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DAC 6 – A NEW MANDATORY DISCLOSURE REGIME PUSHING THE FRONTIERS OF AUTOMATIC EXCHANGE OF INFORMATION (AEOI) TO NEW LIMITS

Contributed by:

Directive on Administrative Cooperation (DAC) 6 – EC DIRECTIVE 2018/822/EU (25.5.2018)

European Council Directive 2018/822/EU of May 25, 2018 (DAC 6) represents the biggest shake-up of rules on automatic exchange of information (AEOI) in the EU since the imposition of the Common Reporting Standard (CRS) back in 2014.

However, unlike the CRS and DAC Volumes1 to 5 which have hitherto targeted financial institutions DAC Volume 6 has its focus on mandating disclosure of Reportable Cross Border Tax Arrangements from “intermediaries” involved in cross-border tax arrangements with their clients.

Many intermediaries, including law firms, accountants and auditors, have until now broadly not needed to report tax information periodically since they fall outside the “financial institution” definition under the CRS.

This is all about to end.

The European Commission has made it clear that it sees intermediaries at the heart of aggressive tax planning and is therefore seeking mandatory disclosure from them.

The International Aspect – Jurisdictions Outside Europe

The OECD will no doubt follow for non-EU jurisdictions.

It is clear that mandatory disclosure requirements are on the increase the OECD (Organisation for Economic Cooperation and Development) is going to follow the European Commission in the imposition of enhanced mandatory disclosure requirements for cross-border transactions.

The EU Perspective

What is DAC 6?

“DAC 6” stands for the Directive on Administrative Cooperation in (direct) taxation in the EU, volume 6.

It operates as the sixth amendment to the long-running series of directives designed to encourage cross-border information exchange in the EU. The CRS, for example, was implemented in the EU in 2014 under “DAC 2.”

DAC 6 is the part of the DAC series which provides for mandatory disclosure of reportable cross-border tax arrangements (RCBAs).

The background for the implementation of DAC 6 by the EU is of course the ongoing international tug-of-war between the Organization for Economic Co-operation and Development (OECD) under its framework on Base Erosion and Profit Shifting (BEPS), in particular Action Plan 12, and the ever-growing prominence of low or no tax international  financial hubs that look to the increasing commoditization of international finance.

Standard principles of EU law require that EU Directives such as the DAC 6 Directive be implemented by member states through local laws in order to be locally applicable.

DAC 6 has been in force across the EU and reports as described in the directive would have been due as from 1st July 2020 with the obligation to report cross border arrangements occurring post June 25, 2018, which was the 20th day following publication of DAC 6 in the EU’s Official Journal.

On 24th June 2020 following informal agreement reached by EU member states the EU Council announced that the EU will give EU member states an extended time period to comply with DAC 6 requirements.

The reason given for this is the impact of the coronavirus pandemic.

In reality however, if the EU were to be totally honest, if there can ever be a convenient time for a global pandemic for DAC 6 this was it. The initial deadlines of 1st July 2020 for reporting cross border arrangements and 31st August 2021 for reporting historical cross border arrangements (from 25th June 2018 to 30th June 2020) was looking an increasingly onerous obligation, that would have been almost impossible to comply with and enforce. The extended dates of 1st January 2021 and 28th February 2021 respectively still appear to be optimistic, but with rigorous education and application an acceptable degree of compliance may be achievable.

The Disclosure Requirement under DAC 6.

It is important to note that DAC 6 implementation applies as from the date of publication of the DAC 6 directive in the EU Official Journal which was 25th June 2018.

Under DAC 6 “intermediaries” are subject to reporting requirements.

An intermediary is any legal or natural person:

  • that designs, markets, organizes or makes available for implementation or manages the implementation of an RCBA); or
  • that provides, directly or by means of other persons, aid, assistance or advice with respect to designing, marketing, organizing, making available for implementation or managing the implementation of an RCBA.

Intermediaries that are involved in that way with RCBAs must report information on the RCBA to their tax authorities: it is here that DAC 6 resembles a form of AEOI similar to the CRS. There will then be automatic exchange of that information with other EU tax authorities.

In certain situations, the obligation to report can fall on the taxpayer itself. Taxpayer’s obligation to report arises where an intermediary is a non-EU person (which is narrowly defined), where no intermediary is involved—such as where an RCBA is arranged in-house—or where an intermediary does not disclose owing to legal professional privilege.

The question of whether a professional intermediary who is involved but who may be precluded from reporting by applying legal professional privilege is under an obligation to ensure that reportable cross border arrangements that they have been involved in is a legal moot point.

What is a Reportable Cross-Border Arrangement?

An arrangement will be considered “cross-border” where at least one of the participants is based in the EU (and regardless of the location of other participants). Therefore, in theory if one participant is in the EU, say London, another in North America, another in Hong Kong and another in Mexico the arrangement may be “reportable”.

