At the end of June, the European Union (“EU”) amended EU Council Directive 2011/16/EU and its cumulative amendments (referred to in the aggregate, as the Directive on Administrative Cooperation “DAC 6” or the “Directive”) to give EU Member States the option to defer imminent DAC 6 reporting deadlines by up to six months due to disruptions caused by COVID-19. (Various sources, including the European Union, refer to the Directive as “DAC6” without a space between DAC and 6. We use the alternative format in this post.) The amendment to the Directive also includes language potentially allowing for an additional three-month extension depending upon how the pandemic unfolds, but cautions that further delays are unlikely. Many EU Member States promptly announced a full six-month deferral, including Belgium, Croatia, Cyprus, the Czech Republic, Hungary, Ireland, Luxembourg, the Netherlands, Sweden, and the UK. To date, Finland and Germany have announced that DAC 6 reporting will commence without any delay on August 31, 2020.
If U.S. multinationals with affiliates in the UK or EU countries have not taken steps to identify reportable tax planning and other arrangements caught up in the DAC 6 dragnet, they should do so immediately because the reporting requirements are onerous.
For readers unfamiliar with DAC 6, an overview of this new reporting regime follows.
What is DAC 6?
DAC 6 is a new reporting regime implemented by all EU Member States and the United Kingdom that requires disclosures of cross-border tax planning. Although DAC 6 is an EU directive, the UK has embraced and adopted the requirements of DAC 6 as sound tax policy notwithstanding its departure from the EU. Accordingly, any references in this post to the EU and DAC 6 should be interpreted to include the UK. Importantly, U.S. companies with foreign affiliates in Europe and the UK will be affected by these requirements. This post addresses the basic requirements of DAC 6, including the deadline for initial disclosures.
DAC 6 refers to a series of EU directives beginning with EU Council Directive 2011/16/EU and the subsequent six amendments through Council Directive (EU) 2018/822 on May 25, 2018. As amended, the Directive requires reporting of cross-border arrangements to EU tax authorities. The reporting obligations fall on “intermediaries” (including advisors, banks and businesses) or, in some circumstances, on the taxpayer itself. The information reported is collected in a central directory accessible by the competent authorities of the Member States.
Although the primary objective of DAC 6 is to combat aggressive tax planning, the Directive applies broadly and may cover arrangements that have no particular tax-driven motive. The Directive requires each EU Member State to implement the DAC 6 rules with national legislation by December 31, 2019, although a number of Member States are still developing and finalizing guidance. The Directive also requires such legislation to impose effective and proportionate penalties for violations of national rules implementing DAC 6.
When is DAC 6 Reporting Effective?
To make compliance with DAC 6 more challenging, the reporting deadlines vary by country, and countries are modifying their deadlines due to COVID-19. Originally, disclosures for transactions during the approximate two-year period from June 25, 2018, to June 30, 2020, (the “historical period”) were to be due by August 31, 2020. In addition, prospective rolling reporting requirements commence effective July 1, 2020, for reportable cross-border arrangements arising after the historical period. This rolling reporting requirement is required on a continuing basis within 30 days of the earlier of (1) the day after an arrangement is “ready” or “made available” for implementation, or (2) when the first step in the implementation is made. However, the Directive does not expand on the terms “ready” or “made available,” so specific guidance will need to be issued by EU Member States.
On June 24, 2020, however, the EU Council adopted an amendment to DAC 6 giving EU Members States the option to defer by up to six months the deadlines for reporting under DAC 6 in light of “the severe disruption caused by the COVID-19 pandemic.” See the EU Council Press Release announcing this amendment to DAC 6.
The amendment also provides for an additional extension of up to three months, depending on how the pandemic unfolds through the end of the calendar year. Nonetheless, the Council made it clear that this is only a postponement, and there is no suggestion that DAC 6 will be repealed. Many Member States have already announced a full six month deferral, including Belgium, Croatia, Cyprus, Czech Republic, Hungary, Ireland, Luxembourg, the Netherlands, Sweden, and the United Kingdom. For example, see the announcements from the United Kingdom and Ireland.
At this time, it appears that only Finland and Germany have announced that they will not implement a deferral.
Who is compelled to report under DAC 6?
