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01 June 2020

DAC 6: six types of ambiguity

 EU Council Directive 2018/822 ('DAC 6') was passed in May 2018 and has been incorporated into UK law by the International Tax Enforcement (Disclosable Arrangements) Regulations, SI 2020/25 ('the regulations'). Together, these instruments have introduced a mandatory reporting regime which requires 'UK intermediaries' to report details of certain cross-border arrangements to HMRC. The regime is intended to expose 'aggressive tax avoidance' within the EU.

Unless there is a coronavirus-related postponement (which is possible as a proposal to postpone has been tabled by the European Commission), the regulations will take effect from 1 July 2020 and will apply retrospectively to certain reportable cross-border arrangements dating back to 25 June 2018. Generally, a cross-border arrangement will be reportable where it satisfies at least one of a number of 'hallmarks' of tax avoidance, set out in an annex to DAC 6. Some of these hallmarks are wide in scope. Many, but not all, are subject to a so-called main benefit test, which means they are only met where the main benefit that may reasonably be expected from the arrangement is a tax advantage. This test is discussed below.

The drafting of DAC 6 is imprecise and unlawyerly, and there is scope for debate about what its provisions mean, and what arrangements are caught. The ambiguities in DAC 6, as well as the lack of final guidance so close to commencement, may create real issues for tax and indeed other professionals.

All tax professionals should be aware of these new reporting requirements. There will be an initial 'look back' reporting process, requiring the submission of reports to HMRC in relation to reportable arrangements since 25 June 2018. Unless there is a postponement due to Covid-19, these reports must be submitted before 31 August. After this period, there will be a requirement to report to HMRC about any reportable matters on an ongoing basis.

The issue is, with so little published guidance and so many uncertainties, how will we know what to report? In this article we look, with apologies to William Empson and his famous work of literary criticism Seven types of ambiguity, at six of the ambiguities in DAC 6.

Legal professional privilege

One of the questions lawyers may be asking themselves is to what extent they are protected from having to make reports by legal professional privilege (LPP).

Under the regulations, there is no requirement for a UK intermediary to disclose 'privileged information' (reg 7(1)). Legal advice is normally privileged, and information provided to lawyers in the course of obtaining advice is normally privileged as well. One would therefore expect lawyers to be protected from having to make DAC 6 reports, except where the client has waived privilege. Such a waiver will not generally be advisable but, as noted below, waivers of LPP sometimes occur accidentally.

However, it appears that HMRC may not see the matter this way. An HMRC consultation document issued in July 2019 suggested that much of the information that would need to be reported would not be covered by LPP, because it will be factual in nature, and facts themselves are not covered by LPP. This is very unlikely to be correct, and it is certainly inconsistent with the approach that HMRC has accepted in relation to the DOTAS regime. The Law Society, among others, has made submissions to HMRC on this point. So far, HMRC has not given any formal acknowledgment that what it said about LPP in the consultation document was wrong, although there are indications that its view may have changed.

Even if it is eventually accepted by HMRC that factual information can be covered by LPP, and therefore that lawyers in possession of such information are by default protected from having to report under DAC 6, it should be remembered that LPP can be forfeited, for example through the sharing of legal advice to persons other than the client without the imposition of a condition of confidentiality. The law of LPP is a complex topic worthy of an article in itself. There may be cases where analysis of the issue of whether LPP has been retained may be every bit as time-consuming as analysis of the issue of whether there is a reportable cross-border arrangement.

A further question is the scope for a lawyer to assert LPP where the lawyer has 'marketed' the cross-border arrangement to the client. There are indications that HMRC think LPP is automatically inapplicable in this scenario. HMRC seems to think that the act of 'marketing' is an activity that a lawyer would not properly perform in his/her capacity as a lawyer, so information received by the lawyer in the course of or following such 'marketing' cannot benefit from privilege. This is doubtful, but it may depend on what HMRC mean by 'marketing'.

Even where privilege has been preserved, and means

Tax Journal, Issue 1488, 10 at 11that a lawyer does not have to report, the question of whether a given arrangement is reportable will usually still need to be addressed, because, if it is reportable, the client or another intermediary with awareness of the arrangement may be under a reporting obligation.

