This content is from: European Union

Regulators not ready for the reality of DAC 6

The EU’s expansive mandatory disclosure rules (DAC 6) are challenging the tax authorities almost as much as intermediaries and taxpayers.

Every EU member state has to transpose DAC 6 into national legislation by the end of this year to ensure the reporting standard applies when it officially comes into effect on July 1 2020. It applies not only to advisors and law firms, but also to financial institutions, insurance companies and trusts.

Taxpayers and intermediaries will have to assess and report all TP arrangements since June 25 2018, opening up millions of everyday transactions to undue scrutiny. The problem is a big headaches for banks in particular.

However, with additional tax information being submitted under these rules to tax authorities from next year, some tax authorities are beginning to realise the difficulties they will face in implementing these far-reaching disclosure rules and the work involved in sifting through the countless transactions that the hallmarks will likely capture.

“There’s been an awakening,” said the head of compliance at a UK-based bank. “The regulators have realised that they just aren’t tackling this properly.”

The EU plans to use DAC 6 to insulate the common reporting standard (CRS) against new schemes to get around its requirements. Unlike the CRS, however, the mandatory disclosure rules could vary in design and implementation across the 28-member bloc. Tax authorities need to ensure there is as much harmony as possible but there is no guarantee of the exact same standards applying across the board.

For example, the German Ministry of Finance is looking to extend the rules for cross-border transactions to all domestic arrangements. Meanwhile, the UK’s HM Revenue & Customs is listening to the concerns of British businesses before drafting the legislation and guidance.

One HMRC official said: “We have to implement it, but we have to do it in a fair, reasonable and proportionate way.”

Nevertheless, the hallmarks that establish the reporting thresholds (see last section)  will tend to push taxpayers and intermediaries to ‘over-report’ rather than risk missing a transaction and leaving themselves possibly exposed to a future challenge. This is driving up the administrative burden on both sides of tax collection.

“A flood of reported arrangements means it will be tricky to filter out what would really be worth taking a closer look at,” the head of tax at a German multinational told TP Week.

“The wide hallmarks are both a problem for the tax authorities as well as for taxpayers,” said the head of tax. “For the tax authorities the rules will lead to tonnes of reportable arrangements, most of which are not even close to ‘tax planning’ let alone ‘aggressive tax planning’.”

Casting a net too wide

DAC 6 was put together to police the CRS and make sure taxpayers comply. The European Commission set out to catch the things that the tax authorities might not have even considered and designed the hallmarks as broad as possible to capture ‘unknown unknowns’ with a ‘potential tax effect’. This would cover TP planning around hard-to-value intangibles with no comparables and even safe harbour rules.

“Even arrangements where no tax advantage is obtained might have to be reported,” said Alexander Vögele, chairman of the advisory board of NERA Economic Consulting. “The fact that there is no discussion of tax does not mean that the transaction is out of the scope of the DAC 6 reporting requirement.”

“There are countless numbers of such transfers and agreements within the new economy,” said Philip de Homont, associate director of TP at NERA Economic Consulting.

“It is seriously questionable whether these extensive – and expensive – reporting requirements are proportionate to the problem they are trying to solve,” he added.

Low-value adding services are not exempt even when they meet the OECD guidelines under Action 10. A cost-plus 5% service agreement could trigger the disclosure rules. It’s possible these reporting obligations will create not just more complexity but also more barriers to tax transparency.

This ‘catch-all’ mentality also extends to all manner of transactions, with the definition of intermediaries being expanded to apply to banks and other financial institutions. The fear of missing out on potential tax revenue and closing the tax gap is driving EU policy.

“Tax authorities and legislators around the globe, including the EU believe, that there is way more aggressive tax planning going on than there really is,” the head of tax said.

Why exactly the rules should treat banks as intermediaries is a big question. Some accountants see banks as the future of their industry, and so the tax authorities have to pre-empt a possible shift towards finance. But this is not the only possible explanation.

“We’re an easy target because we’re a bank and there’s a presumption of guilt about certain practices, especially transfer pricing,” one tax director at a European bank explained.

“We don’t actively help clients avoid taxes. No major bank does that anymore,” the director told TP Week. “Banks are risk-taking organisations but we have zero tolerance for certain kinds of risk, tax evasion and tax avoidance are among them.”

Much of the world has moved towards the automatic exchange of information (AEOI) and country-by-country reporting (CbCR). This has not made life easier for banks, but DAC 6 is worse.

“DAC 6 is incredibly frustrating for us, the more we look at it we could take a very conservative view of how to put it into practice or we could take a more realistic view,” the head of compliance said. “We could focus on catching out our clients on any practices that the tax authorities don’t like, but that’s a huge undertaking and it might not be very useful.”

“Honestly I wish they had just exempted financial institutions. The real target should be tax advisors and their firms,” he told TP Week. “But they weren’t ever going to make an exception for banks.”

The hallmarks of DAC 6

The hallmarks set the threshold for what counts as a reportable arrangement under the new disclosure rules.

Category A – Commercial characteristics in marketed tax avoidance schemes, such as:

  • Any confidentiality condition in respect of how the arrangements secure a tax advantage;
  • Any intermediary paid by reference to the amount of tax savings made in the scheme or the success of the scheme;
  • Any standardised documentation and/or tax structure.

Category B –Tax arrangements seen in avoidance planning, such as:

  • Loss-buying;
  • Converting income into capital;
  • Circular transactions, particularly the round-tripping of funds with no commercial purpose at all.

Category C – Deductible cross-border payments and transfers:

  • If the recipient is not resident for tax purposes in any jurisdiction;
  • If the payments or transfers go to zero-rate or near zero-rate tax jurisdiction;
  •  If the payments go to any blacklisted countries;
  • If the payments benefit from a preferential tax regime in the recipient jurisdiction.

It would also cover deductions for deprecations claimed in more than one jurisdiction, as well as double tax relief in respect of the same income. Asset transfers where the amount treated as payable differs between countries.

Category D – Arrangements designed to undermine tax transparency, specifically:

  • Any arrangements that undermine the AEOI reporting obligations.

Category E – Transfer pricing arrangements, including:

  • Any arrangements involving the use of TP safe harbour rules;
  • Any transfers of hard-to-value intangibles for which no comparables exist and where financial projections are uncertain;
  • Any cross-border transfer of functions, risk and or assets resulting in a more than 50% decrease in earnings before interest and tax in the next three years.

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