Enacted in 2018 by the European Union, DAC6 is the sixth version of the Directive on Administrative Cooperation. The directive is designed to provide European tax authorities with more transparency into a company’s financial structure and make it easier to share information among member states in order to combat aggressive tax strategies.
DAC6 requires that companies report on cross-border arrangements or transactions that meet certain requirements or “Hallmarks” and involves at least one EU resident. The goal is to weed out those arrangements that could be used to obtain a significant tax advantage by a company.
While minimum reporting requirements have been established by the EU’s governing body, each of the countries in which this directive will be applied has set their local variations and obligations. Additionally, to aid in the sharing of information between EU countries, each of the local reports will be filed via that country’s automatic exchange of information (AEOI) portal and will be automatically exchanged between EU member states through a centralized database.
Because DAC6 has significant ramifications for U.S. companies with operations in the EU, this article explores what you need to know about reporting responsibilities, what are reportable transactions, when and where to file. We also share some of the challenges and a few best practices to ensure effective compliance.
Disclosure responsibilities
Intermediaries such as external tax advisors, law firms, banks, etc. that have nexus in the EU are primarily responsible for disclosing relevant transactions to the corresponding jurisdictions. Where no external intermediary is involved in cross-border transactions, the obligation then moves to the taxpayer, i.e. the company.
It’s important to note that law firms may not always be able to report due to legal professional privacy rules unless their client waives that right. Also, U.S. advisors are exempt from this rule and are not required to report in Europe.
Reportable transactions
DAC6 identifies different hallmarks of reportable transactions, also known as Reportable Cross-Border Arrangements (RCBA). These include, but are not limited to:
- Transfer pricing and the use of safe harbors
- Transfer of hard to value intangible assets
- Restructuring resulting in significant profit shifts
- Deductible cross-border payments that are not fully taxable where received
- Loss planning
- Use of low tax, no tax, or non-cooperative jurisdictions
- Confidentiality agreements in place
Overall, cross-border transactions that meet the following conditions must be disclosed:
- The transaction involves at least one EU state. While the UK is no longer an EU member state, DAC6 will be applicable in this jurisdiction as well.
- Can be identified under at least one hallmark, and
- There is the potential for significant tax benefits
It’s important to note that even if the financing structure of a company is done via jurisdictions such as Singapore and Hong Kong where income qualifies for foreign source exemption, the reporting qualification still stands. These jurisdictions are commonly chosen as finance hubs since corporations obtain interest benefits in their home countries, which then qualifies under one of the hallmarks described by DAC6. However, if a company can prove that the transaction has a legitimate business purpose, these may not need to be reported, although an additional investigation will be required to back this up.
In certain situations, reporting obligations may be excluded if the company can demonstrate a tax advantage is not the main benefit of the transaction. Companies will need to differentiate between obtaining a tax advantage, which DAC6 is intended to eliminate, and avoiding double taxation. With deadlines fast approaching, companies are actively pushing to identify their reportable transactions and comply with these requirements.
Reporting timeline
DAC6 goes into effect on July 1, 2020. However, due to the Covid-19 pandemic and considering the challenges many of the member states are facing, the EU Commission has proposed an extension on key filings and the exchange of information.
Below are key dates and the new deadlines proposed by the Commission:
- DAC6 is retroactive to June 25, 2018, when it was first approved.
- Transactions initiated before June 25, 2018, are outside of DAC6’s scope.
- For historical transactions initiated on or after June 25, 2018, up until June 30, 2020, reporting would be deferred from August 31, 2020 to November 30, 2020.
- The start of the 30-day period for transactions which become reportable after June 30, 2020 would be deferred from July 1, 2020 to October 1, 2020. All reporting must be completed within 30-days of the initiation of the applicable transactions.
- The date for the first exchanges of information between EU tax authorities on reportable transactions would be deferred from October 31, 2020 to January 31, 2021.
While the proposed changes require the consent of all member states in order to be adopted, it is expected to pass and be implemented immediately.
Where to file
Intermediaries or taxpayers are required to disclose an RCBA to the tax authority of the EU member state, including in the UK, in which the intermediary is a tax resident, incorporated or established, registered with a professional association, or has a permanent establishment (PE).
In the absence of a reporting intermediary, the RCBA must be disclosed to the tax authority of the jurisdiction in which the taxpayer is resident, has a PE, receives income/profits, or carries on an activity. Companies must consider that this may give rise to practical difficulties concerning nexus. In addition, local implementation rules should also be considered since reporting requirements can vary by country.
Challenges
Below are a few of the main challenges companies may face under the DAC6 directive:
Reporting responsibilities: One of the primary challenges of DAC6 compliance is determining who will be responsible for reporting transactions when multiple intermediaries are used in different countries. Designating the appropriate party to disclose relevant cross-border arrangements in this situation can be complex and can lead to inconsistencies in reporting.
Keeping track of what is being reported: It can also be challenging to control who reports what among multiple intermediaries, and especially what an advisor reports if they happen to not work directly for the transacting company.
Language considerations: Some countries require filing in the local language. This adds a layer of complexity when information needs to be shared among member states. Companies must keep this in mind when deciding where to ultimately file.
Reporting timelines and formats: Because arrangements must be reported within 30-days of their initiation or implementation, companies need to ensure the appropriate workflows are in place to identify and report on quickly and on an ongoing basis. Reports must be submitted to tax authorities in an electronic format, following specific schemas, and must pass validation rules.
There are steep penalties for non-compliance with DAC6 rules. In Poland for example, penalties can reach up to €5 million, and in the Netherlands, fines can reach €830,000. So, it pays to be prepared.
Best practices
Below are a few best practices companies can incorporate to ensure compliance with the directive.
- Evaluate the corporate footprint to identify which entities and which countries can trigger DAC6 hallmarks.
- Complete thorough assessments of each transaction.
- Determine who will ultimately be responsible for submitting reports in each jurisdiction.
- Implement a workflow that takes you from data collection to identification and filing in a timely manner. Using a reporting tool can aid in streamlining this process.
- Maintain a database of country tax rules, variations from the EU directive by country, and in-country filing dates.
- Monitor ongoing updates from each jurisdiction.
Conclusion
DAC6 is one of the most impactful tax regulations enacted by the European Union and readiness has become an urgent matter for both intermediaries and taxpayers alike. To ensure compliance with this new law, companies must work closely with their advisors in each jurisdiction in order to implement an effective strategy to handle the ongoing responsibilities and avoid hefty fines and reputational damage due to non-compliance.
DAC6 reporting requirements may just be the beginning of many such regulations around the world. Non-EU countries like Mexico and Norway, are exploring similar reporting regimes of their own.
Disclaimer: This article is intended for informational purposes only and should not be used for legal or regulatory advice.