DAC 6 - Government response and final regulations

On 13 January 2020, HMRC published its consultation response document and laid the necessary implementing regulations in relation to the implementation in the UK of EU Directive 2018/822 (commonly referred to as DAC 6) requiring promotors and “service provider” intermediaries to report details of certain cross-border tax arrangements that fall within one or more “hallmarks”. The legislation will come into force on 01 July 2020, but will affect certain arrangements where the first implementation step was made on or after from 25 June 2018.

The Government has made a number of welcome changes to the rules and accepted much of the feedback that it received to its original July 2019 consultation. However, the promised HMRC guidance has not yet been published and, ultimately, much of the workability of the rules will depend on the approach it takes in that guidance. Draft guidance is however being consulted on with industry groups and there remain a number of issues that need to be ironed out before the final guidance can be published.

Background

Action 12 of the OECD’s base erosion and profit shifting (BEPS) project recommended that jurisdictions should introduce a regime for the mandatory disclosure of aggressive cross-border tax planning arrangements. Whilst the report did not set minimum standards and did not require implementation, it was no surprise that the EU Commission and Member States decided to introduce a disclosure regime, regarding sharing information on cross-border tax planning as consistent with a general trend of increasing tax transparency.

The EU Commission proposed a Directive to amend the existing Directive on Administrative Cooperation (DAC) in June 2017, building on other recent tax transparency developments, including those requiring exchange of information concerning tax rulings and proposals for public disclosure of tax information on a country-by-country basis. This Directive (DAC6) was subsequently approved and adopted and provides for Member States to transpose the Directive into domestic law by 31 December 2019. (It might be noted that the UK failed to meet this deadline due to the lack of Parliamentary time caused by the general election.)

HMRC released a consultation document and draft legislation in July 2019, which set out HMRC’s understanding of the requirements of DAC 6, requesting comments on HMRC’s interpretation of various elements to be used as the basis for eventual guidance to be published by HMRC.

DAC 6 basic requirements

DAC 6 applies to “reportable cross-border arrangements” and requires Member States to introduce rules to provide that “intermediaries” (or, failing which, relevant taxpayers) must provide information to the competent tax authority on such reportable cross-border arrangements within a set time period (usually 30 days). Where a member state receives information concerning a cross-border reportable arrangement from an intermediary or taxpayer, that member state will then need to exchange that information automatically with other Member States, including a range of details concerning the arrangements (such as summary of the arrangements, their value, identification of persons in other member state involved, details of the hallmarks, implementation dates etc). It is intended that the Commission will set up a “central directory” where the information can be communicated to satisfy this requirement. For more details on the provisions of the Directive, see “Mandatory Disclosure of EU cross-border tax planning arrangements”.

HMRC consultation response and final regulations

The consultation response strikes a conciliatory tone, accepting many of the comments received in response to the July 2019 consultation. Equally, however, the response notes that the UK is obliged to implement the terms of the Directive and that there is a limit to the changes that the Government can make at this stage. However, the Government makes clear its commitment to ensuring that DAC 6 is implemented in a way that is proportionate and does not increase burdens on business unnecessarily.

In particular, the Government has noted the concerns raised about the penalty regime, the risk of over-reporting and the interaction of the rules with legal professional privilege (LPP) and have introduced a number of changes as a consequence, including:

• amending the penalty regime to ensure that, whilst it deters non-compliance, it is proportionate and does not unduly penalise those who make genuine mistakes;
• limiting the scope of ‘tax advantage’ to only taxes covered by the Directive (i.e. relevant EU taxes only);
• ensuring that the scope of the rules is limited to UK intermediaries and does not apply to those without a UK connection as well as amending the rules to ensure that the same intermediary does not have an obligation to report in multiple jurisdictions; and
• with a view to ensuring that the rules are compatible with LPP, but noting that the Government will work with stakeholders on the guidance to ensure it does not inadvertently risk impacting on LPP.

