On May 25, 2018, the EU council adopted a sixth amendment to the Directive on Administrative cooperation (hereinafter: DAC6, also called “Mandatory Disclosure Requirement “MDR”) amending Directive 2011/16/EU on the automatic exchange of information. The amendment refers to the introduction of a new mandatory reporting obligation by intermediaries for cross-border arrangements that contain defined characteristics or features and that may potentially be regarded as aggressive and politically undesirable.

The EU member states have been obliged to transpose the Directive into domestic law by December 31^st 2019.  By January 2020, 15 EU members (Austria, Belgium, Bulgaria, Croatia, Estonia, France, Germany, Hungary, Ireland, Lithuania, Malta, Netherlands, Poland, Slovakia and Slovenia) have finalized their respective processes to implement DAC6. Luxembourg passed the necessary law in March 2020. Cyprus, Czech, Denmark, Finland, Italy, Portugal, Romania, Spain, Sweden and the UK have so far not met the deadline.

In a nutshell, DAC6 is a new reporting regime for intermediaries (law firms, accounting firms, tax advisors or the taxpayers themselves such as companies and individuals), to disclose to their local EU tax authorities, reportable cross border arrangements relating to all kind of taxes other than VAT and custom duties. A tax arrangement is reportable if it is a “cross border arrangement” and contains certain defined characteristics features, which are referred to in the Directive as “Hallmarks”.  The information received will be shared with tax authorities in EU-member states so that they can identify any potential tax risks in their jurisdiction. The Directive is designed to increase transparency regarding potentially aggressive cross border tax schemes and provide the EU member states with an early “warning system” on new risks of tax avoidance. To ensure reporting –  non-compliance will trigger substantial financial sanctions, which will be enacted by the member states.

This mandatory reporting should have started as of July 1, 2020 when reportable cross border arrangements had to be disclosed to the tax authorities in a timely manner. In addition, the reporting obligations apply retroactively to cover reportable cross-border tax arrangements in which the first step is taken between June 25, 2018 and July 1, 2020. For these arrangements, the deadline should have been August 31, 2020. However, on May 8, 2020 as a result of the COVID 19 pandemic, the EU Commission proposed a three-month postponement of the starting date for the filing and exchange of information on reporting cross border arrangements. Under the proposal, the reporting process would begin as from October 1^st, 2020. For the retroactive application of DAC6 the proposed reporting deadline would be November 30, 2020 instead of August 31. The EU-proposal for postponement will have to be adopted by the EU Council and subsequently implemented into the national laws of the EU members.

1. What is a reportable cross-border arrangement?

What is a reportable cross-border arrangement? It is a tax arrangement, it must be cross-border and it must include a characteristic or feature that present an indication of potential risk of tax avoidance, referred to as “Hallmarks”.

The concept of an arrangement is very broad and might be any transaction, scheme action, operation agreement, grant, understanding, promise, undertaking or event which concern direct taxes such as corporate income taxes, trade taxes, real estate transfer taxes as well as estate tax and gift tax (including German trade tax). Arrangements (exclusively) concerned with VAT are not relevant.

An arrangement will only be reportable if it encompasses a cross-border element. An example could be a tax arrangement implemented between a German subsidiary and its parent corporation resident in another EU Member State or in any other country. Purely domestic arrangements are in most jurisdictions not covered by the mandatory reporting obligation. There must be always a link to an EU member state.

A cross border arrangement is reportable if it contains one of the five prescribed categories of hallmarks. With some defined hallmarks, reporting is obligated automatically (for example concerning Automatic Exchange of Information) whereas with others, a tax advantage (“Main Benefit Test”) must be fulfilled in addition to the hallmark. A hallmark is basically an indication for a potential risk for tax avoidance. It encompasses compliant but politically undesirable tax structures, structures which have not crossed the line between legal tax planning and abusive tax planning or even tax evasion. The five categories of hallmarks are marked A-E and are the following:

