On December 31, 2020, and with the U.K./EU Brexit transition period coming to an end, HM Revenue & Customs (HMRC), on behalf of the U.K. government, announced that they would significantly reduce their reporting under the EU Council Directive 2011/16/EU on administrative co-operation (DAC) 6. As a result of this announcement the U.K. will restrict reporting to matters falling within Hallmark D only.
The DAC forms one of the main tools within the EU for automatic exchange of information between member states. DAC6 implements the Organization for Economic Co-operation and Development (OECD) Base Erosion Profiting Shifting (BEPS) Action 12 Mandatory Disclosure Rules (MDR) on aggressive tax planning and requires intermediaries to file information that is within their knowledge, possession or control on reportable cross-border arrangements.
Who is an Intermediary?
Under DAC6, an “intermediary” is any person that “designs, markets, organises or makes available for implementation or manages the implementation of a reportable cross-border arrangement.”
There is an additional definition of “any person that...knows or could be reasonably expected to know that they have undertaken to provide such services, knows or could be reasonably expected to know that they have undertaken to provide directly or by means of other persons, aid, assistance, or advice with respect to designing, marketing, organising, managing available for implementation or managing the implementation of a reportable cross-border arrangement....”
The rules are very broad and extend beyond those providing tax services. They can include banks, lawyers, trustees, and many others beyond accountants and tax advisers.
Reportable Cross-Border Arrangements
“Cross-border arrangements” broadly means any arrangement concerning either more than one EU member state or a member state and a third country that falls within various “hallmarks.”
Obligation to Report
The U.K. regulations require any intermediary participating in a reportable cross-border arrangement to make a return of this to HMRC.
The U.K. government announced a number of extensions to deadlines, but the final deadline position is as follows:
- historical transactions, February 28, 2021;
- other cases, 30 days from January 1, 2021.
As the earliest reporting date is June 25, 2018, any arrangements already implemented at June 25, 2018 will possibly not need to be reported upon. However, if there are new arrangements after June 25, 2018, which themselves change those historical arrangements, then those new arrangements themselves may amount to reportable cross-border arrangements in their own right.
Where an intermediary has an obligation to make a DAC6 report, but is prevented from doing so by their obligations under any equivalent of U.K. legal professional privilege, there are provisions to protect the intermediary so no report is required. However, there is a requirement in such circumstances that the intermediary notifies the “relevant taxpayer” (see below) of a reportable position and the responsibility then passes to the taxpayer to report.
As stated above, a cross-border arrangement is only a reportable cross-border arrangement where the arrangement contains at least one of the “hallmarks.” The hallmarks are broken down into five categories, A to E.
The various hallmarks are set out below, together with some of the specific comments or observations. Some of those hallmarks, A, B, and part of C, require an MBT of whether a tax advantage is the main purpose for a matter to be reportable, even if it meets the other aspects of the hallmarks.
Category A: Generic hallmarks of avoidance, including confidentiality agreements, premium fees and standardised documentation;
Category B: Specific hallmarks, including those having the effect of converting income into capital, gifts, or other revenue to be taxed at lower levels or exempt from tax, or arrangements which amount to treaty shopping to circumvent withholding tax;
Category C: Specific hallmarks, including transactions where there are deductible cross-border arrangements between associated enterprises where the recipient is not resident anywhere, or is resident in a low or zero taxation territory, or is listed in an uncooperative territory according to the OECD;
Category D: Specific hallmarks concerning Common Reporting Standard (CRS) avoidance and opaque offshore structures;
Category E: Specific hallmarks concerning transfer pricing linked to safe harbors and transactions between associated enterprises involving intangible assets, for example, intellectual property.
The legislation supporting the introduction of DAC6 is the International Tax Enforcement (Disclosable Arrangements) Regulations 2020, in support of the primary legislation within Section 84 of the Finance Act 2019.
The legislation refers to DAC6 for many of the specifics but provides the U.K. administrative framework, including the requirement to make reports to HMRC, and to introduce penalties for non-compliance.
DAC6, as with all earlier iterations, relates to direct taxation matters. It would not therefore extend to value-added tax (VAT), customs and excise duties and social security contributions such as U.K. National Insurance Contributions (NIC).
Given that the U.K. government has limited its application of DAC6 to Hallmark D, it is worth exploring in greater detail the matters covered under this hallmark.
Hallmark D in Detail
First of all it is important to recognise that Hallmark D is not linked to the MBT, and so if arrangements are caught within the Hallmark D conditions, they will be reportable regardless.
However, it is not the case that the motivations for the arrangements are ignored simply because there is no link to the MBT. DAC6 reports upon potentially aggressive cross-border tax planning arrangements, in line with the OECD guidance, introduced on March 9, 2018.
DAC6 Hallmark D effectively requires the reporting of two things: CRS avoidance arrangements and opaque offshore arrangements.
CRS Avoidance Arrangements
The first reporting requirement is on arrangements which have the effect of undermining the reporting obligation on the automatic exchange of financial account information, including with third countries (this includes CRS reporting, but potentially could go further into other automatic exchange of information (AEOI) agreements). The specific arrangements referred to include:
(a) the use of an account, product or investment that is not, or purports not to be, a Financial Account, but has features that are substantially similar to those of a Financial Account;
(b) the transfer of Financial Accounts or assets to, or the use of jurisdictions that are not bound by the automatic exchange of Financial Account information with the state of residence of the relevant taxpayer;
(c) the reclassification of income and capital into products or payments that are not subject to the automatic exchange of Financial Account information;
(d) the transfer or conversion of a Financial Institution or a Financial Account or the assets therein into a Financial Institution or a Financial Account or assets not subject to reporting under the automatic exchange of Financial Account information;
(e) the use of legal entities, arrangements or structures that eliminate or purport to eliminate reporting of one or more Account Holders or Controlling Persons under the automatic exchange of Financial Account information;
(f) arrangements that undermine, or exploit weaknesses in, the due diligence procedures used by Financial Institutions to comply with their obligations to report Financial Account information, including the use of jurisdictions with inadequate or weak regimes of enforcement of anti-money-laundering legislation or with weak transparency requirements for legal persons or legal arrangements.
