New EU Reporting Obligations in Relation to Cross-Border Transactions

The European Council has adopted new rules aimed at providing EU tax authorities with advance information in relation to aggressive cross-border tax planning. A failure to provide prompt disclosure of such arrangements could lead to the imposition of significant penalties for those involved in such transactions and/or any adviser or intermediary that has designed, promoted or been involved with the implementation of such tax planning. 

The UK already has an existing domestic disclosure regime relating to tax avoidance arrangements (the so-called “DOTAS” regime), but the scope of the new EU Directive – known as DAC6 (Directive) – appears to be wider in certain respects and applies to cross-border arrangements involving an EU party (even if the other party or parties are based outside the EU). So, for example, the Directive could apply to transactions involving UK and US entities. 

Although the new reporting rules will only apply from July 2020, the rules will have retrospective effect so as to trigger an obligation to report in relation to any cross-border arrangement that has its first step after 25 June 2018. EU Member States must incorporate the Directive into their domestic laws by the end of 2019, and apply those rules from 1 July 2020 (with retrospective effect). Although Brexit might conceivably prevent the UK’s adoption of the Directive, it is likely that the UK will be required (or will choose) to adopt the new rules. 

Scope

The scope of the Directive is governed by whether the cross-border arrangements present certain “hallmarks”. As a broad summary, these hallmarks are: 

A. The arrangement requires the parties to keep it confidential; the fee is linked to the tax saving arising from the arrangement or the documentation and/or structure relating to the arrangement is standardized. This is broadly similar to requirements under the UK DOTAS reporting rules. 

B. The arrangement involves contrived steps in connection with the acquisition of a loss-making company. This might include, for example, an arrangement that converts income into capital (which is thereby taxed at a lower rate), or an arrangement that is essentially circular or self-cancelling and is designed to yield a tax advantage. 

C. The arrangement involves tax-deductible cross-border payments between associated entities where the recipient is subject to zero or almost zero taxation, exempt from tax, or taxed in a jurisdiction that is on the EU blacklist. This might include, for example, an arrangement where depreciation deductions or relief from double taxation is claimed in more than one jurisdiction, or a tax arbitrage arrangement that involves a transfer of assets. 

D. The arrangement is designed to avoid tax reporting obligations such as CRS, or otherwise seeks to avoid the exchange of information or disclosure of beneficial ownership information. 

E. The arrangement relates to transfer pricing that involves the use of safe harbor rules to avoid arm’s length pricing or certain transactions involving “hard to value” intangibles. This might include, for example, an arrangement involving intragroup transfers of functions and/or risks or assets if the projected annual earnings before interest and taxes (EBIT) during the three-year period after transfer is less than 50% of the projected annual EBIT assuming the transfer had not been made. 

It is important to note that hallmarks A and B and certain arrangements within C above can only be taken into account where the main benefit (or one of the main benefits) that may reasonably be expected from the arrangement is the obtaining of a tax advantage. However, the obtaining of a tax advantage is not relevant to some arrangements in C (such as certain hybrid arrangements) or transactions within D and E above. 

Disclosure Process 

Disclosure must be made to the home tax authority of the taxpayer or relevant intermediary, and the information will then be exchanged on a quarterly basis among EU tax authorities. The primary responsibility for making such disclosure or report is with any intermediary involved with designing, marketing or organizing the arrangement, or who makes the arrangement available from implementation or manages its implementation. However, if the intermediary is eligible for a legal privilege, unless such privilege is waived the reporting obligation will pass to the taxpayer. The report must include client-specific information, such as the client’s name, address and tax reference number, as well as the size of the transaction. Disclosure must be made within 30 days of the arrangement first being made available to the taxpayer. 

Conclusion 

As the reporting obligations will extend to cross-border arrangements going forward, it will be important for investment management groups and other taxpayers and their advisers and intermediaries to monitor whether any transaction in which they are involved could be reportable. Given the breadth of the circumstances set out in A to E above, many relatively common fund structuring and financing arrangements could be within scope. However, it is to be hoped that further guidance will be forthcoming to clarify grey areas in conjunction with the implementation of the rules into domestic law. 

In particular, asset managers should consider any arrangements involving tax-deductible cross-border payments where the recipients of the payments are resident in a low-tax or no-tax jurisdiction, or in circumstances where group companies currently rely on transfer pricing exemptions or safe harbors. Restructurings involving cross-border business transfers might also need to be considered carefully, as may structures involving hybrid entities. 

It is also possible that asset managers might themselves be intermediaries in certain circumstances, such as when they are involved in designing or implementing cross-border products. This would especially be the case if the arrangement involves a tax-planning aspect.

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