Nevertheless, much of the burden of ensuring the rules are workable will fall on the guidance, which (disappointingly) are yet to be published (other than in draft form for industry consultation). The Government has acknowledged that the new rules are broad and, since this is a new regime, there will genuinely be areas where business will be uncertain about the circumstances in which they need to report. The Government is, therefore, keen to provide as much certainty as possible to those who will be affected and to minimise the burdens on business. Accordingly, HMRC has committed to provide detailed guidance on the application of the rules, working closely with interested stakeholders in drafting the guidance to ensure it is helpful in providing clarity to businesses and taxpayers. The guidance will provide examples of how the rules will apply in different circumstances, recognising that the application of the rules will often depend on the facts of a particular arrangement. These will draw on the many examples provided to HMRC in response to the July 2019 consultation.

Reportable cross-border arrangements

A reportable cross-border arrangement is one that concerns either more than Member State or a Member State and a third country, and contains at least one “hallmark”. The consultation considered in what circumstances an arrangement might “concern” more than one jurisdiction (as required by DAC 6), pointing out that the mere fact that a company is resident in a jurisdiction will not result in the arrangement concerning that jurisdiction if, for example, the arrangements concern only a PE of that company in another jurisdiction.

The response rejects any suggestion that there should be a statutory definition of this concept but confirms that “HMRC will include examples in guidance to illustrate when an arrangement concerns multiple jurisdictions”, working with stakeholders “to ensure the guidance provides as much clarity as possible, drawing on helpful examples already provided during the consultation”. The guidance will seek to strike a balance in “ensuring that arrangements that could be used to avoid or evade tax are reported, while avoiding over-reporting of benign transactions”.

Intermediaries

Much of the concern to the original consultation related to the identification and reporting requirements on intermediaries. There are two types of intermediary potentially affected by DAC 6, promotors (ie those who design, market, organise, make available for implementation or manage the implementation of a reportable cross border arrangement) and service providers (ie those who provide aid, assistance or advice in relation to the designing, marketing, organising or implementing of reportable cross border arrangements). In particular, a service provider can argue that they are not an “intermediary” where they did not know and could not reasonably be expected to know that they were involved in a reportable arrangement. The consultation response addresses concerns over the extent to which a service provider will be expected to do extra due diligence to establish whether or not there is a reportable arrangement by confirming that guidance will make clear “what would be expected of intermediaries in different situations” and that “intermediaries will not be required to do any additional customer due diligence beyond what they would normally do in the course of their business and in compliance with their existing obligations”.

In order to be an intermediary, a person also needs to be: tax resident in a Member State; providing services relating to the arrangement through a permanent establishment in a Member State; incorporated in, or governed by the laws of, a Member State; or be registered with a professional association relating to legal, taxation or consultancy services in a Member State. However, the Government has accepted that the original draft rules were too wide and has now incorporated new definitions of “UK intermediary” to ensure that the regulations do not apply to intermediaries without a connection with the UK. Similar changes have been made to the UK regulations in relation to “relevant taxpayers” by inserting references to “UK relevant taxpayer”.

Lawyers may be prevented from disclosing certain information due to legal professional privilege (LPP). However, HMRC expressed the view in the original consultation that LPP would not remove a lawyer’s responsibility to report other information, such that lawyers would be expected to report information that is purely factual (such as the names of taxpayers and a description of the transaction). Responses made it clear that the proposed structure of the rules would be difficult for lawyers to operate and risked threatening LPP. The Government has now agreed that the rules as originally drafted could cause difficulties in ensuring that LPP was not breached. Accordingly, the regulations have been modified with a view to preventing this (in particular by making any obligation to notifying other intermediaries of their reporting obligations subject to LPP) and HMRC will work with representatives from the legal sector to provide guidance on how the rules will operate. HMRC’s position in response to the consultation in connection with LPP currently falls short of accepting an “all or nothing” approach to reporting – i.e. it has not ruled out its original position in the consultation document that a partial report can be made where LPP applies.

