Analysis: The UK implementation of DAC 6: examining the draft regs

Legislative history and timetable

DAC 6 came into force on 25 June 2018 and provided a timetable for EU member states to implement the disclosure regime, which forms part of the wider EU regime on automatic exchange of information. Member states are required to introduce implementing legislation by 31 December 2019 and the first disclosures are to be made after 1 July 2020. This has created an immediate problem in that DAC 6 will ultimately require taxpayers to make disclosures in relation to transactions entered into on or after 25 June 2018, even though domestic implementing legislation has only now begun to emerge. This means that taxpayers (and advisers) may now face the task of going back and reviewing transactions undertaken during this period to ascertain whether they are disclosable or not. Where the first step of a transaction takes place between 25 June 2018 and 1 July 2020, the disclosure will need to be made by 31 August 2020. This information will form part of the first batch of automatic exchange, which is scheduled for 31 October 2020.

Form of the draft regulations 

The draft UK regulations contained in the consultation follow the same approach taken in relation to other international automatic exchange of information regimes, such as FATCA, in that the regulations set out the mechanics of how the reporting will work within the context of the UK tax system. Generally speaking, the key aspects of the regime, such as who should report and the types of transaction to be reported, are left to the DAC 6 Directive itself, which is then referred to directly by the draft regulations.

The draft regulations also import, by reference, the description of each hallmark and definitions of the key terms (‘intermediaries’, ‘relevant taxpayer’, ‘reportable cross-border arrangement’ and ‘reportable information’). Whilst this should ensure some consistency between member states, there are plenty of areas where jurisdictions might take a different view. For example, the question of who is an ‘intermediary’ for the purposes of DAC 6 is capable of being interpreted differently in different jurisdictions which may create difficulties in determining exactly who has the responsibility for reporting. There is much detail in the consultation, including the basic nature of the regime. It is not possible to cover all of this here (see ‘The EU reportable arrangement rules for intermediaries’ (Geoff Hippert), Tax Journal, 3 May 2018), so this article assumes a certain amount of knowledge of the purpose of the rules and focuses on the proposed approach to the UK implementation of four main aspects of the regime:

• identifying what is disclosable under the UK rules;
• identifying who should make a disclosure under the UK rules;
• practical management of reporting in the UK; and
• cross-border issues created by discrepancies in domestic implementation amongst member states.

The UK rules: what is disclosable

Despite the uncertainty provided by the way in which DAC 6 has been implemented, practitioners in the UK have, at least, experience of the UK’s DOTAS regime contained in FA 2004 Part 7, with which DAC 6 has much in common. There should therefore be familiarity with the concept of looking at whether a transaction contains certain ‘hallmarks’, which are viewed by the tax authorities as indicators of aggressive tax avoidance transactions. However, unlike the UK DOTAS regime, which contains a general requirement for disclosable transactions to have a tax avoidance purpose, DAC 6 does not apply a tax avoidance test to all of the hallmarks. This has the potential to catch a number of standard transactions with no particular tax motive, which creates compliance difficulties as it would not be immediately apparent to those involved in the transaction that a filing might need to be made. There are two major defined terms in the draft UK regulations that expand on terms that are not explicitly defined in the Directive. The first is ‘tax’, which is defined in para 12(2) of the draft regulations as including tax in any jurisdiction (whether a member state or not). This appears to be in keeping with the way in which the underlying Directive is drafted, but it can lead to a result where a transaction may be reportable even though no member state is disadvantaged as a result of the transaction. This could lead to accidental non-disclosure of transactions simply because parties may not have taken tax advice in their member state on the basis it was seen to be irrelevant.

The second defined term is ‘tax advantage’, which is defined at para 12(1) of the draft regulations. The first part of this definition will be familiar to UK tax practitioners as it contains the usual language providing that a tax advantage is broadly any reduction in tax, increase in relief or tax deferral. It does, however, go on to provide that a tax advantage only occurs if it cannot reasonably be regarded as consistent with ‘the principles on which the relevant provisions that are relevant to the reportable cross-border arrangement are based and the policy objectives of those provisions’. Whilst this language is somewhat vague, it does give a technical reason why the rules should not apply to a transaction such as an investment in a pension (provided not undertaken as part of some wider avoidance scheme). This is a helpful and welcome legislative development and could potentially counter one of the main difficulties with the main purpose test in UK domestic legislation.

DAC 6 will require taxpayers to make disclosures in relation to transactions entered into on or after 25 June 2018, even though domestic implementing legislation has only now begun to emerge

The UK rules: who must disclose?

The draft regulations define ‘intermediary’ by reference to the Directive. The guidance provided by HMRC in the consultation then identifies two distinct categories of intermediary. The first are ‘promoters’, those who actually design, market, organise, make available or implement a reportable arrangement. The second, ‘service providers’, simply provide assistance or advice in relation to those activities. HMRC’s approach is that service providers will not be intermediaries if they did not know and could not reasonably have been expected to know that they were involved in a reportable arrangement. This is a welcome clarification. The example given is of a bank providing finance. The bank is not expected to make a disclosure if it does not have sufficient knowledge of the wider arrangements and of whether any hallmark is present. The bank is not required to do significant additional due diligence to establish whether an arrangement is reportable. Service providers which regularly act at the periphery of transactions may be relieved by this clarification.

