“Reporting aggressive tax arrangements, a challenge!”

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In the coming months, due to EU Directive, DAC 6, financial sector players will be expected to report additional information about arrangements implemented by their clients that could be perceived as potentially aggressive. How can financial institutions with no, or with limited, tax resources, comply?

After OECD BEPS recommendations translated into EU Directives, CRS, AML 4 with tax fraud being a new predicate offense of money laundering, the Luxembourg financial sector continues to face additional legal requirements to achieve a greater transparency.

The implementation of the 6th avatar of the Directive on Administrative Cooperation, commonly known as DAC 6, aims at strengthening tax transparency and fighting against what is regarded as aggressive cross-border tax planning through the identification of specific hallmarks.

While normally DAC 6 makes it mandatory for Luxembourg intermediaries (being promoters or mere service providers) to report those arrangements deemed to be “aggressive” from a tax perspective to the Luxembourg tax authorities, the current amended version of the DAC 6 draft law will shift some responsibilities to taxpayers.

Indeed, DAC 6 foresees that taxpayers will be liable to the reporting obligation if there is no EU intermediary involved in the arrangement or if intermediaries are subject to professional secrecy as defined by the Member States’ domestic laws. Following the opinion of the State Council, it is now likely that tax advisors of audit firms, lawyers and domiciliation companies having a qualified accountant status (which would have been considered most of the time as primary intermediaries) be exempt from the DAC 6 reporting obligation.

Considering that those primary intermediaries will benefit from the waiver of their reporting obligations, they will be shifted to other intermediaries (e.g. banks), or probably in most cases, to the taxpayer. In such cases, the final assessment will be of the responsibility of such intermediaries not covered by professional secrecy or of the taxpayer (even though they will be informed of the pre-analysis made by the waived advisor).

Taxpayers would also need to consider solutions to report the arrangements notified by their advisors.
Murielle Filipucci

Murielle Filipucci,  tax partner,  PWC Luxembourg

Therefore, other intermediaries that thought to rely on the DAC 6 reporting made by the tax advisors to waive their obligations to perform their own reporting would need to reconsider their operational procedures.

Similarly, taxpayers would also need to consider solutions to report the arrangements notified by their advisors. In addition, they would have to disclose in their own tax returns the use they made of such arrangements. The Luxembourg draft law, in line with position taken in neighboring countries (notably France and Germany), will result to the paradox that a Directive primarily targeting tax advisors would impose in practice reporting obligations to taxpayers.

Nevertheless, this change in the draft law does not mean that those intermediaries would be exempt from any due diligence obligations. Indeed, they will remain liable to assess which arrangements they design, market, organize, or for which they provide (directly or indirectly) implementation assistance or advice would be in scope of DAC 6.

Operationally speaking, all intermediaries (with a professional secrecy or not) would need to, if not already done, start a DAC 6 project that should first focus on the impact assessment.

Typically, each business unit within an organization should:

• Review its products, services, the type of documentation collected from the clients depending on the associated risk level; and

• Identify request for tailor-made products and services and the rationale behind such request.

Such impact assessment will help to determine the desired target operating model and the governance that should be implemented around this regulation.

We do not expect financial institutions to report a material volume of arrangements. The difficulty would be to prove to tax authorities why a particular arrangement was not reported.
Murielle Filipucci

Murielle Filipucci,  tax partner,  PWC Luxembourg

From our experience, financial institutions will face three main challenges. The first one is around the divergent interpretation of the Directive regarding treatment of branches which is of particular importance for the Luxembourg banking sector. Indeed, based on the Luxembourg draft law, relevant cross-border arrangements related to the foreign branch would need to be reported to the Luxembourg tax authorities. However, based on certain foreign laws (in our example, France), a French branch of a Luxembourg bank would need to report its relevant cross-border arrangements to the French tax authorities. Hence, in practice double reporting or double exemption scenario could occur while operationally speaking, a Luxembourg head office may have to report arrangements that are not recorded in its systems and assessed based on different laws, procedures and processes.

Secondly, we do not expect financial institutions to report a material volume of arrangements. The difficulty would be to prove to tax authorities why a particular arrangement was not reported. This would require a compliance framework, if possible technology enhanced, to assess the reportability of all new arrangements (or at least the one not clearly excluded by the impact assessment) and archive the reasoning behind the conclusion obtained.

Finally, the reportability assessment implies judgmental input (e.g. regarding if the arrangement was mainly tax driven) and a better understanding of the tax documentation collected for AML purposes which is a big difference to CRS reporting, for example where all data could be extracted from the IT system. As such, training plan and detailed guidance included in procedures would need to be implemented keeping in mind that the first reporting on arrangements put in place since 25 June 2018 would need to be assessed and reported by 31 August 2020.