The sixth incarnation of the EU Directive on Administrative Cooperation in the Field of Taxation (Directive (EU) 2018/822, generally known as "DAC6") requires, in broad terms, intermediaries to disclose cross-border arrangements (involving one or more EU jurisdiction) exhibiting one or more defined avoidance "hallmarks". One of those hallmarks (Hallmark D) targets arrangements which undermine the rules on automatic exchange of information ("AEOI") and/or registers of beneficial ownership. It is this element of DAC6, in the context of private holding structures, which forms the focus of this article (although other DAC6 hallmarks might potentially apply in certain circumstances).
Just as we have in recent months been asked to consider the meaning of "stay alert", so too have we been required to ruminate on the meaning of "undermining reporting obligations". The publication of guidance on this matter, as well as other aspects of DAC6 was of course welcome. However, before considering relevant aspects of the guidance, it is revealing to consider the typical errors made innocently by those who do not seek to undermine the automatic exchange obligations.
Mistakes in applying the CRS
The errors identified by HMRC included:
- wrongly classifying trusts as financial institutions or non-financial entities
- incorrectly carrying out due diligence requirements
- mistakes when reporting discretionary beneficiaries
- failing to identify the individuals behind controlling entities.
In short, the mistakes included reporting the wrong information, not having the correct information to report in the first place and not knowing when to report at all.
Of course, mistakes will happen with a reporting system that asks the operator to conceptualise trust interests as bank accounts, makes fine distinctions based on what proportion of a trust portfolio is subject to discretionary management, and invites subtle nuances of interpretation between participating jurisdictions. There is a degree to which the CRS undermines itself, through its combination of complexity and imprecision. When the above aspects of DAC6 are added to the equation, there is a certain irony.
Disclosure of arrangements which undermine transparency rules
Before launching into the detail of what might be disclosable, it is worth pausing to note that there are parallel disclosure regimes between EU (and EEA) jurisdictions and other jurisdictions. The above elements of DAC6 apply within the EU, whilst other jurisdictions are invited to adopt the MDR. The preamble to DAC6 encourages Member States to use the MDR as a source of illustration or interpretation, in order to ensure consistency of application across Member States and presumably to promote consistency between EU and non-EU jurisdictions. However, there will be separate sets of rules. Each EU jurisdiction will choose how to transpose DAC6, and each non-EU jurisdiction will choose whether and how to adopt the MDR. The below paragraphs consider HMRC's interpretation of the application of DAC6 in the UK after it was transposed in January 2020 by The International Tax Enforcement (Disclosable Arrangements) Regulations 2020 (the "UK DAC6 Regulations"), which took effect on 1 July 2020 (subject to the comments below on timing).
DAC6 UK Guidance
HMRC updated its International Exchange of Information Manual ("IEIM") on 30 June 2020 to include guidance on the UK DAC6 Regulations (following production of a draft earlier this year, which was shared with a number of professionals). As mentioned above, DAC6 targets, among others, arrangements which seek to subvert transparency provisions (requiring them to be reported to the most proximate EU tax authority, which then exchanges the information with other EU tax authorities as relevant).
HMRC's guidance firstly makes clear that DAC6 and the MDR share substantial common ground and HMRC will interpret Hallmark D consistently with the MDR in those common parts (IEIM645000).
The first part of the transparency hallmark (Hallmark D(1)) targets arrangements which have the effect of undermining or circumventing reporting obligations under EU Directive 2014/107/EU (which implements the CRS) or equivalent AEOI agreements (e.g. the CRS), or which take advantage of the absence of AEOI. HMRC's guidance (at IEIM645010) repeats the MDR commentary in various respects, including by stating that the test is objective (looking at the effect). It is to be determined without reference to the subjective intention of the parties. Rather, it is to be considered from the perspective of a reasonable person in the position of a professional adviser, with a full understanding of the terms and consequences of the arrangement. Whilst the test is objective, the intention of the parties is still relevant in determining the effect of the arrangement. So the test is objective not subjective, but subjective evidence is relevant in drawing an objective conclusion. This is not perhaps the easiest test to apply.
The guidance does go on to repeat examples from the MDR commentary of arrangements which are caught, such as transferring accounts to a jurisdiction which has no AEOI provision with the taxpayer's home jurisdiction. It further highlights certain features of an arrangement which would suggest it is caught, such as a transaction that is otherwise uncommercial but for the benefit of avoiding CRS reporting.
The guidance also repeats that an arrangement does not circumvent CRS legislation merely because it results in non-reporting, provided that it is reasonable to conclude that such non-reporting does not undermine the policy intent of the CRS legislation. It gives the example of funds in a French bank account (reportable under the CRS) being used to acquire French property (not reportable under the CRS) and explains that this would not be caught, as such steps are not inconsistent with the policy intent of the CRS.