Category A Hallmarks focus on agreements, which for example contain a confidentiality clause, prohibiting the disclosure of the cross-border tax arrangement to other intermediaries or to financial authorities or are contingent fee arrangements where the fee is dependent upon the amount of resultant tax advantages. Furthermore, Category A hallmarks do include arrangements that have standardized documentation or structures and are available to more than one relevant taxpayer. In this context, it is not quite clear whether the creation of a domestic corporation by a foreign resident (a very common structure) would not be considered a standardized structure. Furthermore, not clear whether an account or tax lawyer is already obligated to report, if the agreement contains a confidentially clause or the fee will be dependent on the tax benefit to be expected (these contract clauses are frequent).

Category B hallmarks do contain arrangements, which have the effect to convert income into capital, gifts or other categories of revenue which are taxed at a lower rate or are exempt from tax.

Category C contains hallmarks where there are cross border transactions, which give rise to a deductible payment between two or more associated enterprises (enterprises would be considered associated if one holds at least a 25 % participation in the management, control, capital or profits of the other enterprise) where the recipient’s resident jurisdiction does not impose a corporate income tax or the tax rate is almost zero, or the recipient benefits from a full tax exemption it his residence jurisdiction, or he benefits from a preferential tax regime in its residence jurisdiction. Furthermore, Category C hallmarks do also include arrangements that give relief from double taxation in respect of the same item of income or capital in more than one jurisdiction with the result that the income is not taxable in any jurisdiction. For the later arrangement, the reporting obligation is not subject to the “Main Benefit Test”.

Hallmark Category D compromises arrangements that may have the effect of undermining the reporting obligation under the Common Reporting Standard (CRS), thus having the effect to circumvent the reporting obligations on automatic exchange of financial account information, or undermining the rules on identification of beneficial ownership. An example could be that a Swiss private bank refers a EU client to a US trust company, which in coordination with the Swiss bank plans to move the client’s assets to a discretionary irrevocable US trust, so that disclosure under the Common Reporting Standard will be prevented.  Such a structure will have to be reported by the EU client since there is no EU intermediary. Another example would be if a non-transparent entity is interposed in order to distort the identity of an economic beneficial owner. The prescribed hallmarks under Category D Category do trigger automatic reporting without being subject to the main benefit test.

Category E Hallmarks refer to specific arrangements concerning transfer pricing, and which do not require a main benefit test.

Hallmarks A and B and to some extent C will only be satisfied if an additional “Main Benefit Test” is satisfied. To satisfy this test one of the main objectives of the arrangement must be to obtain a tax advantage. The test is not precisely drafted and will require a significant degree of judgement. An example for a tax benefit could be if a foreign subsidiary to a German parent company makes a dividend distribution, which is tax exempt according to para 8b of the German corporate tax law and the profits are not taxable in the jurisdiction of the foreign subsidiary. The tax exemption for the dividend distribution under German Corporate Tax law is intended to prevent double taxation. However, if the profits are not taxable in the jurisdiction of the foreign subsidiary there is a tax advantage which has not been intended by the German legislator.  Not clear whether “the Main Benefit Test” would be fulfilled would be in the example where a German parent corporation transfers to a Dutch subsidiary capital and the subsidiary loans the amount back to the German parent at an arm’s length interest rate. The distribution of profits by the Dutch subsidiary to the German parent is tax exempt according to para 8b German Corporate Tax Law. Profits are subject to tax in the Netherlands. The interest payments are deductible by the German parent and taxable in the Netherlands. In this example the parties basically exploit the corporate tax rate differential between Germany (33 % including German trade tax) and the Dutch tax rate of 25 %. The question would arise whether the exploitation of a preferential tax rate would by itself fulfill the main benefit test under DAC6 reporting.