Multiple reports by separate intermediaries are not always required. However, an intermediary will need evidence that the reportable arrangement has been reported by another intermediary or the taxpayer. HMRC consider that it will be sufficient for an intermediary to be provided with a correct arrangement reference number (ARN) for them to have sufficient evidence that a report has been made. However, HMRC also made the point in the July 2019 consultation that an intermediary will need to be satisfied that the report covers the information that they would have been required to report, so that a report by an intermediary dealing only with a part of the arrangements will not remove the need for an intermediary involved in the whole of the wider arrangements from making a separate report. Many respondents pointed out that this would inevitably lead to multiple reports, which is inefficient for both business and HMRC. In its response, the Government agrees that duplicate reporting should be avoided where possible to minimise burdens on both business and HMRC, but made the point that given the structure of the rules and the requirements of the Directive some multiple reporting is almost inevitable. However, HMRC will work with interested parties to provide guidance setting out what level of evidence an intermediary will need in order to be exempt from reporting themselves. In particular, the response confirms that where an intermediary who is a promoter has reported the arrangement, an intermediary who is a service provider and is provided with an ARN will be able to rely on that report being complete, without having to verify it directly.

Concerns were expressed as to the application of these rules to partnerships and collective investment schemes. The Government has confirmed that partners may be intermediaries in their own right, however partnerships will be able to make relevant reports on behalf of partners who would otherwise have to report separately and indeed share the burden of any penalties imposed.

The Government has also acknowledged the particular issues in applying these rules to asset managers and collective investment vehicles. For example, respondents identified concerns around which participants in the asset management industry would be intermediaries and whether funds with investors in different jurisdictions would automatically be caught by these rules. The Government has stated it will work with the sector to provide guidance, to ensure the rules operate in as effective a manner as possible.

The Government also recognises that there may be challenges in applying the rules in situations where an intermediary is on loan or is seconded. How the reporting obligations will operate in these situations will depend on the particular circumstances, such as the location of the secondee. HMRC will work with industry to provide guidance to deal with these scenarios.

Disclosure

The trigger date for reporting is based on the earlier of when the arrangements are “made available for implementation” or the arrangement is “ready for implementation” or “when the first step in the implementation” has been made. As such, the relevant taxpayer does not need to have implemented or even started to implement the arrangements. Simply having an arrangement made available to them for implementation is sufficient. However, regard does need to be had to the documents and information in the knowledge, possession or control of anyone working at the intermediary to identify if the arrangement is reportable. Respondents commented that these dates could be ambiguous and the response confirms that “HMRC will also work with stakeholders to provide guidance on how the trigger points should be interpreted”, particularly the meaning of ‘made available’ and ‘first step’.

However, the July 2019 consultation took the line that the full details of the arrangement do not need to be finalised in order for the arrangement to be made available, as long as the essence of the arrangement is identifiable. “For example, if an arrangement has been developed and is offered to a client, but the client backs out of implementing it, the arrangement has still been made available and so is reportable.”

Taxpayers have a continuing obligation to report for each accounting period that the taxpayer “participates” in the reportable arrangements. HMRC envisage that a white space disclosure with a reference number will be appropriate for income and corporation tax returns. Following responses to the consultation, and to ensure that the burden on taxpayers does not become unduly onerous, the Government has amended the draft regulations to reduce the burden so that reporting is only required in the first year that the taxpayer participates in the arrangement and any later year where a direct tax advantage.

Hallmarks

In order for a cross-border arrangement to be reportable, one or more of the hallmarks in DAC 6 must be present.

Certain of the hallmarks require the “main benefit or one of the main benefits” of the arrangements to be the obtaining of the tax advantage. On this issue, HMRC confirm that the main benefit of an arrangement will therefore not be to obtain a tax advantage if the tax consequences of the arrangement are entirely in line with the policy intent of the legislation upon which the arrangement relies. Therefore, the use of certain products which are designed and intended to generate a certain beneficial tax outcome, such as ISAs or pensions will not inherently mean that the main benefit test is met.

The DAC applies to all taxes of any kind levied by a member state apart from VAT, customs duties, excise duties and social security contributions. However, HMRC originally took the view that, for the purposes of defining tax advantage, tax is defined more broadly, and not only included taxes levied by EU member states, but also equivalent taxes levied in other jurisdictions. Following responses to the consultation, the Government has now accepted that references to tax advantage should be limited in scope to taxes to which the DAC applies; that is to direct taxes arising in EU member states. The regulations have been amended to reflect this.

More generally, in response to criticism from respondents as to the width of the hallmarks, the Government has stressed that the application of the hallmarks will depend on the facts and circumstances of the arrangements, and that clarification on their application is best provided through guidance and examples. Amending the scope of the hallmarks in the regulations would risk not implementing the Directive properly.

