The new disclosure obligation on tax intermediaries

The European has finally approved after a particularly quick procedure the Directive requiring so called tax intermediaries to supply specific information on transnational transactions with tax relevance. We are talking about Directive 2018/822  of 25 May 2018 (Official Journal June 5), amending Directive 2011/16/EU as regards mandatory automatic exchange of information in the field of taxation in relation to reportable cross-border arrangements.

1.- Background to the Directive

Some countries had tried out reporting mechanisms for transactions that could involve aggressive tax planning. Examples are the tax shelter disclosure system in the U.S. or the DOTAS (disclosure of tax avoidance schemes) regime in the UK. These experiences spread to other countries and were the inspiration for BEPS Action 12 on mandatory disclosure rules. In the final report on this action, the OECD called for the use of these disclosure regimes, in relation to the “promoters” of standard schemes identified through hallmarks. Disclosure would have the dual aim of providing immediate information to the authorities and as a deterrent from offering abusive planning schemes.

Taking up these ideas in the BEPS project, the European Commission submitted a Proposal for a Directive of 21 June 2017, and, following the political agreement by ECOFIN on March 13, 2018, the wording of Directive 2018/822 was reached containing notable differences with respect to the wording of the initial proposal, especially in relation to broadening the personal scope of the reporting obligation itself. The Directive amends Directive 2011/16, on automatic exchange of information between the member states in the field of taxation, which is why it is known as DAC6.

2.- Content of the Directive.

The contents of the Directive are easily summarized. The so called tax intermediaries must report to their tax authorities specific information on any cross-border arrangements in which they take part, where those arrangements have any of the hallmarks listed in the Directive itself. Then the member states will automatically exchange that information and therefore have prompt knowledge about abusive or potentially abusive planning arrangements.

The information must relate to a cross-border arrangement (“dispositifs” and “mecanismos” in the French and Spanish versions). There are no reporting obligations for purely domestic arrangements, not affecting any other state, although a member state may unilaterally include those transactions in the scope of the mandatory reporting regime.

No definition is given of “arrangement”. It must be interpreted as meaning any dealing or transaction or set of dealings. And these arrangements are mandatorily reportable where they have any of the characteristics or hallmarks set out in the New Annex IV to Directive 2011/16.  These hallmarks appear to relate to different objectives. The first two of the five hallmark categories relate to the typical standard tax planning arrangements usually involving a tax purpose combined with a fee for the promoter and a confidentiality clause. The third category is targeted at arrangements leading to a no tax scenario by taking advantage of certain tax regimes including the absence of any corporate income tax or a zero or “almost zero” rate. The fourth category is designed to deter arrangements that may have an impact on the automatic exchange of information between countries and the identification of beneficial ownership. And the last category is perhaps the most controversial due to relating to transfer pricing matters. It includes arrangements linked to the transfer of hard-to-value intangibles and certain reorganizations between companies in the same group with transfers of functions, risks or assets, if the projected annual earnings before interest and taxes (EBIT) of the transferor over the three-year period after the transfer, are less than 50% of the projected annual EBIT if the transfer had not been made.

It is the intermediaries of a member state, not the taxpayers, in principle,  that have the obligation to report these arrangements. And the Directive deals with a very broad definition of intermediary. It encompasses anyone who designs, markets, organizes, or makes available for implementation or manages the implementation of a reportable cross-border arrangement. But it also means anyone that knows or could be reasonably expected to know that they have undertaken to provide, directly or through others, marketing, organizing, making available for implementation or managing the implementation of a reportable cross-border arrangement. Where more than one intermediary is involved, the reporting obligation falls on all of them, unless the same information has already been filed by another of those intermediaries. The relevant taxpayer has the reporting obligation only if there is no intermediary because the arrangement was devised and implemented in house or where the national rules on legal professional privilege relieves all the intermediaries from this obligation.

The reportable information appears to relate only to identifying the transactions, their characteristics and values.

