by Alex Postma
In March, the European Union (EU) adopted far-reaching tax reporting rules that took effect on 25 June. While most attention has been focused on their effect on large multinational corporations, the rules apply equally to small businesses and even to individuals that have dealings across borders.
The reach of these rules expands beyond income taxes to cover all levies except value-added tax, social security contributions, and customs and excise. The new Disclosure Directive leaves many questions unanswered, but companies can take steps now to mitigate risks.
So what does the EU want? In a nutshell: cross-border tax arrangements that meet certain criteria (hallmarks) must be reported to the tax authorities. These reports must detail the features of the arrangement, the benefits, the criteria that triggered the reporting and the identification numbers of the taxpayers.
Until July 2020, the reporting is limited to cross-border arrangements that began implementation after the Directive entered into effect. However, this will then be expanded to “arrangements that are ready or have been made available for implementation.” And although in the first instance the reporting obligation rests on (tax) services providers, there are several exceptions where taxpayers themselves are required to report.
Now, one may ask: “What is an arrangement, and what are these hallmarks?” Here we immediately arrive at the main difficulty of applying these rules. Even though the Directive requires Member States to extend reporting to transactions that happen after 25 June 2018, the European countries have until December 2019 to go through their own legislative processes and develop and define the terminology that will tell us what we need to do today.
Is this effectively retroactive application possible, or even constitutional, in the various Member States? But perhaps more importantly, the question arises as to the wisdom of introducing substantial reporting obligations on an entire European business community with no time to build the processes and information systems and with details of what to build still underway.
Unfortunately, the Directive puts the business community in just that position. It directs EU Member States to implement new legislation and leaves much of the fine-tuning and wordsmithing to the individual countries. For now, this causes significant concern for tax professionals and taxpayers alike.
Let me give a small example of the questions we are trying to answer — and my apologies for getting technical. One of the hallmarks (C2) states: “Deductions for the same depreciation on the asset are claimed in more than one jurisdiction.” Now what situations could this potentially apply to?
- Branch assets outside a country of incorporation could, depending on the rules in the country of residence, have depreciation both in the branch country and in the residence country. Is this covered?
- US companies, for their US tax calculations, need to take into account the depreciation on all the assets in their subsidiaries. Is that intended to be covered?
- In fact, some countries may have controlled foreign corporation (CFC) provisions that reduce the CFC income by the depreciation of assets in the country of the CFC. Is this intended?
- Will some EU Member States interpret this rule to include the depreciation on the “right-to-use asset” in IFRS 16 Lease situations?
These are just a few of the questions surrounding the C2 hallmark, one of many in this new Directive. Is this really the type of information the EU is after, or is it only looking for situations in which two taxpayers are purposefully intending to obtain a tax deferral from using differences in ownership rules between the different Member States? The ambiguity in the Directive will — in my view — lead to massive over-reporting, which is not efficient for the tax authorities and will be massively time-consuming and costly for taxpayers.
One may also ask: “What does the EU legislator mean to achieve with this Directive?” In the view of the EU, it is critical that Member States’ tax authorities obtain more and better information about what they see as potentially aggressive tax arrangements. This, they believe, will improve the tax authority’s ability to close loopholes and make it easier to undertake adequate risk assessments and carry out tax audits. For this purpose, all mandatory disclosure reports will be recorded in a central directory accessible to the Member States.
If the experience with the EU countries that already have a form of mandatory disclosure (Portugal, the Republic of Ireland and the UK) is any kind of measure, the “closing of loopholes” is not likely to generate significant legislative activity from the Member States. This is due in part to the discouragement effect of the Directive.
On the other hand, the level of detail in the Directive is very different from its three EU predecessors, as it provides very broad information to tax auditors to undertake risk assessments and to carry out tax audits. More focused audit activity is therefore likely to follow.
If you have not yet found the opportunity to get up to speed with the Directive, here are some things you should do to prepare:
- Check your service contracts with your tax providers for confidentiality clauses or whether the fees are contingent on the tax outcome to confirm that you are not tripping immediately on hallmarks.
- Keep a detailed logging system that differentiates by hallmark so that two years from now you can apply new insights after all the Member States have turned this into domestic legislation. This can then be applied to all the instances you have logged.
- Make sure it is clear who is responsible for the filing for each instance that needs to be reported and keep track of what is submitted. Think about consistency. Different advisors filing reports with different perspectives will not help you.
- Be fully aware that arrangements that are submitted will be seen once the relevant entities are audited. Properly documenting and maintaining detailed files will be key.
- Engage with your country’s legislator to explain the consequences of too broadly drafted provisions, and of diverging implementations, in the different EU MS.
Getting this right is important. Member States are directed to include penalties that are effective, proportionate and dissuasive. If the penalties that were used for country-by-country reporting provide any indication, they could be substantial — potentially several hundreds of thousands of euros per breach — and they could also include non-monetary penalties.
How we can help: International Tax Services