Category A hallmarks: confidentiality, remuneration related to tax advantage and standardised documentation

The draft guidance suggests that, whilst any confidentiality provision would need to be relevant to how the arrangements secure a tax advantage (as opposed to general commercial confidentiality), evidence of such a provision may be “more circumstantial”, including discouraging users from retaining marketing material or taking external advice, requiring correspondence to be directed to the promotor or prohibitions on disclosure to HMRC unless made under a statutory notice. As regards standardised documentation, HMRC make the point that many situations in which standardised documentation is used (such as ISAs) will not be caught because Category A is subject to the main benefit test. Nevertheless, following adverse feedback, the Government has said that it will work with stakeholders to provide clarity on what ‘substantially standardised’ documentation means, and which kinds of documents HMRC would not consider to be substantially standardised for these purposes.

Category B hallmarks: loss buying, income into capital, circular transactions

In relation to income into capital schemes, HMRC accept that there must be a “conversion” of income into capital. As such, simply being given share options as part of a remuneration package (potentially taxable as capital) there is no “conversion” of income into capital, there “has simply been a choice made between different options, which are widely used and have an underlying commercial rationale”. Where the arrangements that lead to the conversion of income to capital are contrived, rather than normal commercial practice, or involve artificial steps then the hallmark will be triggered.

Category C hallmarks: specific cross-border transactions

HMRC has acknowledged that intermediaries may have insufficient information in relation to these hallmarks, which depend for example on cross-border payments between associated enterprises being deductible. Accordingly, if an intermediary does not know, and could not reasonably be expected to know, what the effect of a payment will be, then it will not be required to make a report. This may be exacerbated by tax transparent entities. HMRC take the view that the recipient will, in the case of transparent vehicles such general partnerships, be the partners, rather than the partnership, and so it will be the partners who are the recipients for the purposes of judging whether the hallmark is met. For widely held partnerships, there may be situations where the tax residence of all the partners is not known to an intermediary. Where an intermediary does not know the residence of the partners who are party to the arrangement, it is unlikely that the arrangement can be said to concern other jurisdictions.

HMRC has the detailed responses to the scope and application of the Category C hallmarks and the concerns raised and has committed to working closely with stakeholders to provide guidance to clarify the application of these hallmarks.

Category D hallmarks: undermining reporting obligations or obscuring beneficial ownership

The consultation made it clear that a promotor advising clients to move funds from a jurisdiction where the Common Reporting Standard (CRS) is in force to one which has not implemented CRS in order to ensure that funds are not reported would be caught by these reporting obligations. However, a bank simply processing such an arrangement would not normally have sufficient insight into the arrangements as a whole and so would not normally be expected to report. The response document clarifies that an arrangement will not be reportable simply because it involves the transfer of money or assets to jurisdictions that have not yet implemented the CRS. In and of itself, that would not be sufficient to undermine the CRS. HMRC will provide guidance on potential indicators that an arrangement could undermine the automatic exchange of information.

As regards obscuring beneficial ownership, HMRC specifically mention the use of nominee arrangements or arrangements involving jurisdictions where there is no requirement to keep such information or method to obtain it. However, institutional investors (and entities owned by them) are not considered to be structures which obscure beneficial ownership for these purposes.

Category E hallmarks: transfer pricing arrangements

HMRC has highlighted that category E hallmarks do not apply if the relevant taxpayer and associated enterprise are exempted under the Small and Medium Enterprise (SME) definition in the UK TP Rules. This is another example of HMRC recognising taxpayer’s concern around over-reporting and undue burden arising from DAC 6 on small and medium businesses.

As regards the requirement to report the use of “safe harbour” rules, HMRC have confirmed that merely entering into an APA is not the use of a safe harbour – rather it is an agreement as to the correct TP treatment. Further clarity regarding the application of this treatment to Advance Thin Capitalisation Agreements (ATCAs) needs to be confirmed as well as other types of rules which could be considered within the definition of safe harbours eg low value-adding services guidance.