2. Who is subject to the reporting obligation under DAC6?

The main targets of the reporting obligations under DAC6 are the “intermediaries”.  Only in limited cases the user of the reportable tax arrangement, thus the taxpayers themselves are responsible for reporting. An intermediary is any person involved in designing, marketing, organizing, making available for implementation or managing the implementation of a reportable cross-border arrangement. Intermediaries encompass tax advisors, lawyers, auditors, accountants who contribute to the creation or implementation of reportable tax planning structures. In addition, intermediaries can be financial service providers, who market or organize the implementation of the structures, such as asset manager, family offices, banks and insurances. In some jurisdictions, also an auxiliary intermediary can have reporting obligations, if this auxiliary intermediary has played a specific role with regard to a given tax structure (Germany does not obligate an auxiliary intermediary to report).

In order to qualify as an intermediary obligated to reporting, the intermediary must have some connection (nexus) to a EU member state, i.e. has to be a resident, or has to have a permanent establishment or is incorporated or is registered in a professional register (such as a Bar Association) or is registered with a professional organization in connection with the provision of legal, tax or advisory services in a EU member state. If there is no EU intermediary the report obligation shifts to the EU taxpayer. That means, a tax advisor outside the EU with EU clients need to analyze whether the services rendered to clients are potentially reportable and inform their EU resident clients about a possible reporting obligation.

The reporting obligation will also fall on the taxpayer himself if the EU intermediary is subject to legal professional privilege not waived by the taxpayer.  Furthermore, reporting would shift to the taxpayer if the intermediary is an in-house lawyer of a corporate group who designs, market or manage the reportable cross-border arrangement in-house.

3. What information will have to be reported, when and how?

The reportable information includes personal data of the taxpayer and the intermediary, a detailed description of the relevant hallmarks, that make the cross-border arrangement reportable, a summary of the arrangement without disclosure of commercial or professional secrets for example, a date on which the first step in implementing the reportable transaction was or will be made, details of the applicable law that form the basis of the reportable arrangement, the value of the reportable arrangement (not clear whether the total value of the structure is meant or only the value of the tax benefit) and the member state of the taxpayer.

The reportable information must be reported to the Competent Authority of the EU member State depending on whether the intermediary or the taxpayer is required to make the relevant filing. The respective authority assigns a registration number and a disclosure number to the respective reporting.  The intermediary must forward the assigned numbers to the respective relevant taxpayer who has to state both numbers in his respective tax returns. As a consequence, the reporting under DAC6 not only informs the EU member state about market developments at an early stage but also enables the relevant tax authorities to carry out tax audits more effectively.

Reporting is to be filed within 30 days beginning on the day after the reportable cross-border arrangement is made available for implementation, or on the day the arrangement is ready for implementation or when the first step in its implementation has been made, whichever occurs first.

The reported information will be subject to automatic exchange of information among tax authorities of EU Member States. For this, the EU Commission is setting up a register into which each EU Member State must regularly (quarterly) enter the information on reportable arrangements which it has received in its jurisdiction.

4. Penalties for non-compliance

Incorrect reporting or failure to comply with any disclosure obligation will be an administrative offense. The member states shall make all measures necessary to ensure that penalties are implemented. In Germany, the non-compliance will be considered an administrative offense with a maximum penalty of Euro 25,000 each time.

Conclusion

The reporting requirement under DAC6 affects intermediaries, such as lawyers, accountants, family offices, banks, insurances and taxpayers who have some EU presence.

They have to report certain arrangements which fulfill certain described hallmarks to the local tax authorities which then will enter them into a EU register. The reporting depends very much on the definition of the hallmarks (which is not all clear) and on the definition of intermediary and it is to be expected that the 27 EU member states will not have uniform legislation for the transposition of the EU Directive into domestic law. Main targets of the reporting obligation are certainly EU-tax lawyers, advisors, accountants and family offices, but also non EU service providers should be concerned about DAC6 if they have EU clients, because they will have to inform the client about a potential cross border transaction. DAC6 will definitely improve transparency and deter aggressive tax planning. In addition, DAC6 will provide the authorities with an “early warning system” on new risks of tax avoidance and even cause audits to be more effective. For the intermediaries, multinational enterprises and taxpayers DAC6 is certainly another costly compliance burden.