Directive on Administrative Cooperation (DAC)

Businesses that may be entering into or advising on cross-border arrangements within EU jurisdictions, will need to review where mandatory reporting will be required. DAC6 applies to arrangements that fall within certain hallmark requirements, where the expected benefit can result in a tax advantage via a CRS Common Reporting Standard (CRS), which is global standard for the exchange of automatic tax and financial information. This data will then be shared to a central directory that is accessible by the National Competent Authority in each Member State. Failure to comply with the new directive amendment can result in penalties and sanctions imposed by local tax authorities as well as reputational risk.

What is a Hallmark?

A set of specific characteristics or features of cross border arrangements that could potentially present an indication of risk of tax evasion as listed in Annex IV of the Directive. As part of the Directive, hallmarks are split into 5 categories. Hallmarks only apply if a threshold ‘main benefit’ test is reached. Hallmark categories are as follows:

• Category A – Generic hallmarks linked to main benefits test
• Category B – Specific hallmarks linked to main benefits test.
• Category C – Specific hallmarks that relate to cross border payments
• Category D – Hallmarks undermining reporting obligations
• Category E – Hallmarks undermining reporting obligations

What is a ‘Main Benefit’ test?

The test indicates that the main objective of the arrangement, is to obtain a tax advantage. This can be extremely difficult to interpret.

What is an intermediary?

This can be any firm or person that ‘designs, markets, organises or makes available for implementation or manages the implementation of a reportable cross-border-arrangement (RCBA)’. These include, but are not limited to, accountants, lawyers, banks and insurers.

What must be reported?

• Identity of taxpayers and any intermediaries involved in a transaction which includes, but are not limited to, tax ID number, tax residence, and name and place of birth if the taxpayer is an individual.
• Applicable hallmarks
• Relevant local legislation
• Summary of arrangement
• Value of arrangement

What are the penalties for non-disclosure?

The Directive states that any penalties implemented into local legislation within an EU Member State must be ‘effective, proportionate and dissuasive’. Failure to comply could also lead to reputational damage as well as sanctions.

Taxation and its interaction with our markets is an important area of focus for ISLA. As mentioned above, the DAC 6 hallmarks will only apply if the threshold ‘main benefit’ test is met whereby, you can identify that the main outcome of an arrangement is for a tax advantage. This can be particularly tough to apply; where firms would understand the broad commercial rationale behind their client’s transactions, it is unlikely that they would know when entering into a securities lending agreement why a client is entering into it specifically, and especially whether it is tax motivated, unless this is agreed prior to terms of contract. Whilst the MDR’s can be widely interpreted, it is clear that the spirit of the Directive is to disclose anything that has a significant tax outcome due to the structure of the transaction. DAC 6 is mainly focused at large corporate transactions, and the impact of potential financial and reputational damage is too large for firms engaging in securities lending to ignore. Firms must understand which transaction types are affected under the disclosure regime, and identify any transactions undertaken throughout the transition period. Where a financial institution is acting solely as a counterparty to a securities lending transaction or as an agent organising the transaction, then firms will need to clarify whether they were acting as an ‘intermediary’.

For more information on how DAC 6 applies to securities lending and borrowing, please see our Position Paper, drafting with Deloitte LLP here.

If you wish to participate in discussions around DAC and other tax matter relating to securities lending and borrowing – please sign up to ISLA’s Tax Working Group. For enquiries, please contact regtech@isalemea.org