Several other indications arise from the consultation:

• A service provider who does not know (and could not reasonably be expected to know) the jurisdiction of residence of the recipient of a payment or what the effect of a payment will be will not be an intermediary for DAC 6 purposes.
• The draft regulations confirm that an employee of an entity that would be regarded as an intermediary should not be personally liable to report or pay penalties.
• The ‘recipient’ of a payment will be the person taxable on its receipt so that, for example, for a partnership the partners will be treated as the recipient.
• Payments between associated persons made to blacklisted countries are automatically caught. Bermuda’s appearance on the blacklist for a short period in March 2019 raised some concerns. We now have part of an answer: the list of blacklisted countries should be examined on the day on which the reporting obligation arises and does not need to be re-examined after that point. What is not clear though is when the reporting obligation for the pre-1 July 2020 arrangements arises. Is it on the day on which the first step is implemented or 1 July 2020, the first day of the specified period during which a report must be made?

Practical management of reporting in the UK

Cross border complexities

There are a number of further complexities that arise from cross-border transactions (which, by the very nature of the legislation, are inherent to the regime).

Even in a UK-only context, this would be complicated enough, but once the cross border element is included, the position becomes even more complex

The first complexity is that each intermediary needs to work out where it needs to report. The Directive sets out a hierarchy where the rules of more than one member state require disclosure and the UK regulations follow this strictly. This should ensure that a transaction is reported in only one jurisdiction, but does mean that (say) a UK branch of a German resident company would need to ascertain whether a transaction is disclosable under the German DAC 6 rules, even if the transaction has little connection with Germany.

The second complexity arises where another intermediary is required to report and has made a report. This should exempt all other participants, provided they obtain evidence that the disclosure has been made and contains all the information they would have had to report. This will again require consideration of the disclosure rules under several jurisdictions in order to establish whether a disclosure has been properly made in a manner that satisfies the reporting requirements of all those jurisdictions, which rather cuts across the philosophy of only requiring one disclosure to be made.

This is exacerbated where the rules differ from one member state to another in terms of what needs to be disclosed and by whom. Looking at this from a UK perspective, this means that helpful interpretation from HMRC has the potential to cut both ways. For example, a transaction may be entered into under which there are various UK consequences. Careful consideration of the UK DAC 6 rules leads the parties to consider that no UK disclosure needs to be made, as the transaction is in keeping with the purpose and policy of the underlying UK tax legislation. The transaction has a participant in another member state in which such transactions are explicitly subject to domestic anti-avoidance rules. This party therefore takes the view that its own authority would expect the transaction to be disclosable, which is an odd result when the transaction has no tax effect in that jurisdiction.

Further difficulties are introduced by legal privilege. An intermediary is not required to report legally privileged information. When the intermediary is unable to report because of legal professional privilege, it is required to inform other intermediaries of the fact and of their reporting obligations. Privilege only extends, of course, to privileged information: HMRC is clear that it considers most of the information requested to be factual and not privileged in nature. The examples given are of names of taxpayers and intermediaries and descriptions of the transactions undertaken. In practice it seems likely that intermediaries would agree for reporting to be undertaken by a party who is not subject to legal privilege who will make a single report with all the required information. Privilege works very differently across different jurisdictions and so lawyers must expect to devote a fair amount of time to negotiating the intricacies of the regimes when advising cross-border.

If taxpayers and intermediaries get it wrong, the penalties can be significant. Penalties for failure to report the crossborder arrangement largely follow the DOTAS approach (starting with daily penalties of up to £600 but allowing for the First-tier Tribunal to impose penalties of up to £1m). Failure by a relevant taxpayer to make an annual return can be up to £10,000 per arrangement. There are also penalties of up to £5,000 for failure to notify an arrangement reference number or to make three monthly returns in respect of marketable arrangements.

What next?

The materials provided for consultation provide a steer in some areas of concern but fall short of being complete guidance. It had been clear since it was first published that the DAC 6 reporting obligations would be far-reaching. We now have some examples from HMRC and some of the ‘surely nots!’ can be taken off the monitoring list from a UK perspective. We also have some encouraging commentary in relation to the extent of an intermediary’s deemed knowledge of arrangements. Unless a concerted effort is made to align the domestic implementation and interpretation with that of other member states, however, this may create more difficulties for intermediaries than it solves. We look forward to publication of the guidance. In the meantime, taxpayer and intermediaries would be well-advised to:

• Continue monitoring and maintaining a record of potentially reportable transactions in preparation for 2020 reporting.
• Discuss commercial arrangements around the reporting process itself. What oversight, rights of comment etc. will be retained by those parties that do not report? Do engagement letters need to be amended to allow for this?
• Work closely with colleagues in other member states to understand how DAC 6 is being implemented and raise awareness of discrepancies in approach.
• Keep a track of areas of uncertainty and the basis on which decisions in those areas were taken.
• Consider raising areas of uncertainty with HMRC during the consultation period which runs until 11 October.