3.- Conclusions

This Directive plays a crucial part in the move to review tax planning  practices, but has a defect by starting out from a lack of definition because it mixes up the information, and the combatting and the prevention of tax fraud, without clarifying the limits separating them, and shies away from any attempt to make the system it sets out serve to give greater legal certainty. To the contrary, it advises that the reporting of this information does not serve to obtain any degree of certainty in advance over the validity that the tax authorities will give to these arrangements. So its implementation in the various states may be confused and could ironically aid tax competition between them in addition to placing obstacles to the functioning of the internal market by leaving out purely domestic arrangements.

In Spain’s case, the transposition of the Directive will without a doubt rekindle old problems that have never been resolved: how to define tax advisors and the meaning and scope of their legal professional privilege. Elsewhere, by somehow singling out so called tax planning it will affect the internal organization of the profession.

On the intellectual origin of blockchain (III). More on the recent forerunners

I ended the previous post on the subject of David Chaum and how his DigiCash did not lead to a proper break with traditional cash. The disruptive leap in this respect, even if still only in a theoretical or speculative realm, is attributable to the following two characters in this story.

The first of these characters actually worked with David Chaum at the unsuccessful DigiCash company. I am talking about a U.S. citizen with a Hungarian surname: Nick Szabo. A multi-talented man: computer science graduate (1989) from the University of Washington, cryptographer and jurist. Besides working at DigiCash, he was the designer of bit gold, a digital currency project, forerunner of Bitcoin and blockchain. Many have said in fact that the real person behind the pseudonym “Satoshi Nakamoto” –the bitcoin creator – is Szabo, something he has always denied. British writer and journalist Dominic Frisby said: “I’ve concluded there is only one person in the whole world that has the sheer breadth but also the specificity of knowledge and it is this chap…”. There is even a subunit of the Ether cryptocurrency (the currency running on the Ethereum platform) that was given his name (the szabo).

Szabo’s first great contribution on this subject was a paper entitled “Smart contracts: building blocks for digital free markets”, published in a Californian futurist and transhumanist journal called Extrop in 1996. In this visonary article, Szabo, computer engineer, cryptographer, as well as jurist, asks how the Internet, combined with modern cryptographic protocols (asymmetric or double key cryptography, blind signature systems such as those devised by Chaum, multiple signature systems, mixing protocols) could revolutionize traditional contract law, by enabling such a basic part of the law, a contract, which is the basis of the whole of our market economy, to be up to meeting the requirements of online trading. It was in this paper that the term and idea of “smart contract”–now part of everyone’s vocabulary- was created: a software program through which obligations that are both agreed and programmed are enforced automatically, giving rise to a contract that executes itself, aided by computer technology. Which is ideal particularly for a contract not just between absent parties but also between strangers who have no ground for trusting each other. This was also where we first saw the term “smart property” used to refer to a smart contract incorporated into a physical object (a vehicle, the lock of a house), so the physical availability of that object is also programmable according to the terms of a specific agreement.

This first paper on smart contracts was revised and extended in a 1997 publication entitled “Formalizing and securing relationships on public networks”. Here we now find an allusion to the idea of a distributed trust, in other words, to how the participation of several agents in the monitoring and recording of a transaction is a guarantee of certainty and protection against fraud.

This idea was explored further and started to gain importance in publications such as “Secure Property Titles with Owner Authority” a paper published in 1998, in which, faced with the problems of political uncertainty and discretionality –in less developed countries especially- that are associated with centralized property record systems, it was proposed to have a titles database distributed or replicated across a public network (a record system that –it tells us- would be able to survive a nuclear war). This involves the creation of a kind of property club on the Internet that gets together and decides to keep track of the ownership of some kind of property. The title held by each is authenticated with the electronic signature of the previous owner a process that is reproduced with each successive owner, forming a chain. And the record of the chain of titles which shows the current owner of each item of property is based on a consensus of the majority of the participants, given that it is unlikely that they will all come to an agreement to commit fraud. As we shall see, here lies the core of the ownership recording system for the bitcoin.

