Mandatory Disclosure Rules under DAC 6

Private Wealth

Screening for Hallmarks...

Following years of OECD preparation, EU Member States are currently implementing mandatory disclosure rules (MDRs) for the automatic exchange of potentially aggressive cross-border tax planning arrangements. DAC 6 is a minimum standard designed as an "early warning system" to help domestic tax authorities fight tax avoidance. Given the hallmarks’ broad scope, even tax experts find DAC 6 hard to interpret. It remains to be seen if non-specialists are up to legislative speed…

DAC 6 has its origin in the OECD’s Mandatory Disclosure Rules (2015) whose objectives were to (i) provide tax administrations with early information on potentially aggressive tax planning practices (ii) identify promoters and users thereof and (iii) deter the "tax avoidance market".

MDRs have a long prehistory: in the US (1984), Canada (1989), South Africa (2003), UK (2004) Portugal (2008), and Ireland (2011).

What is Tax Avoidance?

According to a classic definition, tax avoidance "occurs when persons arrange their affairs in such a way so as to take advantage of weaknesses or ambiguities in the tax law". The European Court of Justice (ECJ) defines tax avoidance as "wholly artificial arrangements designed to circumvent national tax law".

Whereas the terms "tax planning" or "tax mitigation" commonly refer to acceptable practices of profiting from fiscally attractive options, the term "tax avoidance" designates win-win outcomes for taxpayers clearly not intended by the legislator and, while observing its letter, clearly go against the spirit of the law.

In the Age of Zero Tolerance

Despite the launch of the CRS framework in 2014, a coordinated network of bloggers, investigative journalists (ICIJ, OCCRP), dedicated media outlets (Guardian, Süddeutsche, Tagesanzeiger, etc.), lobbyist groups (Tax Justice Network, Global Witness, Oxfam) have been exercising pressure on the OECD to push through a zero-tolerance policy for tax avoidance under the CRS.

For example, the International Consortium of Investigative Journalists (ICIJ) encourages whistle-blowers on its website Leak to Us "to securely​ ​submit​ ​all​ ​forms​ ​of​ ​content​ ​that​ ​might​ ​be​ ​of​ ​public​ ​concern​ ​–​ ​documents, ​photos, video​ ​clips​ ​as​ ​well​ ​as​ ​story​ ​tips". To collect evidence of wrongdoing, the Guardian’s whistleblowing platform uses the anonymous router Tor – which, ironically, is itself described as a "dark corner of the web".

The leaks exploited by the ICIJ and others have nourished a nearly constant news flow of offshore scoops, in which non-expert investigative journalists and bloggers, often with no law-enforcement background, engage in speculations and second guessing about the gravity (and sometimes mere relevance) of a disperse and at times unverified set of data:

2013             Offshore Leaks

2014             Jersey Files

2014             Luxembourg Leaks

2015             Swiss Leaks

2016             Panama Papers

2020             Luanda Leaks

2020             Cyprus Leaks

2020             FinCen Leaks

By keeping advocacy and media pressure high, interest groups such as ICIJ and TJN have effectively contributed to the emergence of a culture of leaking on all social levels culminating in the launch of the OECD’s own whistle-blower platform in May 2017. It enables interested parties to report "potential schemes, products, or structures to circumvent the CRS" on an anonymous basis via the OECD’s Automatic Exchange Portal.

What is DAC 6?

Under the EU’s Directive on Administrative Cooperation (DAC 6), intermediaries (accountants, advisers, lawyers, banks) and, in absence thereof, the taxpayer himself, must notify aggressive tax planning arrangements (dating back to 25 June 2018) with a cross-border dimension (involving several European Member States or a Member State and a third country) which contain specific hallmarks (that is, qualifying features or characteristics) within 30 days to their domestic tax authorities.

European Member States must then categorize the arrangement (involving a scheme reference number) and exchange the arrangement’s key features via the EU’s Common Communication Network (CCN) with all other European Member States on a quarterly basis, in particular:

• The intermediary’s / taxpayer’s name, place of birth, date of birth, residence, TIN;

• The arrangement’s qualifying hallmark(s);

• The arrangement’s functioning, its market name, e.g. "Golden Visa" ("without leading to the disclosure of a commercial, industrial, or professional secret");

• The arrangement’s (expected) implementation date;

• The arrangement’s relevant domestic legal basis;

• The arrangement’s value (for example in expected tax savings etc.);

• Mention of the European Member State likely to be affected by the arrangement;

• Mention of any other person in a European Member State likely to be affected by the arrangement.

