More transparency rules, less tax avoidance

The European Council has taken important steps to enhance the exchange of information between tax administrations in order to promote tax transparency and fair tax systems in EU countries. This in turn creates a deeper and fairer single market. However, ambiguity in disclosure obligations and a high threshold requirement risks leaves the door open wide enough for dubious tax schemes to slip through.

One of the benefits of the European Single Market is that EU citizens and businesses have the freedom to move, do business and invest across national borders. But since direct taxation is not harmonised across the EU, this freedom also entails that some taxpayers manage to avoid or evade paying tax in the countries they reside or do business in. In 2011, the EU Council agreed to ramp up cooperation between tax administrations to help make sure taxpayers pay their fair share (Council Directive 2011/16/EU).

On 25 May 2018, the cooperation between tax authorities was enhanced to include mandatory automatic exchange of information in relation to reportable cross-border arrangements (Council Directive 2018/822/EU). This new directive further expands the scope of automatic exchange of information in tax matters, which  had already been enlarged to include automatic exchange of financial account information in 2014, of cross-border tax rulings and advance pricing arrangements in 2015, and of country-by-country reporting in 2016.

Mandatory disclosure of aggressive tax planning schemes

Mandatory disclosure rules require intermediaries such as tax advisors, accountants and lawyers to report to tax administrations on aggressive tax planning schemes they are selling or making. Taxpayers are also required to report to tax administrations on the aggressive tax planning schemes they are making use of.

The mandatory disclosure rules aim to combat tax avoidance by means of helping identify regulatory loopholes, helping tax administrations to assess the risks, having deterrent effects on taxpayers and reducing the supply of these schemes by tax advisors.

In 1984, the United States became the first country in the world to introduce mandatory tax disclosure rules. Since then, a few other countries including some EU members have also introduced mandatory disclosure rules into their tax systems (The UK, Ireland, Portugal, plus Canada, South Africa, South Korea and Israel among non EU countries). Indeed, the Lux Leaks and Panama Papers scandals and the fiscal State Aid cases pushed this anti-tax avoidance mechanism up on the EU base erosion and profit shifting agenda by demonstrating the role of intermediaries in the area of aggressive tax planning. As a first result of this political pressure, the European Council has now not only required common tax rules for mandatory disclosure in Member States by 31 December 2019, but also placed an obligation on all Member States to automatically exchange information on reportable cross-border schemes by 1 July 2020.

More information for all EU governments

The new directive requires that the information is automatically exchanged with other EU members through a central directory. Thus, all EU countries will have access to a database on tax avoidance schemes. A similar database called the “aggressive tax planning depository” has existed within the OECD: such depository includes 400 types of schemes but is only available to a close-knit group of countries. The new directive will create a level playing field for all EU member countries in terms of access to such relevant information.

Failure of the Promoter-Based Approach

The assessment of the recent progress however is not entirely positive. The potential for ambiguity on what constitutes a tax avoidance scheme creates a serious risk that cross-border arrangements go unreported. Precisely because there are numerous and regular conflicts between tax administrations and taxpayers/advisers on the interpretation of tax laws, it should be expected that many schemes will be designed in grey areas which certain promoters might chose to interpret as not being subject to the remit of the reporting obligation. To mitigate against this risk, the reporting obligation should not just fall on either the client using an aggressive tax planning scheme or the promoter (tax advisers) of the scheme, but on both.

Unfortunately, the directive places the disclosure obligation primarily on the intermediaries, i.e., the tax advisors, accountants and lawyers designing and selling aggressive tax planning schemes. In some limited instances, taxpayers are also obliged to disclose tax planning schemes. If both were obliged to report independently on marketed/used tax avoidance schemes, the detection of illicit schemes would have been facilitated.

High Threshold Requirement: The Main Benefit Test

The new Council directive sets out generic and specific hallmarks for describing whether a transaction is reportable or not. This is a general implementation under existing mandatory disclosure regimes. However, the directive also sets ‘the main benefit test’ as a threshold that a reportable scheme must satisfy before it is assessed against the generic hallmarks and some specific hallmarks. For a scheme to satisfy the test, it must be established that the main benefit, or one of the main benefits which a person may reasonably expect to get from the scheme, is a tax advantage. While threshold requirements are often used to filter out irrelevant disclosures and reduce tax administrative burdens, setting up a high threshold for disclosure can create an inappropriate justification for escaping mandatory disclosure obligations. The OECD stated that the main benefit test is a high threshold for disclosure. Thus, the European Council has opened a door through which intermediaries may inappropriately skip out on their mandatory disclosure obligations.