Whilst this is not within DAC6 itself, the OECD MDR guidance refers to the test of whether arrangements are in actuality CRS avoidance arrangements where “it is reasonable to conclude that it is designed to have, or marketed as having, the effect of circumventing CRS Legislation.”
The OECD guidance provides additional assistance in understanding whether arrangements are reportable. It states at paragraph 5 (page 25), “the simple fact that an Arrangement has the effect of non-reporting is not sufficient for it to be considered to have the effect of circumventing CRS Legislation. This will only be the case where it is reasonable to conclude the Arrangement undermines the intended policy of the CRS Legislation.”
In terms of the test of “reasonableness,” the OECD guidance states that the test will be passed “where a reasonable person in the position of a professional adviser with a full understanding of the terms and consequences of the arrangements and the circumstances in which it is designed, marketed and used, would come to this conclusion [CRS circumvention]”
Opaque Offshore Arrangements
The second reporting category is for arrangements involving non-transparent legal or beneficial ownership chains involving the use of persons, legal arrangements or structures:
- that do not carry on a substantive economic activity supported by adequate staff, equipment, assets and premises; and
- that are incorporated, managed, resident, controlled or established in any jurisdiction other than the jurisdiction of residence of one of the beneficial owners; and
- where the beneficial owners are made unidentifiable.
The other key aspects of DAC6 still apply when considering whether Hallmark D arrangements are reportable; i.e., is there a U.K. intermediary? Also, are the arrangements cross-border arrangements? etc. It is also important to undertake any analysis in terms of understanding the two types of intermediary.
The second definition of intermediary under DAC6, referred to earlier, includes arguably more passive intermediaries; “service providers,” including intermediaries who are essentially facilitating or managing structures linked to cross-border reportable arrangements. This group of intermediaries is interesting, both in terms of DAC6 generally, but also in relation to Hallmark D matters, as one notes within the definition set out above the concept of “reasonable knowledge” of reportable arrangements.
The lack of reasonable knowledge is a defense for non-reporting and the associated penalties for non-compliance. However, deliberately structuring matters so as not to know arrangements are reportable would clearly not meet the defense and potentially lead an intermediary into a very difficult place with HMRC: beyond the ultimate risk of criminal action, HMRC have introduced civil penalties for enablers of tax evasion and avoidance, in 2016 and 2017 respectively.
It is important to appreciate that where there is no U.K. intermediary, reporting may still be required on the cross-border arrangements if there is a relevant taxpayer, in this case one that has a U.K. nexus.
A U.K. taxpayer is someone where:
- the U.K. is the jurisdiction where the relevant taxpayer is resident for tax purposes;
- the U.K. is the jurisdiction where the relevant taxpayer has a permanent establishment benefiting from the arrangement;
- the U.K. is the jurisdiction where the relevant taxpayer receives income or generates profits, although the relevant taxpayer is not resident for tax purposes and has no permanent establishment in any member state;
- the U.K. is the jurisdiction where the relevant taxpayer carries on an activity, although the relevant taxpayer is not resident for tax purposes and has no permanent establishment in the U.K.
A significant question also has yet to be clarified: having collected the data in relation to Hallmark D, will HMRC pass this over to the EU? Without specific agreement, the answer will likely be no.
On DAC6, it is worth also appreciating that if the cross-border arrangements are involving another (non-U.K.) EU member, full reporting will still apply via the other EU intermediary.
As the U.K. has now left the EU, the U.K. has stated it will consult on introducing specific OECD MDR rules in the coming year, which will then most likely replace the Hallmark D disclosure requirements.
Those outside the U.K. should not view that the U.K. now limiting its reporting to DAC6 Hallmark D is a sign that the U.K. has pulled back on intermediary reporting. The U.K. introduced its own Disclosure of Tax Avoidance Scheme (DOTAS) rules in 2004, and in fact many would say the DOTAS rules were the model for the wider DAC6 rules we have today.
However, the U.K. reporting regime hallmarks are not all the same as DAC6, although Hallmark A looks more or less the same. Also, all hallmarks under the U.K. regime require an MBT. And of course, whilst reporting may or may not take place in the U.K. under DOTAS, these rules do not themselves trigger any reporting overseas. They do still have other teeth, including the requirement in the U.K. to pay relevant tax up front, under the U.K. accelerated payment rules introduced in the Finance Act 2014.
It will be very interesting to see if, or how, the U.K. and the EU will approach exchange of information going forward into the future.
Part 2, Title XI, Chapter 5 (Taxation) of the Free Trade Agreement (FTA) does commit both parties to “good governance in the area of taxation, in particular the global standards of tax transparency and exchange of information and fair tax competition....” One would say this is an indication that the U.K., and HMRC, will commit themselves to international exchange of information, and whilst the U.K. will limit reporting under these provisions to the OECD MDR approach and Hallmark D, HMRC will still exchange under wider mechanisms such as the CRS.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Gary Ashford is a Tax Partner of Harbottle and Lewis LLP and a Council Member of the Chartered Institute of Taxation.
The author may be contacted at: firstname.lastname@example.org