The main benefit test and the meaning of 'tax advantage'

An even more fundamental uncertainty concerns the main benefit test (MBT). As already noted, some, but not all, of the DAC 6 hallmarks are subject to this test. The test is met if 'the main benefit or one of the main benefits which, having regard to all relevant facts and circumstances, a person may reasonably expect to derive from an arrangement is the obtaining of a tax advantage'. The EU legislation does not specify what it means by 'a person', creating ambiguity about whether the reference is to a hypothetical reasonable person or an actual participant in the arrangement. Arguably, the fact that all relevant facts and circumstances must be taken into account points to the second of these possible interpretations. The relevant facts and circumstances must be those of the actual participant, or perhaps a hypothetical reasonable person in the same position as the actual participant (which amounts to more or less the same thing). Crucially, the relevant facts and circumstances must, logically, include the contents of any advice (or, in the case of a marketed scheme, promotional material) given to the participant regarding the tax effect of the transaction. Self-evidently, such advice/material may misrepresent the chances of the transaction 'working' so as to generate a tax advantage. It may therefore create a reasonable expectation that a tax advantage will be derived in cases where, if the participant was correctly advised, he would understand that the chances of this are low or zero. In other words, a participant may have an expectation of a tax advantage that is reasonable, and yet incorrect.

'Tax advantage' is also not defined in the EU legislation. However, it is defined in the regulations, as including reliefs, repayments, avoidance and deferrals etc. where 'the obtaining of the tax advantage cannot reasonably be regarded as consistent with the principles on which the relevant provisions.... are based and the policy objectives of those provisions' (reg 12(1)(a)). It follows that where obtaining a tax saving can reasonably be regarded as consistent with the relevant principles and policy objectives, it does not constitute a 'tax advantage' for these purposes.

The test here seems similar to the so-called double reasonableness test in the general anti-abuse rule (GAAR). The definition of 'tax advantage' for the purposes of the MBT recognises that there may be a range of views about whether a particular tax saving is consistent with the principles on which the relevant tax legislation is based and the policy objectives of that legislation. A tax saving is not a 'tax advantage', as defined, provided that at least some reasonable people would consider it consistent with the principles and policy of the relevant legislation, even if a consensus could not be achieved.

In theory, this point is of course very helpful, as it narrows the application of the hallmarks which are linked to the MBT. However, it means that to apply the MBT, it is necessary not only to determine whether some tax benefit was intended to be secured by the arrangement, but also whether that benefit could reasonably be regarded as consistent with the policy of the relevant tax legislation. Although there are some cases where this will be obvious, there will be many where it is not. Although the broad policy of tax legislation is usually clear, taxing provisions can have effects that verge on the arbitrary. It can be difficult to determine whether the ultimate effect of a given set of taxing provisions is what the legislature 'meant', or to discern the thinking behind a particular provision. Not infrequently, the only safe way to determine what the legislature intended is to look at what it actually enacted.

Further difficulty here is created by the GAAR, TAARs and the recent tendency of the UK tax tribunals and courts to adopt 'purposive', non-literal interpretations of UK tax legislation. These developments mean that, in the current climate and within the current tax code, it is debatable whether achieving a UK tax saving that is clearly contrary to the policy of the relevant tax legislation is even possible. Generally, there is a strong argument that if a tax saving can be secured, it must be consistent with tax policy, because if it weren't, there would be something to stop it. But if that is right, it implies that where arrangements intended to achieve UK tax savings are concerned, the MBT will generally only apply to failed arrangements, i.e. those that, properly analysed, will not have secured the tax saving that was their main purpose. A participant in such an arrangement may reasonably, but wrongly, expect to secure such a tax saving if he receives incorrect or incomplete advice.

This line of argument seems to limit the compass of the MBT-linked hallmarks, in the context of UK tax planning, rather severely. Can they really have such limited ambit? However, the conclusion reached above perhaps isn't that surprising when it is remembered that DAC 6 is EU-wide legislation, and that there may be variations in the sophistication of tax legislation across the EU. It is possible that the MBT-linked hallmarks will have more of a job to do under the iterations of DAC 6 that apply in other European countries. But under the UK iteration of these rules, it is an interesting question how many cases, in reality, will involve a UK tax saving that could not reasonably be regarded as consistent with policy.

