On 25 May 2018 the EU Council published a directive (https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32018L0822) amending Directive 2011/16/EU on the automatic exchange of information, which is known as DAC6. The amendment refers to the introduction of a new reporting obligation for cross-border tax arrangements that may potentially be regarded as aggressive and politically undesirable. The EU Member States are obliged to transpose the directive into domestic law by 31 December 2019.
The German federal government has now passed a draft law, broadly in line with EU requirements, that addresses the implementation of the mandatory disclosure of cross-border tax arrangements.
As of July 1, 2020, reportable cross-border tax arrangements must be disclosed to the tax authorities in a timely manner, and before the start of any tax audit here in Germany. In addition, the reporting obligations will also apply retroactively to cover reportable cross-border tax arrangements in which the first step is taken between June 25, 2018 and July 1, 2020.
New mandatory disclosure rules under DAC6
Under the latest amendment of the European Directive on Administrative Cooperation 2018/822 (“DAC6”), EU Member States are obliged to transpose mandatory reporting rules for potentially aggressive tax planning structures (tax arrangements) into domestic law. A tax arrangement is reportable if:
- it is a “cross-border tax arrangement”, and
- certain hallmarks as stipulated in Annex IV of DAC6 are fulfilled.
Under the German draft law for the implementation of DAC6 mandatory disclosure rules, Germany will enact reporting obligations for cross-border tax arrangements that are largely in line with DAC6. However, there are some particularities in terms of how DAC6 will be implemented in Germany.
Cross-border tax arrangements only
The new reporting obligation covers only cross-border tax arrangements. Let’s assume that a tax arrangement is implemented between a German subsidiary and its non-resident parent in another EU Member State or in any other country. Such cross-border arrangements are relevant only if they impact German taxes that are not harmonized across the EU, such as corporate income taxes, trade taxes, real estate transfer taxes, and insurance premium taxes, for instance. Arrangements (exclusively) concerned with VAT are not relevant.
Debates were lengthy and heated as to whether Germany’s implementation of the new disclosure obligation would also cover purely domestic tax arrangements. The current draft law does not include a domestic reporting obligation, but such obligation still might be introduced in a separate draft law later.
The hallmarks, which are grouped into five categories (A to E), aim to cover generic and specific characteristics as well as certain consequences of tax planning. These hallmarks encompass compliant but politically undesirable tax planning structures, i.e. structures that have not crossed the line between legal tax planning and abusive tax planning or even tax evasion.
- Category A focuses on the advisor-client relationship (e.g. confidentiality agreements, remuneration) and the nature of tax structures (e.g. highly standardized structures).
- Category B addresses specific results of tax structures (e.g. double deduction of depreciation amounts, low-taxed payments).
- Category C deals with cross-border payments in a controlled situation (e.g. tax-exempt payments received from a related party).
- Category D focuses on situations in which the reporting of financial accounts under CRS is avoided and certain cases of economic ownership structures.
- Category E deals with selected transfer pricing matters.
The wording of the draft law does not discernibly differ from the DAC6 requirements, but the German federal government has expressed its own understanding of the hallmarks in an accompanying explanatory note. Take the following examples:
Explanatory note: examples for hallmarks
A standardized structure (Category A) is defined as the establishment and use of foreign financing companies, particularly in low-taxing foreign countries, if the design of the structure can be used by other taxpayers without significant changes in content or concept. Likewise, the centralization of intra-group services in low-taxing states, e.g. a purchasing company, can also represent a standardized structure of the design in connection with this hallmark.
Category B refers to “round-tripping intangibles”, for instance. These are self-developed intangible assets that are licensed (non-exclusively) by a domestic parent to a foreign low-taxed subsidiary for the manufacture of end products. Since the German parent remains the owner of these intangible assets and is not affected by the contractual exclusive and time-limited nature of the license, a relatively low license rate can be at arm’s length. If the end products manufactured by the foreign subsidiary are sold to the parent, a reportable cross-border tax arrangement is in place.
Main benefit test
The hallmarks of Categories A, B and, to some extent, C give rise to a reporting obligation only if the “main benefit test” is satisfied. This refers to whether it can be established that the main benefit or one of the main benefits which a person may reasonably expect to derive from an arrangement is obtaining a tax advantage.
Therefore, DAC6 and the German draft law distinguish between hallmarks that lead to a reporting obligation once objective characteristics are fulfilled (Categories C to E) and those for which an additional subjective characteristic (i.e. a taxpayer’s intention) must be satisfied (Categories A to C).