An arrangement may be “reportable” where it contains at least one of “hallmarks” outlined below. The Hallmarks are loosely designed as indicators of presumed aggressive tax avoidance by the EU.

The hallmarks are themselves broken down into five sub-categories:

  • Hallmark category “A”: arrangements whose tax benefits are subject to confidentiality arrangements that give rise to performance fees or mass marketed schemes;
  • Hallmark category “B”: arrangements such as the contrived acquisition of loss-making companies, the conversion of income into capital or other forms of income, or so-called circular transactions;
  • Hallmark category “C”: arrangements that give rise to tax deductions without a corresponding amount of taxable income, to certain double reliefs or deductions, or other such mismatches;
  • Hallmark category “D”: arrangements that have the effect of undermining the CRS or the rules on identification of beneficial ownership;
  • Hallmark category “E”: arrangements concerning transfer pricing.

Certain hallmarks will only be satisfied if an additional “main benefit test” is satisfied. To satisfy the test, one of the main objectives of the arrangement must be to obtain a tax advantage.

As will be appreciated, the above tests are not only imprecisely drafted but require a significant degree of judgment to determine if they apply.

If one considers the possibility of national competent authorities across the EU taking different views it is inevitable that there will be a patchwork approach to enforcement.

What Happens if there are Multiple Intermediaries?

This will frequently be the case, and in many cases arrangements will involve more than one EU country. DAC 6 has painted a picture of an ideal world where all the intermediaries cooperate with one another and take the same view on what is reportable, and where a single intermediary is charged with the reporting. DAC 6 fails to set out a strict reporting regime.

It is clearly unsafe and imprudent for any business engaged in cross-border business to leave reporting to chance and to risk non-compliance and investigations.

As lawyers we must impress upon our clients that it is in their interests to take a strong lead in coordinating the DAC 6 reporting exercise.

It is clear that at times the presence of multiple intermediaries is likely to lead to multiple reporting. In such cases care must be taken for the reporting to be consistent.

Exemptions from DAC 6 Reporting Requirements

  • Domestic tax planning arrangements will be out of scope. For an arrangement to be caught, it will need to have a cross-border element.
  • Only direct taxation, such as income tax, is relevant for the purposes of determining tax planning arrangements within scope. For example, tax planning in relation to value-added tax would remain out of scope.
  • Depending upon the rules relating to legal professional privilege (LPP), LPP may be fully adopted as a limitation on the disclosure obligation.
  • The directive provides for penalties against intermediaries for non-compliance.

The Wider Implications of Increased Mandatory Reporting

DAC 6 aims to ensure that the disclosure of information on reportable arrangements in the EU occurs in a harmonized manner. The level of detail that will be requested and the interpretation of the “Hallmarks” will determine the level of information that tax departments and ultimately the EU Commission will receive from intermediaries. The fear is that the information that may be required in terms of disclosure will ultimately have little, if anything, to do with harmonized tax reporting, but may be used in an infinite number of ways.

What Does DAC6 Mean for Cyprus Legal and Accountacy Professionals – Make or Break?

Despite the fact that for a number of years now Cyprus has been fully, if not over compliant with all relevant EU regulations in relation to both financial reporting and compliance, it is still is still, unfairly, viewed and indeed referred to as a “tax haven”. This is a picture that envious rival economies in both Europe and abroad like to disparage Cyprus.

In truth Cyprus is not a tax haven. It is a cost – effective jurisdiction that allows companies of substance to operate their businesses in a fully compliant and extremely tax efficient manner and to benefit from one of the lowest, if not the lowest corporate tax rates in the world. That is the key competitive advantage of Cyprus.

Europe is however inexorably moving to the introduction of full and transparent disclosure of cross border arrangements and to a Europe-wide uniform taxation system.

DAC 6 is another step in this direction, and it comes at the same time as the decision of the Russian Federation to revise its double tax treaty with Cyprus and it adds another compliance measure and an extra layer of costs to burden the “intermediary” and the client.

Cyprus will come under pressure to enforce DAC 6 rigourously. This is yet another challenge that the Cyprus services sector will face in the next few years and one that it will need to face and overcome.

The method and manner of national enforcement DAC 6 is a challenge that must be taken up by our Government and by our professional associations with a view to avoiding a repetition of the compliance fiasco that we are enduring with our banking system, where it is now easier to open a bank account for a client in Switzerland than it is in Cyprus.

The approach that Cyprus will take must be business focused and must be geared at retaining and increasing and enhancing business rather than making it more difficult for business to remain in and transact through Cyprus.

Legal professional privilege must be supported and insisted on by Government as an exemption to the reporting requirements of Cyprus in relation to DAC 6.

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