DAC6: Disclosure of cross-border tax arrangements

On 25 June 2018 an EU Directive (known as DAC6) entered into force. DAC6 is designed to give EU tax authorities early warning of new cross-border tax schemes. It requires tax authorities to be notified of cross-border tax arrangements satisfying certain 'hallmarks'. The tax authorities will then automatically exchange the information with other relevant EU tax authorities.

The rules have been in force in EU member states since 1 July 2020, but the first reporting obligations were deferred by most EU countries until 2021 because of the coronavirus pandemic.

The UK enacted the rules and the UK government had said it was committed to applying them even after Brexit. However, it was announced at the end of 2020, that the UK rules would be amended so that reporting requirements would only be required in the UK in respect of hallmark D of DAC6.

Hallmark D is based on the Model Mandatory Disclosure Rule (MMDR) proposed by the Organisation for Economic Cooperation and Development (OECD). It covers arrangements designed to circumvent the common reporting standard (CRS) and arrangements intended to disguise beneficial ownership. CRS requires financial institutions in countries which have signed up to the standard to make annual reports of non-residents holding bank accounts and other financial accounts.

The UK intends to consult in 2021 on new rules to replace the current rules. These new rules will be based on the OECD MMDR rather than the EU's DAC6.

Under the UK's current mandatory disclosure rules an 'intermediary', or in some cases a taxpayer, will be obliged to notify HM Revenue & Customs (HMRC) of an arrangement which is 'cross-border' and satisfies hallmark D of DAC6.

Cross-border arrangements

The rules apply to a 'cross-border arrangement', which means an arrangement concerning the UK or an EU member state and another country, which could be an EU member state or a third country, where at least one of the following conditions is satisfied:

• not all participants in the arrangement are tax resident in the same jurisdiction;
• at least one participant in the arrangement is tax resident in more than one jurisdiction;
• at least one participant in the arrangement carries on a business in another jurisdiction through a permanent establishment there and the arrangement forms part or all of the business of that permanent establishment;
• at least one participant in the arrangement who is a tax resident in one jurisdiction carries on an activity in a different jurisdiction without being tax resident or creating a permanent establishment there; or
• the arrangement has a possible impact on the automatic exchange of information or the identification of a beneficial owner.

Hallmark D

DAC6 sets out a list of 'hallmarks' – or features often present in tax avoidance arrangements. These are numbered A to E. Some of the hallmarks are subject to a main benefit test, which means there will only be an obligation to report if the main benefit or one of the main benefits which a person may reasonably expect to derive from the arrangements is the obtaining of a tax advantage. Some of the hallmarks are very widely drafted and can apply to normal commercial arrangements not designed to avoid tax.

Only hallmark D is relevant to the UK rules. It is not subject to the main benefit test. There are two parts to hallmark D: D1 and D2.

Arrangements will be caught by hallmark D1 if they have the effect of undermining or circumventing reporting obligations under the EU's Directive of Administrative Cooperation (DAC) or equivalent agreements on the automatic exchange of financial account information, or which take advantage of the absence of automatic exchange of information. This includes reporting obligations under CRS.

Hallmark D2 applies where arrangements involve non-transparent legal or beneficial ownership chains which use persons, legal arrangements or structures:

• that do not carry on a substantive economic activity supported by adequate staff, equipment, assets and premises;
• that are incorporated, managed, resident, controlled or established in any jurisdiction other than the jurisdiction of residence of one or more of the beneficial owners of the assets held by such persons, legal arrangements or structures; and
• where the beneficial owners of such persons, legal arrangements or structures are made unidentifiable.

The test of whether beneficial owners are made unidentifiable looks at whether beneficial owners can reasonably be identified by tax authorities. The identity of the beneficial owners does not have to be publicly available.

In relation to trusts, HMRC has confirmed that where the beneficiaries are named, or identified by class, the beneficiaries would not be considered to be made unidentifiable. Similarly, where there is the possibility of beneficiaries being added to a trust in the future, this would not necessarily trigger this hallmark, unless people were deliberately excluded from the trust temporarily to try to avoid being identified.

The UK regulations specifically provide that hallmark D must be interpreted in accordance with the OECD MMDR and its accompanying commentary.