The main targets of the reporting obligation under DAC6 are not the taxpayers themselves, but their advisors and financial service providers (intermediaries) who contribute to the creation or implementation of reportable tax planning structures. An intermediary is any person who designs, markets, organizes or makes available for implementation or manages the implementation of a reportable cross-border tax arrangement. The reporting obligation is limited to those intermediaries who are resident or have a permanent establishment in an EU Member State, in particular.
The draft law’s definition of an intermediary does not materially differ from the definition under DAC6. Unlike the DAC6 directive, however, the German draft law does not contain a reporting obligation for “auxiliary intermediaries”, but it does make clear that an intermediary must have played a specific role with regard to a given tax structure. As regards the geographical limitation, the draft law defines a “German” intermediary as someone who either (1) is a tax resident in Germany or (2) has a permanent establishment situated in Germany that provides services in relation to a reportable tax arrangement, or (3) is registered in Germany in a professional register or with a professional organization in connection with the provision of legal, tax or advisory services.
However, some unclarities remain under the German draft law. For instance, let’s assume that a German resident entity has a branch office in a third country. The branch office provides services in relation to a reportable tax arrangement, but the head office in Germany has no involvement in these services. In that case, it is questionable whether the head office in Germany will have a mandatory reporting obligation under German law, because the entity still qualifies as an “intermediary” as per 1 and/or 3 above. Otherwise, the relevant taxpayer will have a reporting obligation.
Under the German draft law, an affiliate of a group of companies providing tax advice (i.e. the group corporate tax department at the parent) for another group affiliate should also qualify as an intermediary and may therefore face a reporting obligation with regard to reportable cross-border tax arrangements designed, marketed or managed “in-house”.
Neither is it fully clear under the German draft law whether a law firm in the form of a separate legal entity or the individual tax advisor who acts on behalf of that law firm qualifies as the intermediary. In our view, only the law firm should qualify as an intermediary if it has concluded a service contract with the relevant taxpayer and the individual tax advisor is an employee of the same law firm. The same conclusion should apply to situations in which an individual in-house tax advisor is employed by the relevant taxpayer, in which case the reporting obligation lies with the relevant taxpayer as his/her employer.
DAC6 gives EU Member States the option to exempt intermediaries from the mandatory reporting obligation where it would breach legal professional privilege. If the reportable tax arrangement is devised by the taxpayer himself (i.e. no intermediaries are involved), or if the involved intermediaries are residents in third countries only, or if domestic laws prevent the reporting by the intermediary, the reporting obligation will shift to the user of the tax arrangement, i.e. to the taxpayer.
The German draft law exempts German tax advisors, lawyers and public auditors from the mandatory disclosure obligation due to legal professional privilege, although a waiver of this privilege is possible. Thus, the disclosure obligation can shift to the relevant taxpayer of the tax arrangement. However, intermediaries that claim legal professional privilege are still required (1) to inform the relevant taxpayers of such privilege and its possible waiver and (2) to submit data on the general scope of the reportable tax arrangement on a no-name basis.
Reportable information includes personal data of the taxpayer and the intermediary, a detailed description of the relevant hallmarks, and the value of the reportable arrangement, for instance.
The reportable information must be reported to the Federal Central Tax Office located in Bonn, Germany, within 30 days beginning, for instance, on the day after the reportable cross-border tax arrangement is made available for implementation. Next, the Federal Central Tax Office assigns a registration number for the disclosed arrangement and a disclosure number.
The reported information will be subject to automatic exchange of information among tax authorities of EU Member States. The European Commission is therefore setting up a register into which each EU Member State must regularly (quarterly) enter the information on reportable arrangements which it has received in its jurisdiction.
Incorrect reporting or failure to comply with any disclosure obligation will be an administrative offense with a maximum penalty of €25,000 each time. These penalties will apply only to cross-border tax arrangements set up after June 30, 2020.
Recommended actions for multinationals
The draft law is still in the legislative process, which is expected to be finalized by the end of 2019. However, no significant amendments are expected.
Therefore, multinationals with operations in Germany can take action right now to preempt the expected outcome of the legislative process as outlined above:
- Start analyzing cross-border tax arrangements that were set up in Germany since mid-2018 or that are contemplated for the near future, because the explanatory notes on the draft law provide detailed guidance on each hallmark and reportable arrangements
- Prepare accurate documentation for reportable tax structures that must be disclosed. It is expected that the disclosure of these tax structures will become the roadmap for future tax audits in Germany.
- Prepare accurate documentation also for non-reportable tax structures that do not have to be disclosed, in particular for potentially aggressive tax structures that are not covered by DAC6. It is expected that their non-disclosure will be challenged in future tax audits, like these structures themselves.
- Be prepared for complex technical and procedural reporting issues for taxpayers and intermediaries if a cross-border tax arrangement must be disclosed.