On Hallmark D(1) (undermining AEOI rules), the HMRC guidance does not add greatly to understanding what is in scope but is helpful in making clear the intention to align with the MDR.
On the second transparency hallmark (Hallmark D(2)) – obscuring beneficial ownership – HMRC's guidance (at IEIM645020) is a little more instructive. It clarifies that beneficial owners need actually to be made unidentifiable (e.g. through the use of undisclosed nominees, or artificially reducing a holding stake below 25%) in order for the arrangement to fall within scope. Further, it clarifies that beneficial owners do not need to appear on a public register in order for the arrangement to fall outside scope (but where they do appear on a public register, a safe harbour would apply).
In an update to HMRC's earlier draft guidance, it is now stated that the hallmark would not generally apply where a person is obliged to identify beneficial ownership under anti-money laundering legislation in accordance with FATF standards, and successfully does so. Seemingly, if an intermediary in a well-regulated jurisdiction is able properly to complete its AML checks, then beneficial ownership cannot have been obscured.
The same supplementary text is also instructive in relation to trusts. Where the beneficiaries are named or identified by class, rather than specifically by name, HMRC would not consider the beneficiaries to have been made unidentifiable. Similarly, where there is the possibility of beneficiaries being added in future, the arrangement would not necessarily fall within scope. However, if beneficiaries were deliberately excluded from the trust temporarily, with a view to avoiding identification, that would appear to fall within scope. This does raise questions over the inclusion and use of powers to add beneficiaries. One would have thought that an arrangement would be clearly outside scope if the intentions over the use of a power to add were set out in a letter of wishes, and those future intended beneficiaries were consequently named on the UK trust register (even if only as a class). However, a Red-Cross trust administered in a jurisdiction without equivalent trust registration obligations would be at least highly questionable (subject to whether the arrangement began before the disclosure obligations took effect).
The HMRC guidance highlights the objective nature of the test (what a hypothetical, informed observer would reasonably conclude) and refers to the MDR commentary.
Which intermediaries are within scope of the UK DAC6 Regulations?
HMRC's published guidance is also helpful in other respects, primarily in identifying when a non-UK intermediary is in scope of the UK legislation and when an intermediary can be duly satisfied that another intermediary has discharged the disclosure obligation.
A non-UK intermediary can be in scope of the UK DAC6 Regulations where it is resident in the UK, trades through a permanent establishment in the UK or is governed by (or incorporated under) the law of a UK nation. It can also fall within scope if it is registered with a professional association in the UK, but the guidance clarifies that this is only where that association has a governance or supervision function in respect of the intermediary's work. This would be the case where the association was able to prevent the intermediary carrying out its professional activity, able to impose monetary sanctions or carried out anti-money laundering supervision (IEIM621140). This is a helpful limitation, albeit it does make clear that there are several gateways through which a non-EU intermediary might have a parallel disclosure obligation in the UK as well as its home jurisdiction under local MDR legislation (see below).
The guidance goes on to provide a degree of clarity as to when an intermediary (or taxpayer) can be excused from a reporting obligation where another person has made the report. Broadly, this applies where there is evidence available that a report has already been made. When a report is made, HMRC will issue an arrangement reference number (an "ARN") to the reporting intermediary (which it should share with other intermediaries and the taxpayer – IEIM656000). The reporting window is only 30 days and so it might be difficult to determine within that time whether another person has submitted a report. To avoid duplicate reports being submitted in cases of doubt, HMRC will accept that that a reasonable excuse exists for not submitting a report within the 30 day deadline (and that, consequently no penalty applies), where an intermediary understood that another person was going to make the report but had not yet received the ARN. However, the report would need to be made without unreasonable delay if it subsequently became clear that it was required.
The guidance does not make clear how disclosure in an EU jurisdiction would excuse a UK intermediary. More generally, it is not clear how the exchange of information between the UK and EU jurisdictions under DAC6 will work following the end of the Brexit transitional period. Indeed, whilst HMRC's guidance (IEIM630020) makes clear that arrangements continue to be reportable during the transition period (albeit subject to the delayed timetable set out below), there is no mention of what happens after that period. So, it is not inconceivable that a report by an EU intermediary under local DAC6 regulations might need to be duplicated in the UK, due to the absence of recognition.
Further, as set out above, non-EU jurisdictions will implement bespoke regulations transposing the MDR into local law, and will not be within DAC6. On the basis of current announcements, it does not appear that disclosure in a non-EU jurisdiction (under local MDR legislation) would remove the need for a UK disclosure under the UK DAC6 Regulations (for a reportable arrangement). For instance, a professional trustee in a Crown Dependency, if it has a sufficient EU footprint (see above) or is dealing with an underlying taxpayer in the EU, might need to report the same arrangement twice (under parallel regimes) or the EU taxpayer might need to make a parallel disclosure. However, as it is envisaged that there will be exchange of information between jurisdictions under the MDR, this is subject to further development.
