By Matthew Johnston
What is DAC 6?
DAC 6 is the unofficial name for EU Council Directive 2018/822; the sixth incarnation of the Directive on Administrative Cooperation. This regulation expands the reporting obligations of financial intermediaries and in some cases, taxpayers themselves. DAC 6, emerges from a context of increasing anxiety from governments about large scale tax evasion. Its purpose, therefore, is to disincentivise tax evasion by creating a wide range of scenarios which require a high degree of disclosure.
What are the main hurdles to mandating disclosure?
There are two major hurdles before disclosure becomes mandated. The first, is that there must be some sort of cross border arrangement which involves an EU jurisdiction. The second hurdle is more complex, the arrangement must fit under one of several “hallmarks”, situations typically used to avoid tax.
A main benefit test applies to many of these “hallmarks”. This verifies whether the main benefit (or one of the main benefits) of the arrangement, having regards to the context, is the obtaining of a tax advantage. This serves to protect against DAC6 from over-regulating, capturing too much of what businesses and individuals do in the normal course of dealings. For example, UK guidance views “a main benefit” as picking up any benefit that is not “incidental” or “insubstantial”, a low threshold. If the tax outcome is of significance in the way you decide to structure a transaction, disclosure should be your default course of action.
What are the different categories of hallmarks under DAC 6?
Category A represents signs of marketed tax avoidance schemes. These scenarios involve intermediaries such as accountants actively advertising for clients to take part in tax avoidance schemes. They are often characterised by confidentiality agreements between taxpayers and intermediaries and intermediaries being paid a portion of the tax saved.
Category B involves tax structuring methods commonly used by companies to reduce their overall tax burden. The first of these methods targeted, is loss buying. Loss buying concerns, companies acquiring others for their trading losses, which can be offset against their own tax bill. Similarly, taxpayers often try to convert income into capital, in order to benefit from lower tax rates, this too meets the threshold. Finally, there are circular transactions, with no commercial purpose, where funds are round-tripped through multiple jurisdictions in order to benefit from lower tax rates abroad.
Category C concerns with cross border transfers. DAC6 will be activated for instance where the destination is a 0 tax jurisdiction or one with a preferential tax regime. This category also contains where tax deductions for depreciation are claimed in multiple jurisdictions or where there is tax relief claimed in multiple jurisdictions. It is obvious why the EU would seek transparency over steps such as this which are common and easy ways to avoid tax.
Category D targets structures which try and reduce tax transparency. For instance if an arrangement obscures the beneficial owner of an asset, that owner might be able to avoid the tax on that asset. Similarly an arrangement to try and get around tax reporting regulations would itself have to be reported.
Category E focuses on the practice of transfer pricing. Arrangements which fall under this category, include practices like base erosion where risks and assets are transferred to low tax jurisdictions. This is reportable where it leads to a more than 50% decrease in earnings before interest and tax are calculated. Another reportable arrangement involves the practice of using hard to value intangibles, which are assets where no reliable comparables exist and where cash flows are highly uncertain. This makes these assets very hard to reliably tax, which makes them good avenues for tax avoidance.
What are the impacts of DAC 6?
It is very obvious why the EU seeks to increase transparency of these arrangements and their scale. The amount of information that must be disclosed is wide ranging; from the more obvious: including names of the parties and dates of transfers, to a summary of the arrangement including relevant business activities and their value.
Interestingly DAC6 mainly focuses its reporting obligations on intermediaries. This term is wide ranging, covering consultants, accountants, financial advisers, lawyers (including in-house counsel), banks, trust companies, insurance intermediaries and holding companies. The theory behind this, is that intermediaries are more visible and thus more easy regulated. In this case, taxpayers are only made to report, when there are no intermediaries, or the intermediaries are protected by legal professional privilege. Only one party needs to report for an arrangement, intermediaries should coordinate between themselves.
Time limits are strict. Reports will need to filed within 30 days of the day on which the arrangement is made available for implementation, the day it is ready for implementation and the day the first step in implementation is made. More stringent reporting obligations are imposed upon marketed schemes that are discussed earlier with the article. These arrangements can be implemented with minimal customisation and as a result are much easier and more accessible. The EU is obviously worried about this trend and so imposes a quarterly reporting requirement so it can more easily track the scale and increase the transparency of these schemes.
How is DAC 6 enforced?
Non-compliance with DAC 6 attracts penalties. The directive prescribes that penalties under the local legislation in all EU Member States must be “effective, proportionate and dissuasive”. In the UK for instance, there is a fixed penalty of £5,000 for failure to comply in many cases, and daily penalties of £600 which should in principle only be charged in the instance of a serious failing, such as where the behaviour leading to the failure was deliberate. Penalties may be cancelled if there is a reasonable excuse. The possibility for the Tribunal to increase penalties up to £1 million remains.
What are the implications of Brexit on DAC 6?
After Brexit, DAC6’s application in the UK has been heavily reduced. Only those arrangements falling under Category D will have to be reported. The UK apparently will change its legislation to instead mirror the OECD’s Mandatory Disclosure Rules.