Taxpayers may need to report cross-border tax planning arrangements to their local tax authorities in EU member states next year under DAC 6 – even when no aggressive tax planning is involved. Tax authorities will then have to exchange the reports with their counterparts in other EU jurisdictions.
Why is it relevant to me?
The idea behind DAC 6 was to target aggressive tax planning schemes involving different jurisdictions. However, its scope is likely to be much wider than that and can range from aggressive tax planning schemes to certain plain vanilla cross-border transactions. For example, tax mitigation strategies affecting group financing or remuneration of individual managers could potentially fall within the scope of DAC 6. In certain cases, arrangements that do not have tax avoidance as one of the main benefits (the "main benefit test") and are carried out predominantly for commercial reasons may also be caught.
General partners ("GP") who operate or invest in an EU member state should consider whether they (or their legal or financial advisers – referred to in DAC 6 as "intermediaries") may be subject to a reporting obligation and, if a reportable arrangement is identified, how to manage the reporting and any consequential risks.
In more detail…
The reporting requirements apply to "reportable cross-border arrangements" entered into after 25 June 2018, which concern at least one EU member state (therefore, a fund vehicle established in an EU jurisdiction with investors based in another jurisdiction, whether or not in the EU, is potentially in scope) and bear one or more of the "hallmarks" listed in DAC 6. The "hallmarks" are widely-drafted and are, in essence, the indicators of potentially aggressive tax planning. Reporting requirements under some (but not all) of the hallmarks will only be triggered if the main benefit test is satisfied.
Although certain "hallmarks" may apply at the level of the fund manager, the majority of "hallmarks" are more likely to apply to the underlying structures. For example:
- dividend income that is distributed from the underlying investment structures up the chain of companies in the form of capital (resulting in a lower tax charge) may be caught;
- arrangements that have substantially standardised documents or structures (or both) that are made available to more than one taxpayer with little customisation can also be within the scope of DAC 6 if the main benefit test is satisfied. In practice, this means that a fund manager that sets up a fund structure that might provide tax advantages to its investors could be required to report the arrangements to its local tax authority. In this regard, it remains to be seen whether standard structures (such as the ones agreed between HMRC and the British Venture Capital Association in 2003) would be caught by the reporting requirement but any deviations from the industry-accepted structures should be considered in more detail; and
- more broadly, arrangements that undermine the reporting obligations under the Common Reporting Standard or involve the use of hybrid instruments or entities are also likely to fall within the reporting requirements.
As a result, GPs could soon start receiving amended engagement letters from their advisers cautioning them of DAC 6 reporting obligations (and work required to examine the DAC 6 position may result in an increase in advisory fees charged to GPs). This is because a reporting obligation would usually lie with GPs' external advisers who were involved in or assisted with putting in place a reportable cross-border arrangement . However, if the arrangement is carried out entirely in-house (or if the external adviser is subject to legal professional privilege), GPs may be required to make a report themselves.
The precise scope of DAC 6 will be determined by EU member states in their national laws. The UK ran a consultation on the proposed new rules to implement DAC 6 into UK laws to clarify the intended approach for businesses and it is expected that the legislation will be published by the end of 2019 (irrespective of Brexit ). Detailed HMRC guidance has not been published yet but it is anticipated that it will confirm that HMRC will not expect common arrangements within the asset management sector to be reportable. Therefore, transactions involving tax exempt funds, or arrangements that take advantage of statutory exemptions and are used as intended by the government, should not in principle be reportable.
The EU member states are required to implement DAC 6 by the end of 2019 and it will be in effect from 1 July 2020. However, since it will apply retrospectively from 25 June 2018, cross-border arrangements effected on or after that date will be caught and have to be disclosed by 31 August 2020.
The filing of a report under DAC 6 should not automatically result in a tax audit, although it is likely to be a starting point for discussions with local tax offices. Penalties will be imposed in case of non-compliance. The UK's implementing legislation envisages relatively low fines of up to GBP 600 per day without limit and could rise to GBP 1 million in egregious cases that go to court. Other EU member states have taken varied approaches with maximum fines ranging from approximately EUR 3,300 in Estonia to approximately EUR 5 million in Poland.
Our recommendation is to consider your approach to DAC 6 by reference to arrangements that have been implemented since 25 June 2018 and (at least initially) take a broad interpretation of the "hallmarks". This would be relevant especially where the GP's advisers are not involved in the day-to-day aspects of the fund operations. Whilst this will add to the list of compliance issues to grapple with, our advice is to start reviewing these arrangements now to avoid last minute crises!