Differences between DAC6 and MDR
Taking into account the encouragement to consider the MDR commentary in applying DAC6 legislation, the substantive coverage ought usually to be in sync. However, as well as the two measures having separate reporting lines, there are other differences.
In particular, the retrospectivity elements of the measures work differently.
- Under MDR, promoters of offending arrangements implemented on or after 29 October 2014 must report within 180 days of the local legislation taking effect. However, this does not apply if the arrangement concerned assets valued at below $1million (or equivalent) and this obligation only applies to "promoters" (but not intermediaries other than promoters). Otherwise, all intermediaries must report within 30 days of a trigger point.
- Under DAC6, offending arrangements are caught if the first step was taken after 25 June 2018, and there is no limitation as to the intermediaries caught by the reporting obligation. If the first step was before 1 July 2020, then the reporting deadline was originally 31 August 2020 (but will now be 28 February 2021 – see below). Otherwise, as with the MDR, intermediaries must report within 30 days of a trigger point.
There are other differences, including the information reported and penalties for non-compliance. Importantly, the definition of "intermediary" is also different, although, in light of the direction towards the MDR commentary, one would expect the term generally to be interpreted harmoniously. Additionally, DAC6 of course covers a number of other hallmarks.
Certain jurisdictions have enacted legislation implementing the MDR (eg Guernsey, Isle of Man), or are in the process of doing so (eg Jersey). We will soon start to see how the two measures work together in practice.
In light of the COVID-19 pandemic, the European Council made a formal amendment to DAC6 on 24 June 2020 giving Member States the option to defer the reporting deadlines by up to six months.
The UK Government is availing itself of this option, as are a number of EU jurisdictions (e.g. Belgium, Luxembourg), and The International Tax Enforcement (Disclosable Arrangements) (Coronavirus) (Amendment) Regulations 2020 were enacted on 9 July 2020 in that regard. As a result, there will be a new timeline for DAC6 to take effect.
- Where the first steps of an arrangement were implemented between 25 June 2018 and 30 June 2020, the reporting deadline will now be 28 February 2021 (not 31 August 2020).
- For offending arrangements triggering a report between 1 July 2020 and 31 December 2020, the 30 day filing period will begin on 1 January 2021.
- Arrangements triggering reporting after that point will need to be reported within 30 days, as normal.
- There is scope for further extension, depending how the pandemic evolves.
Despite the imprecise wording (which might lend itself to wide interpretation), one suspects that the level of reporting under Hallmark D of DAC6 and the MDR will actually be relatively limited in relation to private holding structures (at least in mainstream jurisdictions). Whilst purposive tests are generally unclear, the policy intent of AEOI and registers of beneficial ownership is unmistakable. It will often be obvious where steps are designed purely to secure reduced reporting.
The most important point is that, if a set of steps results in reduced reporting under the CRS or on a beneficial ownership register, there must be an independent and overriding justification for those steps, other than simply reducing the level of transparency reporting. For instance, if family members are to be added as discretionary trust beneficiaries at a later stage, it would need to be, for instance, because they are genuinely intended to have no entitlement pending an independent contingency (e.g. marriage or divorce). Or, for instance, if financial assets were moved to the United States, it would need to be because of an independent need to have assets in the United States (e.g. to invest in a business, or to support a child studying there). Of course, moving assets to the United States might actually make little difference to the AEOI position if the taxpayer's home jurisdiction has a reciprocal Inter-Governmental Agreement with the United States. Where there is a clear non-transparency rationale, it is unlikely that intermediaries would consider the arrangement reportable, except out of an abundance of caution.
The most difficult cases will be where the underlying individuals have a genuine concern about the results of transparency reporting. For instance, one might, in certain parts of the world, fear governmental persecution on grounds of race or religion, in which case one would be nervous about the incumbent government having full visibility over one's interests. A sympathetic intermediary might well find itself with a reporting obligation in such circumstances.
Separately, there is an interesting point where different jurisdictions participating in the CRS apply different interpretations, for instance about the value to attribute to the interest of a pure protector or a settlor who has been excluded from benefit. If one were to move one's assets from one CRS jurisdiction to another because of such interpretational differences, such a step is unlikely to offend DAC6 or the MDR (because there would be no shelter from AEOI) but the position is not free from doubt.
In any event, as with the CRS, there are grey areas and complexities, which mean that there will inevitably be mistakes in applying these measures. One of the most important questions going forward is likely to be how excusable those mistakes will be.