident in a jurisdiction that does not impose any corporate tax or imposes corporate tax at the rate of zero or almost zero. In order for this hallmark to apply, the main benefit test would also need to be met.
A Swedish company makes a tax-deductible payment to an associated company that is resident in a country with 0% income tax. This would fall under the scope of hallmark C1(b)(i), and therefore be reportable, if one of the purposes of the transaction was to obtain a tax benefit.
However, Sweden’s domestic tax legislation includes controlled foreign company (CFC) provisions. Subject to a number of requirements and exceptions, where a Swedish shareholder holds more than 25% of the capital or votes in a foreign low-tax company, the CFC provisions apply. As such, the Swedish shareholder would be liable to Swedish tax on its proportionate share (computed on the basis of its share of the capital of the foreign company) of the foreign company’s net income.
In this example, if there is only one shareholder in the foreign company, and that shareholder is subject to Swedish income tax on the foreign company’s income under the CFC provisions, the payment to the foreign company is not normally considered to lead to a tax benefit, given the income is fully taxed in Sweden. As such this would not be a reportable transaction under hallmark C1(b)(i).
Hallmark E—Transfer Pricing
Hallmark E applies to three specific areas related to transfer pricing, including arrangements which involve:
- the use of unilateral safe harbor rules (hallmark E1);
- the transfer of hard-to-value intangibles (hallmark E2); and
- the cross-border transfer of intra-group activities, risks or assets if the earnings before interest and taxes over the three years after the transfer are reduced by more than 50% (hallmark E3).
It is not subject to the main benefit test.
Each of these is subject to a number of requirements, and in particular differences will apply in terms of application by individual jurisdictions. For instance, the Danish Tax Agency takes the view that the three-year period for hallmark E3 is calculated from the time when the restructuring itself takes place. The Tax Agency does, however, note that tax authorities of other countries may interpret this as three full financial years.
A Dutch company has taken out an interest-free loan from a group financing company in a foreign jurisdiction. Under Dutch tax rules, the Dutch company imputes an interest expense on an arm’s-length basis. However, in the other jurisdiction, interest between group companies is calculated on the basis of the average inter-bank lending rate. This qualifies as a unilateral safe harbor rule and is likely to be reportable under hallmark E1.
A Danish group acquired a technology company in a foreign jurisdiction a number of years ago; the foreign company owns several patents. The patents have not yet been exploited commercially but have undergone significant development and are considered to be ready for commercial application by the group. The group identifies two scenarios for structuring the commercial exploitation of the patents tax-efficiently:
- sale of the patents by the foreign company to the Danish parent company at an estimated market value; or
- a grant of a license by the foreign company to the Danish parent company to develop and utilize the subsidiary’s patents commercially in its own name. The license income will be taxed according to the patent box rules in the foreign jurisdiction.
The sale of the patents to the parent company is likely to be reportable under hallmark E2, as this is an intra-group transfer of intangible assets that are difficult to value. This is particularly the case given the valuation of the patents is uncertain, as the original acquisition of the foreign company was a number of years ago and significant development of the patents has since been undertaken.
The grant of a license to the parent company is potentially reportable under both hallmark E2 and hallmark C1(d).
Hallmark E2 applies as it involves an intra-group transfer of rights in an intangible asset that is difficult to value.
Hallmark C1(d) may apply given the license payments are tax deductible for the Danish parent company, but are taxed under the foreign patent box scheme, which is a preferential tax scheme. However, for hallmark C1(d) to apply, the main benefit test would need to be met. If the purpose of the licensing arrangement is to establish a more tax-efficient ownership of the patents, it is likely that this test would be met, given that one of the main purposes of the transaction is the obtaining of a tax advantage.
- The scope of the hallmarks is very broad, and they require the disclosure of a wide range of arrangements. Whilst some of them might involve tax schemes, there could be others which do not fit the description of traditional tax avoidance schemes.
- It should be borne in mind that the decision as to whether an arrangement is reportable is made with respect to the local domestic hallmarks, which may differ from the hallmarks in DAC6. For instance, Poland and Portugal have included pure domestic arrangements and widen the definition of taxes covered by including VAT. This increases the risk that there may be a requirement to file in multiple jurisdictions if the hallmarks or the interpretation of the hallmarks vary from country-to-country.
- Certain transactions may be potentially reportable under more than one hallmark.
- Given the hallmarks are broadly defined, it is likely that there will be different interpretations by local tax authorities regarding the reportability of an arrangement. Therefore, intermediaries and taxpayers will need to keep track of the requirements in different jurisdictions, making sure that the reporting complies with the domestic legislation.
- The consideration as to whether a hallmark applies is made more difficult as some of the hallmarks are subject to a main benefit test. In practice, its application will be a significant issue. Similarly to the various general anti-avoidance rules (GAAR), jurisdictions will provide their own domestic guidance on the application of this (in many cases deriving from case law on the application of a GAAR), which should also be carefully considered.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Lee Hadnum and Juan Pablo Osman Moreno are Senior Tax Law Analysts with Bloomberg Tax & Accounting.