DAC 6 obliges intermediaries and taxpayers to report “potentially aggressive tax planning arrangements” to their respective national authorities. The scope of the reporting obligations under the rules is surprisingly wide, requiring both intermediaries and companies within the European Union to address those reporting obligations more intensively. In addition, multinational enterprises (MNEs) that advise their group companies could also be caught by the rules as intermediaries.
Although the rules do not enter into force until July 1 2020 across the EU member states, taxpayers and intermediaries will need to review their cross-border arrangements now to ensure they are not unexpectedly caught by the rules in two years.
The EU Economic and Financial Affairs Council (ECOFIN) reached political agreement on March 13 2018 on the final draft of the Council Directive (EU) 2018/822, which amends Directive 2011/16/EU on mandatory automatic exchange of tax information regarding reportable cross-border arrangements.
According to Article 3, No. 19, of the Directive on Administrative Cooperation (DAC), any cross-border arrangement that has at least one of the following hallmarks set out in Annex IV, must be reported to the national EU tax authority as of July 1 2020:
A. General hallmarks;
B. Specific hallmarks which may be linked to the main benefit test;
C. Specific hallmarks related to cross-border transactions;
D. Specific hallmarks concerning automatic exchange of information agreements in the EU; or
E. Specific hallmarks concerning transfer pricing.
Some of the hallmarks listed above lead to a reporting obligation only if they meet the so-called "main benefit" test, which applies to hallmarks A, B and to C.1 (b) (i), (c) and (d). This test will be met if obtaining a tax advantage constitutes the main benefit, or one of the main benefits, a person is expected to derive from an arrangement.
As a reverse conclusion, transactions must be disclosed under some hallmarks even if the arrangements are not tax-driven at all.
As such, even those taxpayers, who do not see tax planning as being part of their tax strategy, will need to observe DAC 6 rules.
Article 2(1) of the Directive requires member states to transpose the Directive into national law by December 31 2019. From July 1 2020, cross-border tax arrangements become reportable, if:
- The reportable cross-border arrangement is made available for implementation; or
- The reportable cross-border arrangement is ready for implementation; or
- The first step in the implementation of the reportable cross-border arrangement has been made.
Reportable arrangements need to be disclosed from this point in time to the local EU tax authority within 30 days.
It should be noted, however, that according to Article 8ab, paragraph 12 of the DAC, intermediaries and taxpayers are subject to an obligation to report arrangements by August 31 2020 if the first step was implemented between June 25 2018 and July 1 2020.
Challenges arising from DAC 6
The challenges arising under the new reporting obligations of DAC 6 are seemingly countless.
The retroactive effect described above forces intermediaries and taxpayers to start analysing their transactions now, in order to determine the scope of what needs to be reported after July 1 2020.
This confronts these parties with the problem that the Directive has not yet been implemented in any EU member state, meaning that there continues to be uncertainty from a regulatory perspective.
Accordingly, only the Directive itself can be used as the benchmark to check potential reporting obligations until local laws across the member states are implemented. Such a retroactive application from June 25 2018 is very much comparable to a direct application from day 1 – but a direct applicability is a legal effect reserved for regulations and not available to directives.
There is no room to dig deeper into the compatibility of the retroactive effect with EU law here. However, it is clear that no intermediary or taxpayer can fulfil their obligations and appropriately document relevant activities efficiently without a supporting database or system. Imagine the challenges of revisiting otherwise potentially reportable transactions for the two-year period between June 25 2018 and July 1 2020 once the various EU member states release their local implementation peculiarities, all the while under the threat of material penalties for non-compliance.
However, there is more to consider when applying the DAC 6 in this interim period.
For MNEs with in-house tax functions, the first question is whether the tax function or its members might qualify as intermediaries in their own right– especially in advising group companies.
Depending on the respective local law, EU member states may take divergent approaches, shifting a considerable liability risk for non-compliance to the tax departments and their members. Clarification on that issue would be of utmost importance.
