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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.

Taxation of the digital economy: the European package.

On March 21 the European Commission published a set of proposed new rules and measures on taxation of the digital economy in an attempt to set a starting point for the expected international negotiations on this matter, when the OECD has preferred to acknowledge the absence of sufficient consensus.

The key elements of this package are two proposals for a directive. One, containing rules on the taxation of businesses with a significant digital presence. The other, an announced proposal for a directive on the common system for a tax on digital services, charged on income from the provision of certain digital services. In other words, a proposal for the creation of a new tax in every member state on the income from those services, as a transitional solution until the directive on significant digital presence can be approved, which is not currently possible due to the failure to reach a consensus within Europe and internationally. The third element completing the package is a Commission Recommendation approved on the same date, March 21, suggesting that member states include in their tax treaties with non-Union states the guiding principles in the European Union on the idea of significant digital presence. All of which is rounded off with a Communication from the Commission to the European Parliament and the Council on the background and reasons for the proposed reform.

Through this package the European Commission has taken a step further towards its goal to harmonize corporate income tax and moved the global debate on by proposing a two-stage plan. Faced with the absence of a consensus over the taxation of this income, the Commission has proposed first implementing a tax that in actual fact taxes income at 3 percent. This new digital services tax would be charged on income from the provision of certain digital services and only where they are provided by certain companies earning sizable revenues. In the terminology used by the Directive, taxable services are those consisting in the placing on a digital interface of advertising or which allow users to find other users and to interact with them as well as the transmission of data collected about users which has been generated from such users on digital interfaces. These services are taxable where the provider’s worldwide revenues exceed €750 million and the total amount of taxable revenues obtained within the Union exceed 50 million.

The Commission acknowledges however that this tax is only a provisional solution and proposes a directive on corporate income tax for companies with a significant digital presence, a concept that involves an ad hoc reformulation of the old concept of permanent establishment.

This proposal for a directive assumes that the application of current corporate income rules to companies in the digital economy “has led to a misalignment between the place where the profits are taxed and the place where the value is created”. Consequently, it is clearly acknowledged that a reform of the principles of international taxation is necessary to adapt them to an economy in which intangible assets and the value of data are fundamental elements, without losing sight of the goal to tax income where wealth is generated. It is admitted that the traditional rules fail to tax the income of a nonresident in the absence of a physical presence and acknowledged that the principles governing the transfer pricing system lead to an underpricing of the functions and risks associated with the digital economy. Not even the CCCTB rules could ensure recognition of greater participation in the taxation of the income arising from the new economy for the states where the users of this digital economy are located.

Faced with this challenge, the proposal for a directive puts forward the this idea of a “significant digital presence”, as a new element broadening the concept of permanent establishment. It only captures, however, income arising, not from the digital economy, but from the provision of certain digital services, services delivered over the internet or over an electronic network and the nature of which renders their supply essentially automated and involving minimal human intervention, and which cannot be provided without information technology. The proposal details a number of services included in this definition such as the supply of digitized services generally, services proving or supporting a business or personal presence on an electronic network or those generated automatically from a computer via the internet or via an electronic network, in response to specific data input by the recipient, in addition to those listed in annex III, which basically relate to services delivered over the internet, or the sale of goods or other services facilitated by the use of internet.

This digital presence also requires certain thresholds to be met, notably a number of users greater than 100,000 or a number of contracts between companies for the provision of those digital services higher than 3,000, in that member state.

Besides altering the concept of permanent establishment, the proposal for a directive recognizes that the problem lies also, or especially, in the profit attribution rules, and therefore sets out its own profit attribution rules in this case, by including among the risks and functions any economically significant activities performed through a digital interface, especially in relation to data or users which are relevant to the exploitation of the company’s intangible assets.  The profit split method is the preferred method to determine attributable profits.

In short, one of the main problems associated with this tax package is simply the lack of consensus or international agreement which makes it very difficult to apply these principles and definitions in member states’ relationships with non-Union countries. The Commission Recommendation is very well-intentioned by trying to include this solution in relationships with non-Union countries through the negotiation of tax treaties which, moreover, it is admitted would otherwise prevail preventing a harmonized global solution from being applied. And to achieve that solution in an OECD or any other context, we will come up against the obstacles posed by the differing interests of the countries concerned, according to the types of companies they have.

