BlueBridge’s DAC6 State of Play (Issue no. 3)

Please find BlueBridge’s DAC6 State of Play (Issue no. 1) and DAC6 State of Play (Issue no. 2), here and here, respectively. In these quasi-monthly blogs, we will provide reports on:

• The advances of DAC6 legislation and accompanying regulatory guidance in various EU Members States;
• The updates to reporting portals, XML schema and other IT infrastructure;
• The progress surrounding evolving topics, such as the treatment of EU-approved, special regimes, exemptions for legal professional privilege (LPP), mechanisms of local enforcement and other topics that may vary across EU jurisdictions;
• The evolving interpretations of the hallmarks that determine the reportability of cross-border arrangements;
• The compliance techniques adopted by assorted industries; and
• The news from the non-EU states that are implementing the OECD Mandatory Disclosure Rules (MDRs).

The Main Benefit Test

With scant DAC6 guidance issued in the summer months, this issue of the BlueBridge DAC6 State of Play will concentrate on what is currently the hot topic amongst DAC6 regulators and practitioners: The Main Benefit Test (MBT). Since the publication of the original DAC6 protocol in June 2018, questions surrounding the MBT have flourished. What does it mean? How will it work? Will it expand to apply to other Hallmarks? Will it be pulled back from Hallmarks to which it currently applies?

The MBT operates as a second element for numerous Hallmarks, the list of descriptors that DAC6 uses to identify aggressive cross-border tax planning. The mandatory application of the MBT necessitates that certain Cross-Border Arrangements (CBAs) must also satisfy the test in order to qualify as a Reportable Cross-Border Arrangement (RCBA). As such, it was poised to function as limiting factor, something that would reduce the volume of RCBAs by instituting another criterion that must be met.

However, the text of the MBT opened up doubts about how effectively it would limit reporting obligations. It states in pertinent part:

Th[e MBT] test will be satisfied if it can be established that 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.

Initial regulator comments suggested that the benefit in question need not be the sole benefit or even the primary benefit, but simply a benefit of the CBA. Further, the subjective mind state of the Intermediary or beneficiary of the CBA is irrelevant. The standard of knowledge is to be an objective one, disregarding the knowledge and aims of the involved parties. Moreover, the majority of Hallmarks subject to the MBT involve a deductible cross-border payment of some sort that–leaving aside the tax treatment of the payment in the low-tax jurisdiction of the payee–reduces the taxable income of the party in the high-tax jurisdiction of the payor, which is in and of itself a tax advantage. While the DAC6 protocol instructs Intermediaries to disregard the tax advantage obtained in the low-tax jurisdiction for purposes of the MBT, it says nothing about disregarding the advantage obtained from the reduced taxable income in the high-tax jurisdiction. Because such a tax advantage standing alone should always be recognized as a benefit by a reasonable person, the broad interpretation of a “main” benefit reduces the MBT to meaningless formalism as it never limits the Hallmark. Accordingly, advisors and commentators were compelled to devise other methods of limiting the vast scope of DAC6 RCBAs.

However, two sets of DAC6 guidance notes released at the beginning of the summer revived the use of the MBT as bona fide limiting factor on the qualification as RCBAs. In the UK’s guidance notes, released on 30 June 2020, HMRC specifies several tax advantages that might be obtained through a CBA, such as relief, reductions and deferrals of taxation. Then, however, HMRC adopts the interpretation that such tax advantages do not count towards the MBT if they can “reasonably be regarded as consistent with the principles“ on which the domestic tax code provisions relevant to the cross-border arrangement are based and the policy objectives of those provisions. The guidance notes then provide examples of circumstances where a relevant tax advantage is obtained–but the MBT might remain unmet–because the advantage in question is consistent with UK tax policy goals.

A set forth in the Dutch guidance notes, released on 30 June 2020, the Dutch method of enlarging the MBT is more direct. First, it narrows the interpretation of a main benefit as one that is “one of the most important” benefits of the CBA, rather than any tax benefit. Then, it quotes the draft HMRC DAC6 guidance that the MBT is not satisfied if the tax advantages obtained “are entirely in line with the policy intent of the legislation upon which the arrangement relies.” Finally, it distills this abstract and lawyerly concept into a practical, two-pronged inquiry. All else being equal, the MBT can be met only if (i) the CBA would not have been implemented were the anticipated tax benefit not obtainable or (ii) the CBA features supplemental elements added to obtain the tax advantage in question. In order to help illuminate this policy the Dutch regulators propose a thought experiment: Would the implementation of the CBA remain the same if the tax benefit were revoked? If so, then the MBT is unmet.

So, which approach is superior, the UK or the Dutch one? The answer to that question is intriguing, distilling to a battle between the greater administrability of the Dutch MBT versus–perhaps–the preferable outcomes of the UK one. That battle is, however, beyond the scope of this blog. We will delve into the Dutch and UK MBTs‘ comparison during our webinar on the MBT planned for mid-October (please click here to be added to the mailing list for our upcoming webinars by downloading our free DAC6 Impact Assessment).

Whichever approach you favor, the decision to fortify the MBT as a limiting factor is most welcome. The methods set out in the UK and Dutch guidance notes do not fully and finally settle the matter though. First, you always feel better with a single solution to a tax problem. A split outcome suggests that the architects of the regime are not aligned in their aims and/or that challenges under the regime cannot be overcome with sufficient diligence and horsepower because the answers are not clear-cut. As such, it is possible that one, both or neither set of guidance proposes the best possible solution to the use of the MBT as limiting factor. That is worrisome. Second, the split will further the regrettable trend for DAC6 to stray from the unified EU-wide regime envisioned at the time of DAC6‘s publication as other EU Member States will select either the UK approach, or the Dutch one, or develop their own third way, or leave the statutory MBT text unmodified. Finally, it is incomplete as only a minority of Hallmarks are privy to the MBT limitation. While the MBT could be expanded to cover other Hallmarks, at present the volume of reports under the other Hallmarks remains unlimited. As such, EUMS tax authorities–including the UK and Dutch ones–may need to develop additional means of limiting the number of CBAs captured by those Hallmarks or risk being deafened by their white noise.