Another important paper exploring these ideas is “Advances in distributed security” published in 2003, where Szabo proposes leaving behind the unattainable idea of absolute certainty, to settle for systems with a high probability of certainty such as that provided by cryptography. In this context, he proposes processes such as distributed time-stamping, the use of hashes as a means of identifying the time-stamped messages or files, the creation of “Byzantine-resilient” replication systems, etc.

Alongside his concern over alternative systems to ensure compliance with contracts and the chain of ownership using the Internet, software programming and cryptography, Szabo also turned his attention to the specific subject of money, going much further than the ideas explored by David Chaum. What concerned him, as we have seen, was the subject of privacy: how the fact of acting as intermediaries in our electronic payments gives the financial institutions knowledge of essential information on our lives. Szabo also confronted another issue: placing the value of the money we use at the discretion of political authorities; the problem of discretionary inflation, in other words. This is where the impact of his 1998 proposal for bit gold lay, which appeared at the same time as another very similar idea: b-money, belonging to Wei Dai.

This Wei Dai is a cryptographer, and a fellow computer science graduate from the University of Washington. In 1998 he published a very short paper with the title “B-money: an anonymous, distributed electronic cash system” in the Cypherpunks mailing-list which was later quoted as a reference work in the whitepaper by Satoshi Nakamoto (no work by Szabo was ever quoted as such). The driving force behind Dai’s work, like any good cryptoanarchist, was basically the opacity of cash transactions, and the terminology was perhaps a little too eloquent: “b-money”. An interesting fact is that the smallest unit of the Ether cryptocurrency is called “wei”, named after that forerunner.

The idea put forward in these proposals (which tie in with the most radical visions of cryptoanarchism of Tim May whom Dai explicitly quotes at the beginning of his paper) is not to represent the existing money that is legal tender in a new electronic format to enable or achieve the anonymity of electronic payments, instead to replace that money originating from the government with a new type of money created by the users themselves, assisted by the web and cryptography. This intention –having, as we can see, much more radical political significance because it questions one of the key attributes of state sovereignty, the printing of money- poses a problem going beyond a simple accounting record issue to control the circulation of money, in other words, avoiding the dual availability of a digital asset: that of how to control the creation of this money, to avoid discretionality and ensure its scarcity, and which is somehow a reflection of an economic activity or value.

Wei Dai proposed a type of regular online auction among the system participants to determine the amount placed into circulation in new digital coins.

Szabo’s approach was different. He had for some time been mulling over the idea of how to make a simple bit string (a given number of zeros and ones) into something of value in itself. He was looking for a digital object that could work like gold. The instrument he devised for this –an application of the hashcash algorithm created by Adam Back to prevent email spam, mentioned also by Nakamoto- was a computational proof-of-work, a solution that could be given an economic meaning similar to gold, through the effort and use of resources required for its extraction; the use of computation cycles, in this case. This electronic money devised by Szabo is therefore managed through a program on the web which puts a given mathematical challenge or problem to the system participants. This mathematical problem or puzzle is related to the cryptographic function known as hashing, and may only be solved using “computational brute force”, in other words, by trial and error using different figures until a string is found that fits. When this result is obtained, in the form of a given bit string, it becomes the system’s first unit of currency. The program rewards the first participant to find that string by giving them the unit of currency, which can then be used by this participant to make payments to other users, and so the unit of currency and its fractions begin circulating. This first bit string, obtained by solving the problem, is the starting point for the next challenge, which the program then poses. This is how new currency units are added to the system regularly and in a programmed way.

This proposal was perhaps a little primitive –owing its existence to a metal-based and therefore materialistic idea of money, as a thing that must be given an intrinsic value rather than simply as a symbol of value-, and misguided too, because the intrinsic value we give to gold does not arise only from its scarcity and the difficulty to obtain it, instead from its intrinsic properties as a substance, which can never be said of a sequence of zeros and ones no matter how difficult they are to obtain.

This idea of Dai’s in relation to having bit gold as b-money would never be put into practice, but is the most direct forerunner of the bitcoin.