Digital Economy and Taxation

There has recently been a resurgence of the debate on the consequences of the digital economy on taxation, or perhaps better expressed as, on the form of adapting international taxation to the digitalization of the economy. Commissioner Moscovici has said that the European Commission will present its new proposals in March, in line with similar declarations from the French government.

This concern over the consequences of digitalization on the economy is nothing new. Leaving aside earlier precedents, such as the OECD works on the digital permanent establishment and the later French 2013 Collin & Colin report, the key milestones in this debate are:

  1. Firstly, the OECD’s BEPS report devoted action 1 to these challenges of the digital economy. The final report in October 2015 was not particularly precise when it came to offering solutions, but it introduced the framework for the debate by determining this need to respond to the consequences of digitalization either in connection with the concept of permanent establishment, by accepting the idea of “significant economic presence”, or by creating new tax concepts, in the form of new “withholding tax” scenarios or of taxes on certain types of transactions to fill the gap left by the lower taxation of companies focused particularly on the digital economy.

In 2017, the OECD launched a new phase in this analysis with the document published on September 22 which should give rise to a specific report appearing soon.

  1. Later, on September 21, 2017, the European Commission published its Communication on a fair and efficient tax system in the European Union for the Digital Single Market.

 

This Communication is connected with the VAT package launched in 2017 which included the announcement in December 2017 of a new VAT system for online cross-border sales.

 

  1. Lastly, various EU countries have approved measures or published important documents. The reform of Italian legislation, which took effect on January 1, 2018, broadened the definition of permanent establishment, to take in economic presences without the backing of a physical presence, and taxed certain digitally supplied services. And in November 2017, the Treasury of the United Kingdom published a detailed “position paper” that is of particular interest.

But what does this movement towards adapting taxation to the digital economy broadly mean? According to the reasons given by the European Commission, the current rules no longer fit the modern context and are resulting in a number of technology giants not paying the taxes they should be paying. As a result, international taxation should allow income to be taxed where it is generated. This standpoint has focused the debate on direct taxation, although it has always been thought that the treatment of the digital economy requires a global view that considers both direct taxes on the income of companies and indirect taxes and, in particular, VAT on the supply of digital goods or services, or digitally supplied goods or services. From another angle, that approach has concealed the greater complexity that the problem encloses.

When the European Commission accepts in its Communication that digitalization affects all companies, but in varying degrees, it is admitting that in actual fact its proposals will be directed at particular business models, which are listed in the Communication itself: basically, online retail platforms, social media models, audiovisual digital services and the so-called collaborative economy. In relation to these sectors, it is sought to alter the rules determining the taxing powers of each state by introducing the concept of a significant commercial presence, even where there is no physical presence, and especially to alter the rules on calculating the tax relating to each state. Beyond taking the opportunity to offer the Common Consolidated Tax Base as a global solution, the Commission accepts the difficulties associated with the task, the setbacks associated with unilateral solutions, and the need to offer alternative solutions to the broadening of the definition of permanent establishment, solutions such as a tax on insufficiently taxed income, a withholding tax on income from certain types of transactions, or a specific tax.

Indeed, as the UK government’s position paper recognizes, the current debate is questioning the validity of the rules developed a century ago, but only to a certain extent or to the extent that those rules are now having effects that are rejected by being unfair for certain countries. As opposed to what we sometimes hear, it is not a question of companies paying taxes where they sell, because now, like then, most states argue that a company must pay taxes where it designs, produces and sells its products regardless of where its customers or consumers are located. What happens is that this principle, which continues to be at the core of consensus, is seen as unfair or inadequate in relation to the taxation of certain activities based (and here countries’ views vary) on the use of their users’ data, on digital advertising services targeted at those users from another country, or on certain digital intermediary platforms. And besides, these issues must be seen in light of other problems arising from the age-old transfer pricing principles, when trying to determine what portion of the income relates to certain intangibles, above all when they are in low-tax jurisdictions.

All in all, the difficulty now lies in how to justify this differentiation in the taxation of certain activities, and how do so without treading on the toes of any of the states with differing positions.