Implications of Reporting under DAC 6

Reporting does not constitute a finding of tax avoidance. Conversely, non-reaction to a scheme by tax authorities does not imply acceptance.

Rather, data collected under DAC 6 will enable domestic tax authorities to (i) quickly close legislative loopholes (ii) assess risks when carrying out tax audits and (iii) engage in communication strategies with taxpayers (by naming and shaming "listed transactions" and "transactions of interest" in public tax alerts and spotlights).

Penalties under DAC 6

Penalties for incomplete, delayed, or non-reporting are capped at £1,000,000 (UK), €830,000 (Netherlands), €250,000 (Luxemburg), €100,000 (Belgium, France), €50,000 (Austria, Denmark), €25,000 (Croatia, Germany), €20,000 (Cyprus, Italy, Malta), €15,000 (Finland, Hungary).

Definition of an Intermediary under DAC 6

Intermediaries are EU persons who (i) design, market, organize or make available for implementation, or manage the implementation of, a reportable cross-border arrangement or (ii) provide aid, assistance or advice to such an intermediary.

Legal Privilege under DAC 6

Legal professional privilege (LPP): European Member States must respect LLP under the respective domestic laws. However, qualified intermediaries claiming LPP must notify without delay any other intermediary, or the relevant taxpayer, of their respective reporting obligations.

Relevant Taxpayers under DAC 6

Relevant taxpayers include "any person to whom a reportable arrangement is made available". In cases where there is no qualifying intermediary or where LPP applies, (non-EU) taxpayers must report in the European Member State with which the closest EU domestic nexus can be established, that is where they (i) are resident (ii) have a permanent establishment benefitting from the arrangement (iii) receive income or generate profit or (iv) carry out an activity (whichever Member State comes first).

Hallmarks under DAC 6

A reportable cross-border arrangement involves:

Hallmark A

(1) confidentiality (owed by the client to the promoter) or (2) a fee payment in proportion to the secured tax advantage or (3) mass marketing with standardized documentation ("plug and play").

Hallmark B

(1) tax reduction via the purchase of a loss-making company or when (2) income is converted into capital, gifts or other low-tax/zero-tax revenue or involving (3) circular transactions (which offset each other).

Hallmark C

Payments between related companies where the recipient is (1) located in no jurisdiction or (2) located in a zero-tax jurisdiction (< 1%) or (3) located in an OECD non-cooperative jurisdiction or (4) fully exempted from tax or (5) benefitting from a preferential tax regime.

Situations where (6) a company can claim depreciation deductions twice or (7) can claim double taxation relief twice or (8) asset transfers involve two different amounts.

Hallmark D

CRS avoidance via (1) artificial reclassification of passive into active NFEs or (2) the use of non-CRS jurisdictions (the United States, Montenegro, etc.) or (3) via the reclassification of income and capital leading to non-reporting or (4) the use of structures avoiding Beneficial Owner (BOs) / Controlling Person reporting or (5) via exploiting weaknesses in a bank’s, or a country’s, AML regime, or a country’s transparency requirements.

Arrangements involving a non-transparent legal or BO chain via structures either (6) lacking economic substance or (7) established outside the BO’s residence or (8) involving unidentifiable BOs.

Hallmark E

(1) the use of unilateral safe harbor rules or (2) the transfer of hard-to-value intangibles or (3) intragroup transfers of assets, functions, or risks reducing the transferor’s EBIT by 50%.

Main Benefit Test

Hallmarks A and B (and certain elements of Hallmark C) are only reportable if obtaining a "tax advantage" (cf. Art. 4.2.) is one of the main benefits a person may reasonably expect (based on objective facts).

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References

Roy Rohatgi (2007) Basic International Taxation. Second Edition. Volume II: Practice (Taxman)

OECD (2015) Mandatory Disclosure Rules, Action 12 - 2015 Final Report (here)

OECD (2018) Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures (here)