The DAC 6 definition of an intermediary is very broad and covers any individual or company with an EU connection who:
- designs, markets, organizes, or makes available for implementation or manages the implementation of a reportable cross-border arrangement; or
- knows or could reasonably be expected to know that they have undertaken to provide (directly or indirectly) aid, assistance, or advice with respect to designing, marketing, organizing, making available for implementation, or managing the implementation of a reportable cross-border arrangement.
An intermediary will have an EU connection where it is resident, has a permanent establishment, is incorporated, or is registered with a professional association (e.g., legal, taxation, or consultancy service).
What arrangements must be reported under DAC 6?
DAC 6 requires intermediaries to report the details of any reportable cross-border arrangement. Generally, a cross-border arrangement is an arrangement that concerns two countries, at least one of which is an EU Member State.
Cross-border tax planning arrangements may concern all taxpayers, including natural persons, legal persons (i.e., companies), and legal arrangements (i.e., trusts and foundations). An arrangement is cross-border if it meets any of these criteria:
- Not all participants in the arrangement are tax resident in the same jurisdiction;
- A permanent establishment linked to any of the participants is established in a different jurisdiction and the arrangement forms part of the business of the permanent establishment;
- At least one of the participants in the arrangement carries on activities in another jurisdiction without being resident for tax purposes or creating a permanent establishment situated in that jurisdiction;
- At least one of the participants has dual residency for tax purposes;
- Such an arrangement has a possible impact on the automatic exchange of information or the identification of beneficial ownership.
An arrangement will be reportable if it meets at least one of the five hallmark categories discussed below. The DAC 6 hallmarks are divided between those that require the arrangement to have a “main benefit” of obtaining a tax advantage before it is reportable; and those which can be reportable even in the absence of a tax motive. The hallmarks can be broadly characterized as:
Hallmarks that cause an arrangement to be reportable only if a “main benefit” of the arrangement is tax advantage:
- Category A: Generic hallmarks of marketed or standardized tax avoidance schemes (e.g., standardized documentation or confidentiality conditions).
- Category B: Specific hallmarks of artificial tax planning structures (e.g., loss buying or circular transactions).
Hallmarks that cause an arrangement to be reportable irrespective of whether a “main benefit” of the arrangement is tax advantage:
- Category C: Specific hallmarks related to cross-border transactions (e.g., depreciation deductions or double tax relief claimed in more than one jurisdiction). Category C hallmarks generally do not require the “main benefit” test to be satisfied, although certain arrangements can only be taken into account if the “main benefit” is obtaining a tax advantage. Category C hallmarks could apply to purely commercial transactions (e.g., an asset sale where the consideration is treated differently in the jurisdictions involved for tax or accounting purposes).
- Category D: Specific hallmarks concerning arrangements which undermine the automatic exchange of information or obscure beneficial ownership.
- Category E: Specific hallmarks concerning transfer pricing. One hallmark includes the use of unilateral safe harbors, which refers to rules applicable only to specific categories of taxpayers or transactions that provide relief from the general transfer pricing rules of a country. Another hallmark includes the transfer of hard-to-value intangible assets when no reliable comparables exist and the projection of future cash flows or income are highly uncertain.
How should an arrangement be reported?
Reports for transactions during the historical period and subsequent rolling reporting will be made based upon the requirements of each EU Member State, so it is incumbent on taxpayers to identify the rules for each country in which they are subject to reporting. Difficulties arising due to COVID-19 have further delayed and complicated this process, but deadlines are looming and imminent over the next several months for certain countries like Finland and Germany.
Reporting under DAC 6 requires the disclosure of a significant amount of information, including taxpayer and intermediary identification information, details of hallmarks that make the arrangement reportable, and a description of the arrangement, its value, and relevant business activities. Companies should ensure that they have access to this information and also that they do not risk breaking confidentiality obligations by disclosing it. Some confidentiality agreements include a carve-out for disclosures required for “lawful compliance,” which may apply to DAC 6 reporting. The Directive also permits an exception from reporting if the reporting obligation would breach legal professional privilege under the laws of a Member State.
An intermediary may be exempt from full reporting if it can demonstrate that another intermediary has reported the arrangement. This is true even where disclosure has been made in another EU Member State. An intermediary will have to be certain that full disclosure has been made, requiring high levels of cooperation between the intermediaries.