In one of our previous issues we have informed you about the directive that is being prepared and concerns mandatory automatic exchange of information in the field of transparency applicable for tax consultants which would have an impact on notification obligation not only for tax advisors. The directive concerning tax and cross-border reportable arrangements was passed in May 2018. The Directive gives a deadline for implementation of the provisions into national legislations of member states; December 31, 2019. The new legal provisions which are necessary for accordance with the Directive must be applied by the member states no later than July 1, 2020.

Introduction

The European Union is attempting to protect tax interests of individual member states, and that’s why a leak of information, such as the Panama Papers, gave even more of an incentive to the lawmaker to fight the growing aggressive tax planning. The EU believes that some tax evasions are caused by financial intermediaries or tax consultants. For these reasons, a directive was drawn up (which amended Directive 2011/16/EU on administrative cooperation in the field of taxation), which gives financial intermediaries and other providers of tax consultancy the duty to inform the tax administration about any potentially harmful tax planning.

In the previous article we have informed you about the subjects which are obliged to make public certain information, and included the dates for publication. In this article, we would like to talk about what are the characteristics of harmful tax planning and what are the possible sanctions for not complying with the notification obligation.

Defining the hallmarks

What will actually be the subject of notification obligation? This draft has not attempted to define the term agressive tax planning and instead compiled a list of aspects and transactions which are a clear indication that someone is attempting tax evasion or even tax abuse.

The notification obligation applies to intermediaries or taxpayers who conduct any cross-border arrangements (defined below) which fit the description of at least one of the characteristics listed in Annex 4. of the Directive. There are generic (A) and specific hallmarks (B-E). Generic hallmarks and specific hallmarks of the B category can be taken into account only if the test of main benefit is passed.

The test is passed if the main benefit of the arrangement is the obtaining of a tax advantage.

General characteristics (A) include:

• The taxpayer undertakes to comply with a condition of confidentiality which may require them not to disclose how the arrangement could secure a tax advantage vis-à-vis other intermediaries or the tax authorities.
• The intermediary is entitled to receive a fee for the arrangement and that fee is fixed by reference to the amount of the tax advantage derived from the arrangement; or whether or not a tax advantage is actually derived from the arrangement.
• An arrangement that has substantially standardised documentation and is available to more than one relevant taxpayer without a need to be substantially customised for implementation.

Specific hallmarks (B) include:

• Acquiring a loss-making company, discontinuing the main activity of such company and using its losses in order to reduce its tax liability. Including through a transfer of those losses to another jurisdiction or by the acceleration of the use of those losses.
• An arrangement that has the effect of converting income into capital, gifts or other categories of revenue which are taxed at a lower level (or exempt from tax).
• Circular transactions resulting in the round-tripping of funds, namely through involving interposed entities without other primary commercial function or transactions that offset or cancel each other or that have other similar features.

Specific hallmarks (C) related to cross-border transactions include:

• An arrangement that involves deductible cross-border payments made between two or more associated enterprises where at least one of the following conditions occur:
  • the recipient is not resident for tax purposes in any tax jurisdiction,
  • although the recipient is resident for tax purposes in a jurisdiction, that jurisdiction either does not impose any corporate tax or imposes corporate tax at the rate of zero or almost zero; or is included in a list of third-country jurisdictions which have been assessed as being non-cooperative etc.,
  • the payment benefits from a full or partial exemption from tax,
  • the payment benefits from a preferential tax regime,
• deductions for the same depreciation on the asset are claimed in more than one jurisdiction,
• relief from double taxation in respect of the same item of income or capital is claimed in more than one jurisdiction,
• transfers of assets where there is a material difference in the amount being treated as payable in consideration for the assets in those jurisdictions involved.

Specific hallmarks concerning automatic exchange of information and beneficial ownership (D). These include arrangements which bring about tax evasion in the jurisdiction in which the tax subject resides. They may include:

• the use of jurisdictions that are not bound by the legal provisions or agreements on automatic exchange of information,
• the reclassification of income and capital into products or payments that are not subject to the automatic exchange of information,
• the use of legal entities, or structures that eliminate or purport to eliminate reporting automatic exchange of information,
• the use of jurisdictions with inadequate or weak regimes of enforcement of anti-money-laundering legislation etc.

The Annex 4. of the Directive includes also hallmarks concerning transfer pricing (E) which include arrangements that involve the use of unilateral safe harbour rules and the transfer of hard-to-value intangibles.

What is understood by the term cross-border arrangement: arrangement in more than one member state, or in a third country and a member state, where at least one of the conditions below is met:

• not all of the participants in the arrangement are resident for tax purposes in the same jurisdiction,
• one or more of the participants in the arrangement is simultaneously resident for tax purposes in more than one jurisdiction,
• one or more of the participants in the arrangement carries on a business in another jurisdiction through a permanent establishment situated in that jurisdiction and the arrangement forms part or the whole of the business of that permanent establishment,
• one or more of the participants in the arrangement carries on an activity in another jurisdiction without being resident for tax purposes or creating a permanent establishment situated in that jurisdiction,
• such arrangement has a possible impact on the automatic exchange of information or the identification of beneficial ownership.

Penalties

The amount and character of penalties for not complying with the notification obligation in the required extent is for the time being left to the consideration of individual member states. The Directive states only that such penalties should be effective, proportionate and dissuasive. We can only ask, how will individual member states go about that. The Czech Act on Income Tax currently includes a penalty for not complying with the notification obligation with tax exempt income. The penalty is a percentage of the amount of the not reported income. The percentage rises with the degree of the transgression. It is the lowest where the tax subject notifies of the income themselves without the tax administration’s intervention, highest where the taxpayer does not comply even in the substitutive time period given by the administration. There are no maximum penalties set of an absolute amount. It can be expected that the financial administration will handle this case similarly.

The form and information reported by member states

To ensure universal condition for implementation of the Directive, the European Commission has been given the authority to adopt a standard form with a limited number of components in different language modes.

The member states will be obliged to report information about intermediaries, their identifications (including name, VAT number, tax residency). It is also necessary to give a detailed description of hallmarks, which are listed in the annex, and which lead to the reporting of this cross-border arrangement. Besides the detailed description of hallmarks and a summation of the contents of the cross-border arrangement which the relevant company conducts, there is much more information that needs to be stated such as the date of commencement of the arrangement, value of the transaction etc.

To conclude

It follows from the above mentioned that the obligation imposed by this Directive will extend also to advocates and tax advisors providing services of the above described character. Question stands, how will the Czech financial administration confront the confidentiality of these two professions, confidentiality anchored in legislation on profession. The Directive takes this into account and allows the member states to adopt measures upon implementations which will exempt tax advisors and advocates from the obligation of providing the above mentioned information, provided that this obligation should be imposed on some other intermediary who would not have to confront confidentiality, or even on the taxpayer directly. In such cases, the tax advisor or advocate would only bring their client’s attention to this notification obligation. Let us see what the amendment implementing this obligation will look like. We will keep monitoring the situation and informing you about any developments.

Veronika Džalavjan & Daniela Riegel