Hallmark A1 and non-disclosure agreements

The next ambiguity concerns hallmark A1, and the question of when a non-disclosure agreement (NDA) can bring an arrangement within this hallmark.

Hallmark A1 is subject to the MBT and applies to a cross-border arrangement 'where the relevant taxpayer or a participant in the arrangement 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.'

Hallmark A1 is evidently aimed at NDAs imposed by promoters of marketed tax 'schemes' on their clients/victims, which seek to keep the 'technology' behind such 'schemes' under wraps. However, the concern with hallmark A1 is that, on a literal reading, it is blind to the purpose of 'the condition of confidentiality'. It might

Tax Journal, Issue 1488, 10 at 12be thought that there is a risk of an arrangement being caught where, for example, an NDA has been put in place between a tax advisor's client and other parties, with the aim of preserving LPP in advice given to the client. This is not uncommon.

There is a good argument that the latter sort of NDA is not, in fact, capable of making an arrangement fall within hallmark A1. Arguably, this hallmark has to be construed purposively, so that it is restricted to NDAs that prevent, or purportedly prevent, parties from disclosing information about tax 'technology' from tax authorities or other intermediaries. It should not extend to NDAs that do permit information to be disclosed to tax authorities as required by law, but prohibit the release of privileged advice.

Hallmark A3 and precedents

Hallmark A3 is a further source of uncertainty. This applies to cross-border arrangements 'that [have] substantially standardised documentation and/or structure and [are] available to more than one relevant taxpayer without a need to be substantially customised for implementation.'

Like hallmark A1, this hallmark is subject to the MBT, which filters out cross-border arrangements that aren't tax-driven, or where any expected tax benefit may be regarded as consistent with tax policy. An example of this might be offshore life bonds, which tend to be based on highly standardised documentation. However, not all situations involving standardised documentation are so clear-cut.

It is hoped that HMRC will be prepared to accept that documents are not 'standardised' merely because a 'precedent' is used as the starting point, provided that there is genuine tailoring of the document to meet the client's requirements. If so, the ambiguity here is around what is sufficient tailoring, and how this would apply to precedent which is routinely used without heavy modification.

Arguably the intention is for this hallmark to catch standard-form documents used by 'scheme' providers, and there is a distinction to be drawn between such documents and 'precedent'-based documents produced by law firms for the particular needs of their clients. Although the largest part of any such document (e.g. the 'boilerplate') will in almost all cases match the 'precedent', key provisions of the document are likely to be different. Even where this is not the case, it is arguable that the process of considering and checking the suitability of these provisions means that the document should not be regarded as 'substantially standardised'.

Hallmark B2: in what circumstances is it right to say that income has been converted into capital?

Of all the hallmarks, perhaps the most unclear is hallmark B2. This hallmark is subject to the MBT, and it applies to '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.'

This is troublingly vague. There are many situations where a capital sum is received and, absent the arrangement, income would have been received, or might possibly have been received. The question is of course when it is correct to say that such income, or potential income, has been 'converted' into capital.

There are indications that HMRC consider arrangements to be outside this hallmark where the arrangements are 'normal commercial practice'. It is not immediately obvious how this factor is relevant. It may have some relevance for the question of whether the MBT is met. But there may be scope for argument about whether a particular kind of arrangement is 'normal commercial practice', so it may not be that helpful as a filter. And there are situations which have nothing to do with commerce, where the concept of 'normal commercial practice' is effectively meaningless.

There is an argument that, for income to be 'converted' into capital, the recipient of the capital needs to have had an income stream, or a right to income, prior to the entry into the arrangement. If that were correct, it would exclude from hallmark B2 situations in which the recipient of the capital might have received income, but had no entitlement to any. That would take out of the equation capital distributions from discretionary trusts where the beneficiary could have received an income distribution, and so on. There is, we would suggest, a fair argument that this is the right reading. However, it is understood that HMRC reads hallmark B2 as potentially applying to cases where there is no right to income, as well as to cases where there is.