Reporting

The rules require a person who is an 'intermediary' in respect of reportable cross-border arrangements to make the report.

'Intermediary' is widely defined as:

• "any person that designs, markets, organises or makes available for implementation or manages the implementation of a reportable cross-border arrangement". This type of intermediary is sometimes referred to as a 'promoter'; or
• any person that "knows or could be reasonably expected to know that they have undertaken to provide aid, assistance or advice with respect to" the above, having regard to the circumstances, information available and expertise of the person in question. This type of intermediary is sometimes referred to as a 'service provider'.

This wide definition could catch financial institutions and trust company and service providers as well as accountants, lawyers, and other tax advisers.

An intermediary is only required to report in the UK if the person is resident, has a permanent establishment, is incorporated, or is registered with a professional association related to legal, tax or consultancy services, in the UK.

If more than one EU or UK intermediary has an obligation to report, one can report and the others are not obliged to make a report in the UK if they have evidence that another intermediary has reported, in the UK or in the EU, and they are not aware that they have information which was not reported.

Businesses themselves, rather than professional advisers could have an obligation to report in several situations. These are where the professional adviser is prevented from making the disclosure because of legal privilege or where the business is itself caught by the definition of intermediary. The business may also have an obligation to report in the UK if it is based in the UK, but its professional advisers are not.

The information that needs to be reported includes details of the intermediaries and relevant taxpayers, the hallmarks being met, a summary of the arrangement and the member states or persons likely to be affected by the arrangement.

Once an arrangement has been reported, HMRC will issue an arrangement reference number which must be provided to other intermediaries.

Timing of reports

From 1 January 2021, arrangements have to be reported within 30 days. The main trigger for the 30 days is the day after the arrangement is made available for implementation is ready for implementation, or the first step in implementing the arrangement is made. For an intermediary which is a service provider, the trigger point for the 30 days in which to report is the day after giving the aid, assistance or advice.

There are specific deadlines for arrangements occurring before 1 January 2021. Arrangements occurring between 25 June 2018 and 30 June 2020 must be reported by 28 February 2021. Those occurring between 1 July 2020 and 31 Dec 2020 must be reported by 31 January 2021.

Penalties

There is a penalty of up to £5,000 for a failure to report. If HMRC considers that in the circumstances this is inappropriately low it can ask the First-tier Tribunal to impose daily penalties, which could be up to £1 million in total.

No penalties can be imposed if there is a reasonable excuse for the failure. In considering whether a person has a reasonable excuse HMRC must consider whether they had in place reasonable procedures to meet their obligations under the UK regulations.

Interaction of UK rules with EU regime

DAC 6 includes provisions designed to prevent reports of the same arrangements having to be made by an intermediary in more than one state or by more than one intermediary.

The amended UK regulations provide that if an intermediary is liable to report the arrangement in an EU member state as well as the UK, it is only obliged to report in the state which features highest in the list in the directive. The state where the intermediary is resident for tax purposes comes higher up the list than the state where it has a permanent establishment through which the services are performed. This means that, as far as UK law is concerned, an EU tax resident intermediary with a UK office operating as a permanent establishment of the EU entity, would not be required to report a hallmark D arrangement in the UK.

However, the same will not apply in reverse, as DAC 6 itself only relieves reporting where a report is made in another member state. So a UK tax resident firm operating in France through a permanent establishment which is an intermediary for DAC 6 purposes because of activities of the French office, could end up having to report a hallmark D arrangement in both the UK and in France.

A UK intermediary is not required to report a hallmark D arrangement if it has evidence that the reportable information has been reported by another intermediary – either in the UK or in the EU. However, DAC6 does not provide for this to apply in reverse, so EU intermediaries are likely to still be required to report in the EU, even if a hallmark D arrangement has been reported in the UK.

The EU has a bespoke platform to facilitate exchanges of information reported under DAC6. Leaving the EU means that the UK is not part of this system and is not bound to share reports with the EU and vice versa. Cooperation in this respect will be subject to the more limited obligation under bilateral double tax treaties, which means that it will not be exchanged automatically. Exchanges will be following a specific request or spontaneously.