There are just weeks until 1 July 2020 entry into application of the European Union’s sixth Directive on Administrative Co-operation in the field of taxation (more succinctly referred to as DAC6). Antonello Argenziano provides an update on the implementation of the directive and the challenges that the market’s facing.
While EU member states have been rushing to get domestic legislation implementing DAC6 onto their statute books, there’s an even bigger rush to comply for the targets of the legislation: intermediaries, which can be individuals or companies and includes lawyers, accountants, corporate service providers, banks, holding companies and group treasury entities.
As of 1 July 2020, they’ll have just two months left to complete preparation of two years’ worth of retrospective reporting on transactions, in accordance with legislation in place for barely months, and in some cases weeks, and this timeline varies, sometimes in significant ways, from country to country.
The directive will require compulsory reporting by EU intermediaries to their domestic tax authority of cross-border transactions or arrangements involving one or more EU member states that exhibit so-called hallmarks of aggressive tax avoidance strategies. Where no EU intermediary is involved, or if they assert a legal duty of confidentiality, which applies notably but not exclusively to lawyers, the burden of reporting falls to any or all EU taxpayers involved in the arrangement.
The last-minute haste to get DAC6 enshrined in law isn’t an unusual situation for EU legislation – the European Commission is almost constantly engaged in harrying recalcitrant member states over their inability to meet deadlines – but it’s concerning, in the light of the retrospective reporting obligation, that the directive imposes on intermediaries.
The deadline for transposition of the directive into national law, 1 January 2020, was missed by seven of the then 28-member states, and as of early March, Greece had still not even published draft legislation. Luxembourg was also one of the laggards, even though the government placed a draft bill before the Chamber of Deputies on 8 August 2019. After amendments to meet concern about professional confidentiality requirements, it was finally approved by parliament on 21 March 2020 and received royal assent four days later.
The legislation is part of a growing trend at European and National level to clamp down on transactions that aren’t in themselves illegal, unlike outright tax evasion, but that may have been designed artificially to reduce the tax liability of one or more parties to the transaction or arrangement.
The fact that an arrangement is reportable doesn’t mean that tax avoidance has been proven, simply that national tax authorities have grounds for examining whether it exceeds legal thresholds for permissible tax efficiency.
The directive sets out a total of 15 hallmarks in five categories that make an arrangement reportable:
- generic hallmarks linked to the main benefit test (whether one of the principal purposes of the arrangement is to obtain a tax benefit)
- specific hallmarks linked to the main benefit test
- specific hallmarks related to cross-border transactions
- specific hallmarks concerning automatic exchange of information, and
- beneficial ownership and specific hallmarks concerning transfer pricing
These hallmarks or characteristics include confidentiality agreements regarding tax advantages, intermediary fees contingent on tax benefits, or standardised documentation or structures that aren’t tailored to a participant’s individual circumstances.
Other hallmarks that may indicate aggressive tax avoidance include: buying of loss-making entities to reduce tax liability, the conversion of income to capital, gifts or other types of revenue taxable at a lower rate, round-trip transactions and deductible cross-border payments involving no- or low-tax jurisdictions or that benefit from other preferential regimes.
The legislation also highlights double tax deductions or relief, transactions that sidestep exchange of information and beneficial ownership reporting obligations, and transfer pricing involving hard-to-value intangible assets or transactions that have the effect of lowering taxable profit in the future.
Because the legislation is retroactive, all relevant cross-border arrangements established since the directive became law, between 25 June 2018 and 30 June 2020, must be reported by 31 August 2020 (arrangements implemented during July must be reported at the end of that month). Information reported to national tax authorities will begin to be exchanged with other EU member states on 31 October 2020.
In addition to this tight deadline, the complications for intermediaries include the fact that legislation in the form of directives offers EU member states some leeway in how they’re transposed into national law. For instance, the EU text doesn’t define what constitutes an “arrangement” or a “tax advantage”, but member states are free to do so, as Ireland has done, as long as the result doesn’t limit the scope of the directive.
Other variations include, for example, a provision in the Dutch legislation specifying that companies in the same group as a taxpayer may be considered an intermediary if it performs tax functions for the group.
French intermediaries are exempt from reporting on arrangements involving their permanent establishments abroad.
Luxembourg’s legislation considers the country’s statutory professional privilege, providing an exemption from reporting not only to lawyers but chartered accountants and auditors.
Unlike the directive, Germany’s legislation doesn’t distinguish between promoters and service providers giving aid, assistance or advice regarding a cross-border arrangement. This will place a reporting obligation on intermediaries with a German nexus – such as a head office or centre of management, or the German permanent establishment of a non-EU intermediary – no matter where the taxpayer is resident, or the tax advantage is derived.
Poland, which exceptionally brought its domestic legislation into force on 1 January this year, has significantly enlarged its scope to include domestic arrangements and all taxes, and it also defines hallmarks more expansively than the EU directive.
Portugal has added value-added tax to the scope, and legislation there and in Sweden also covers domestic arrangements.
So the concerns facing intermediaries include the need for specialist expertise to track variations in the law from country to country, as well as the potentially large number of retrospective transactions or arrangements that must be reviewed in a short time – knowing that clients won’t thank them for over-reporting that could prompt tax authorities to pick over the details of blameless transactions.
Facing a short time to adapt to new legislation (which may yet need further regulatory clarification or guidance), intermediaries face a heavy administrative burden to fulfil the requirements on time and without error. The penalties for non-compliance are heavy, running as high as €5 million in Poland, and even inadvertent mistakes in reporting are liable to be costly.
Many firms are likely to seek external help in meeting the challenge. this will involve, at a minimum, multi-jurisdictional support that brings understanding of local requirements, provided by firms with well-established processes and operational functions to help intermediaries avoid the risk of penalties. Additionally, it’ll involve the use of proven technology to shoulder what may be a substantial administrative burden.
The COVID-19 pandemic has added another layer of uncertainty to the DAC6 implementation process. With stock markets crashing, economies slumping and a wide range of business sectors struggling to keep their heads above water, national authorities, regulators and intermediaries may be distracted by more urgent priorities. Some financial regulatory measures, such as Basel III implementation, have already been delayed because of the pandemic, it’s not inconceivable that authorities might offer some flexibility on DAC6 deadlines.
It now looks as though all EU members (except Greece, but including the UK) will have their domestic legislation in place by 1 July 2020. But the legislators’ efforts are almost done, while for everyone else the hard work is moving up to a new level.
To find out more about DAC6 and how we can help, please get in touch.