The various hallmarks in the EU Directive are often criticised as being too undetermined – but they are not. They are simply set in an extremely wide fashion covering a vast variety of transactions, sometimes seemingly without any direct connection to aggressive tax planning. For example, transfer pricing arrangements need to be reported when safe-harbour rules are used. However, how do those disclosure obligations relate to the principles developed by the OECD under Action 10 for low-value-add activities safe harbour rules? Will taxpayers be required to report cost-plus-5 service level agreements even though they are applying OECD principles, which were developed to combat aggressive tax planning?
However, it is not only hallmark E that opens the door for legions of reportable ‘arrangements’.
Consider the establishment of a permanent establishment (PE) in a country for which the credit method applies under a tax treaty – any depreciation of assets for this PE will have to be considered twice – in the source country and in the country of residence of the taxpayer. Not the fanciesttax planning from our perspective.
Nevertheless, because EU member states are yet to transpose the directive into local legislation, there is still hope that domestic legislators will try to limit the scope of application for the different hallmarks where possible in order to prevent the requirements of intermediaries and taxpayers to become unduly burdensome and lose balance with the intended objectives of the legislation.
Furthermore, the latest feedback of the European Commission on DAC 6, following a meeting on September 24 2018, gives a first positive sign that in certain situations the broad wording of the directive has to be interpreted more narrowly.
However, limitation on the part of local laws will result in taxpayers with a European presence being required to apply those deviating rules in a consistent manner, and it is without any irony that the ‘inclusiveness’ of DAC 6 can only be managed with the appropriate controls and systems of support.
Digital solutions to the challenges
As described above, DAC 6 and its transposition into national legislation triggers complex challenges for advisors and companies alike. The Directive establishes new obligations to comply with disclosure rules in multiple countries.
MNEs will need to manage these challenges with an adequate internal tax compliance management system (TCMS) in order to comply with those rules and to avoid penalties as far as possible (i.e. to what extend the latter will be achieved depends on the implementation of DAC 6 into national legislation). In the process of establishing a TCMS the following questions have to be answered:
- Which business units/functions/departments may be involved in a reportable arrangement?
- Who shall be responsible for the DAC 6 assessment and the reporting?
- How can I manage consistent reporting by the different intermediaries involved?
- How should the relevant information be collected?
- How will the collected information be analysed and reporting decisions be made as well as documented?
- How can tight reporting deadlines be met in the future?
- How can I organise the external reporting in various countries?
In order to answer these questions, MNEs will need to conduct a review of their activities, processes and supporting IT landscape in light of DAC 6. Such a review requires a thorough understanding of the hallmarks.
As DAC 6 reporting will have to be submitted electronically, it does not require much fantasy to realise that an integrated digital solution will be a central tool inorderto satisfy the compliance needs efficiently. This is particularly true if a large number of transactions needs to be analysed, different business departments need to be included, DAC 6 rules of several relevant EU member states need to be observed and various intermediaries are involved as advisors.
The use of a digital solution facilitates the data collection and assessment process as an integrated platform allowing a structured analysis of fact patterns and efficient collaboration followed by electronic submission of reports. With such digital solutions, the review and approval processes can be established and documented along the ongoing business processes in order to determine which arrangements will have to be reported without interrupting the business.
MNEs and intermediaries will have to cooperate more closely on such IT platforms in the future in order to ensure a reconciled reporting of different arrangements.
DAC 6 may become a case study in what can happen when a supranational institution like the EU tries to do the perceived “right thing” but goes too far with the chosen measures.
If a tsunami of reported arrangements hit the competent authorities in each jurisdiction, this has the potential to hide the comparably small number of truly aggressive arrangements. Thereby, the effectiveness of the well thought out intention in highlighting undesired arrangements to tax authorities in order to more properly respond with changes in their legislation might be largely diminished.
When considering the administrative burden for intermediaries and taxpayers, the associated cost, and the additional threat of penalties, it can be only concluded that DAC 6 will build an additional layer of complexity when working in the area of international taxation in the future.
This article was written for International Tax Review by Christian Kaeser, global head of taxes at Siemens, Mark Orlic, tax technology and transformation partner at PwC in Frankfurt, and Arne Schnitger, head of the PWC Germany tax national office.