It is very hard to say, with any confidence, what this hallmark is meant to catch. Part of the difficulty here may be that under the UK tax system, it is questionable whether, in reality, there are any arrangements that can convert income into capital for UK tax purposes, in a manner that goes against the grain of the relevant legislation (see above, re the meaning of 'tax advantage'). Such arrangements are likely to fall foul of specific anti-avoidance measures, such as the transactions in securities legislation or the transfers of assets abroad code, or the GAAR, or purposive judicial construction.

It may be that this hallmark, and the other hallmarks that are subject to the MBT, can only really apply in a UK tax context to arrangements that are intended to achieve a tax benefit contrary to the policy of the relevant legislation, but (viewed objectively) are unlikely to secure that benefit.

Hallmark D1: purely objective?

If the views tentatively expressed above are right, the MBT should represent a substantial filter, and the number of arrangements caught by the MBT-linked hallmarks should be small. But that still leaves those hallmarks which are not subject to this filter. These include hallmark D1.

Hallmark D1 catches 'an arrangement which may have the effect of undermining the reporting obligation under the laws implementing Union legislation or any equivalent agreements on the automatic exchange of Financial Account information, including agreements with third countries, or which takes advantage of the absence of such legislation or agreements.' The ambiguity here is chiefly about intentionality. Is this hallmark satisfied merely if it results in automatic exchange of information (AEOI) rules being undermined, or must the participants have intended that outcome? And what does 'undermining' mean, anyway?

In HMRC's view, the issue of whether an arrangement 'may have the effect of undermining' AEOI is a purely objective one, considering all the facts and circumstances but without reference to the subjective intention of the persons involved. Thus, the test will be satisfied where a reasonable person with a full understanding of the circumstances would come to the conclusion that the arrangement would have the effect of undermining AEOI, even if the actual participants in the arrangement did not intend it to have that effect.

However, there is an argument that, properly construed, Hallmark D1 has a mens rea element to it, requiring the effect of undermining AEOI to be deliberate. In part, this comes from the use of the word 'undermine', which carries an undertone of deliberate subversion. More cogently, perhaps, DAC 6 stipulates that hallmark D1 should be interpreted in accordance with the OECD's model mandatory disclosure rules for addressing CRS avoidance arrangements, and those model rules are expressly directed at 'arrangements designed to circumvent reporting obligations' (emphasis added).

Perhaps the answer to this is that an arrangement can, at least in theory, be designed so as to circumvent AEOI but be implemented by persons who are ignorant of the fact that it was so designed, and have no such objective; in this theoretical situation, hallmark D1 will be met despite the innocence of the participants. But this is surely a fanciful scenario. In practice, it is highly likely that if an arrangement has been designed to circumvent AEOI, it will be put in place by participants who intend to do just that. Conversely, if the participants have no intention of circumventing AEOI, it is extremely unlikely that they will be putting in place an arrangement that has been designed for that purpose. In practice, subjective intentions are very likely to be relevant for the application of this hallmark.

Although there seems to be some ongoing disagreement between HMRC and advisers about how this hallmark should be interpreted, it seems clear, at least, that HMRC accept that an arrangement may result in non-reporting without that 'undermining' AEOI. For example, if cash in a bank account (within reporting) is used to purchase land (outside reporting), HMRC accept that the resultant non-reporting is a natural consequence of the way the reporting rules have been framed and that there is no 'undermining' of AEOI. Similarly, it is hoped that HMRC will accept that, for example, a simple gift of cash to a relative living in a country that is not part of the CRS reporting network (e.g. the USA), made with genuine donative intent and not for the purpose of taking the money outside AEOI, falls outside hallmark D1.

The beginning is nigh

Given the multitude of ambiguities, it will be very hard for professionals to analyse matters and confidently identify whether they should be reporting.

However, HMRC's guidance may not be released until June, and the regulations will come into force in July, unless there is a coronavirus-related postponement further to the recent European Commission proposal. Waiting until the ambiguities are clarified before preparing to report is therefore not an option. Views will need to be taken on many of these points, and it will be crucial to keep a record of legal arguments and thought processes, so that (if necessary) such views can be defended further down the line.


This article was first published in the Tax Journal. Please see here to view.

For more information please contact Dominic Lawrance at dominic.lawrance@crsblaw.com or Elinor Boote at elinor.boote@crsblaw.com

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