Hallmark E(2) concerns hard-to-value intangibles. The important point in time for determining whether “projections of cash flow and income where highly uncertain” in relation to the intangible transferred to an associated company is the time of the transfer. The mere fact that the projections or comparables that were used to determine that no report was necessary subsequently turn out to have been incorrect will not necessarily mean that the decision not to report was incorrect.

Hallmark E(3) applies to cross-border transfers of functions and/or risks and/or assets which has a significant negative impact on the projected earnings before interest and taxes (EBIT) of the transferor. HMRC have confirmed that they regard this test as applying to the individual company making the transfer from a UK perspective, but will take into account consolidation rules in other jurisdictions and “consider the extent to which the rules in the UK can and should mirror those of other jurisdictions”. HMRC also confirm that the reduction of a loss (even to nil) is not caught by the rules (since £0 is not less than 50% of a negative number), but does not comment on the position where a transfer increases the losses expected by a transferor.

HMRC has recognised in relation to Hallmark E particularly the difficulties faced by an intermediary in determining whether the conditions are met where they relate to the (predicted) financial position of a taxpayer entering into arrangements and suggested that an intermediary must consider the arrangement from the point of view of a hypothetical informed observer and take account of all the facts and circumstances (or at least those known to the intermediary, though this point is not explicitly made). In particular, HMRC consider that taxpayers would be expected to produce projections of the financial impact of transfers of assets etc in the normal course, and these (rather than any specifically generated for DAC 6 purposes) should be relied on in determining any reporting liability.

More generally, HMRC acknowledge that it is necessary to apply hallmarks under Category E consistently with UK transfer pricing legislation (which incorporates the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations July 2017 (OECD Guidelines)), in order for the rules to function as intended by the Directive.

Penalties

The penalty regime provides for penalties in a number of areas, such as failure to report or a failure to notify of reliance on LPP. Following concerns that the regime was unduly harsh and encouraged overreporting, the Government has amended the rules so that the default position will be a one-off penalty of up to £5,000, with daily penalties only applying in more serious cases, and subject to the determination of the FTT, which can impose fines of up to £1m. Additionally, the penalty regime has been modified so that daily penalties will only be charged for serious failings, depending on certain “relevant considerations”, including where the behaviour leading to the failure was deliberate. Where the behaviour was not deliberate, or there are no other exacerbating factors such as repeated failures, the penalty will be a one-off penalty, with scope for reduction where there are mitigating factors.

There will be no penalties imposed if a person has a reasonable excuse. Following responses to the consultation, the Government has clarified in the legislation that the existence of reasonable procedures to ensure compliance with the regime must be considered in determining whether a reasonable excuse exists for a failure.

Commencement

The regulations published by HMRC will come into force on 01 July 2020 and will apply to reportable cross-border arrangements:

• which are made available for implementation on or after 01 July 2020;
• which are ready for implementation on or after 01 July 2020;
• in respect of which an intermediary provides aid, advice or assistance on or after 01 July 2020, in relation to designing, marketing, organising, making available for implementation or managing the implementation of the arrangements; or
• the first step in the implementation of which took place on or after 25 June 2018.

In relation to the transitional period from 25 June 2018, the Government recognises that this reporting requirement poses challenges for intermediaries and taxpayers, particularly where the first step was taken prior to the publication of these regulations and guidance. Where a failure to make a report relates to an arrangement where the first step of the implementation predates the publication of the consultation document and the draft regulations, and the failure was due to a lack of clarity around the obligations or interpretation of the rules, which could not reasonably have been inferred from the DAC itself or from previous publications and statements including the publication of draft legislation and guidance, HMRC accept that it is likely that the person will have a reasonable excuse for the failure and no penalty will be due.

Comment

The UK's final regulations to implement new EU mandatory disclosure regime relating to cross-border tax arrangements include some helpful changes, but many aspects of the UK’s implementation remain uncertain. HMRC’s responses to the 2019 consultation give some indication of the direction of travel, but guidance is not expected to be published for some months as HMRC consults with industry groups on draft guidance. Therefore it is important to prepare now for the implementation of DAC6 whether you are an intermediary or taxpayer. This will include reviewing your inventory of transactions/arrangements since 25 June 2018 to identify reportable arrangements and putting reasonable procedures in place to identify reportable arrangements and comply with the rules, which will be crucial for managing reputational risk and mitigating penalties.