The tax transparency saga continues

The international tax system has been constantly changing after the earthquake brought about by the economic crisis in the developed countries, which also had a major impact on defining the global tax system. After OECD’s BEPS (base erosion and profit shifting) report, ever more changes and constraints emerged in three main directions: transparency, economic substance and information exchange.

In its turn, the European Union is taking quick steps in implementing a range of Directives transposing the BEPS ideas. 31 December 2019 is the deadline set by EU for transposing the Directive on the intermediaries’ reporting obligations (DAC6).

Although this Directive should be transposed into the national law in less than 3 months, we still do not have any legal texts, which increases uncertainty over its application.

What is DAC6 about?

In the context of international trends in fighting against abusive taxation practices, as well as the revelations in the Panama Papers, Paradise Papers or Football Leaks affairs, OCDE and EU proposed increasing the diversifying the exchange of information in order to protect national tax bases against erosion.

Therefore, the EU has passed DAC6, the Directive on the exchange of information by intermediaries, which introduces reporting obligations for potentially aggressive tax planning cross-border arrangements, which shall be identified based on specific criteria. Furthermore, besides companies, intermediaries (e.g. advisors, attorneys, etc.) that advise or assist companies in implementing reportable arrangements shall also have the duty to make such reports.

How to report

Each company or intermediary shall have to notify the reportable arrangements to their national tax authority. The tax authorities in each member state shall then submit the information with a platform developed at European level, so they shall be able to better respond to abusive tax practices with legislative changes, as well as with coordinated and targeted tax audits.

At EU level, some countries have moved more swiftly in transposing DAC6. These include Poland, Lithuania, Slovenia and Hungary. 14 other countries have published the draft for transposing the Directive (Austria, Cyprus, the Czech Republic, Denmark, Estonia, Finland, Germany, Italy, Luxembourg, the Netherlands, Portugal, Slovakia, Spain and the United Kingdom).

Who should report

Under DAC6, the duty to report falls either to the intermediaries (e.g., tax advisors, financial advisors, accountants or attorneys), or to the taxpayers. However, the Directive allows member states the possibility to exempt intermediaries from the reporting duty, if they are entitled to privacy on the grounds of professional secrecy. For instance: Luxembourg, Portugal, Cyprus, the Netherlands and Slovenia only exempt attorneys; Slovakia exempts attorneys, tax advisors and auditors; in the Czech Republic, professional confidentiality must be kept by tax advisors, attorneys, auditors and notaries. On the other hand, in France, although still in the draft phase, reporting under DAC6 shall also include attorneys (who are subject to professional privilege), however without disclosing the names of the concerned parties.

What to report

DAC6 lays down a range of criteria for identifying the reportable cross-border arrangements. Under DAC6, reporting shall cover all taxes, except for the Value Added Tax (VAT), customs duties, excise duties and mandatory social security contributions. However, some countries have extended the scope of the reporting obligations. Poland also requires for local arrangements meeting the stipulated criteria to be reported. Furthermore, the reporting duty also covers VAT in Poland and Portugal.

Moreover, the very list of criteria in the Directive is vaguely defined and covers a large spectrum of cross-border structures and arrangements. Based on the available additional information regarding the application of DAC6, many companies will find themselves in the position to report everyday, even trivial transactions, which at a glance may be easily omitted, particularly since the Directive does not lay down any minimum threshold for arrangements.

Without reviewing the extended list of the reporting criteria, here are some possible examples of transactions that should be reported under DAC6 (either based on interpreting the Directive, or by reference to the application rules stipulated by the various member countries): 

• loans taken to finance dividend payments, equity contributions or acquisition/expansion of interest in other companies; 
• debt-to-equity swaps;
• transactions subject to preferential treatment, e.g. reinvested profit may be classified as such under the Romanian law;
• transactions with zero tax or nearly zero tax companies – this category may include transactions with Romanian microenterprises (since, according to the European Commission’s interpretation, the “nearly zero tax” phrase means up to 1%); 
• deducting an asset’s depreciation in multiple jurisdictions – this category may include assets assigned to a permanent establishment whose depreciation shall be deducted both at permanent establishment level and at parent company level (if the tax credit method is applied to avoid double taxation); asset transfers, including the assignments among the parent company and its permanent establishment.
  

Furthermore, some transactions shall only be reportable if they pass the main benefit test (i.e. their main benefit is to obtain a tax advantage). The way to perform this test is not laid down in DAC6, but several member countries have provided clarifications on interpreting and applying it.

For instance, Spain provided a definition of what may constitute a “tax advantage”, i.e.: “reducing the taxable base or the due tax, including deferring the due tax, as well as generating net operational loss or tax credit.” As a matter of principle, any cross-border arrangement that generates a deductible expense or for which tax credit is granted might be within the reporting scope, based on this definition.

Consequences of failure to report: significant fines and even criminal prosecution?
Poland, the first country to have implemented DAC6, also stipulated the harshest fines for failure to comply – up to EUR 4.7 million. Moreover, the intermediaries whose revenues or expenses exceeded EUR 1.85 million in the previous financial year shall implement and use an “internal procedure” for DAC6. Failure to comply with this obligation may be subject to fines as high as approx. EUR 460k. The Netherlands also levies severe penalties: a one-time payment around EUR 800k, and authorities may also proceed to criminal prosecution in certain extraordinary cases. In Austria, Slovakia and Sweden, the proposed fine may be as high as EUR 50k, while it may be less – EUR 25k, in countries such as Hungary, Slovenia, Cyprus, the Czech Republic, Germany.

Other countries are considering introducing penalties according to the number of days of failure to comply (United Kingdom), the intermediary’s size (Denmark) or the volume of the data set that should be reported (Spain).

Conclusion

If we look at the way in which the Directive was transposed in other member countries, there are many questions regarding how DAC6 will be transposed in Romania, such as: Who shall incur the reporting obligation ultimately? How high shall the penalties for failure to report be? Shall national arrangements be included, or just the cross-border ones? These questions add up to reporting criteria that are inherently very complex.

The companies should prepare ahead (by reviewing their transactions, by defining monitoring procedures and mainly by thoroughly understanding the reporting criteria) in order to identify the reportable arrangements with companies both within and outside the European Union. This is the more important as the reporting obligation shall apply retroactively, targeting the transactions starting on 25 June 2018 – i.e. almost one and a half years behind – until 31 August 2020.

It is important for any company involved in cross-border arrangements to know and review the requirements of DAC6, as apparently trivial everyday transactions may be subject to such reporting. This is the more important as the consequences may be significant, particularly since there is no threshold amount. Under DAC6, any arrangement, no matter how small, must be reported, if the criteria are met.

For more information please contact EY Romania.