Hallmarks

To fall within the scope of the Directive, the cross-border arrangement must possess one of the hallmarks listed by the Annex of that Directive.

According to the Directive (Art. 1 20), “hallmark” means: “A characteristic or feature of a cross-border arrangement that presents an indication of a potential risk of tax avoidance, as listed in Annex IV.”

The impact assessment accompanying the Directive proposal, defines a hallmark as “an indicator or a criterion which clearly identifies the schemes that would have to be reported”. 

The European Commission Services’ summary record of 24 September 2018 also indicates that the aim of the hallmarks is “to identify the tax planning arrangements which tax administrations may wish to have a closer look at” but they “do not as such constitute a finding of tax avoidance”. This approach is inspired by the OECD’s position that the fact that a scheme is reportable does not automatically means that it amounts to tax avoidance. Indeed, some of those hallmarks could be found in legitimate transactions. Therefore, a reportable arrangement is not necessarily abusive.

There are two kinds of hallmarks: 

• some are linked to the main benefit test, i.e. they may only be taken into account where they fulfil the “main benefit test”; 
• some are not linked to the main benefit test, i.e. they apply by virtue of the characteristics of the transactions themselves.

However, according to the Italian Ministry of Economics and Finance, all hallmarks under categories A, B, C and E make an arrangement reportable only if and to the extent that such hallmark may determine a reduction of the taxes covered by Directive 2011/16/EU, due by a taxpayer in any EU Member State or in another jurisdiction with which Italy has an agreement in place for the exchange of information. In other words, even though the main benefit test only applies to some of the hallmarks (the same as provided for by the Directive), a hallmark, other than those under category D, makes an arrangement reportable only if a tax advantage can be derived from it.

Hallmarks linked to the main benefit test

There are two kinds of hallmarks linked to the main benefit test:

• some are “generic”, which means that they incorporate features which are not connected to the economic and tax nature of the transaction;
• some are “specific”, which means that they refer to targeted vulnerabilities of the tax system and to techniques that are commonly used in tax avoidance arrangements.

Generic hallmarks linked to the main benefit test are hallmarks A.1 to A.3.

An 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.

As regards this definition, the confidential obligation is owed by the client or a participant in the arrangement regarding other intermediaries or the tax authorities.

The OECD draft on BEPS Action 12 gives the example of a promoter who places a limitation on the disclosure by the taxpayer of the tax treatment or tax structure aiming at protecting the value of the scheme designed by the promoter.

The OECD sums up the common principles related to this hallmark as follows:

1. The scheme or arrangement is (or might reasonably have been expected to be) offered to the taxpayer under conditions of confidentiality;
2. This places a limitation on the taxpayer’s disclosure of the tax treatment, the tax structure of the transaction or on the resulting tax benefit;
3. This limitation protects the tax advisor’s strategies and may enable further use of the same scheme or transaction._[OECD]

The European Commission Services’ summary record of 24 September 2018 mentions that under hallmark A.1, “the concept of the confidentiality is linked to commercial secrets and the business know-how and that it is not related to professional secrecy”.

According to the FTA, this hallmark is also triggered by a general confidentiality condition that requires not to disclose the arrangement to third parties, even if tax authorities are not specifically mentioned.

However, the FTA consider that a confidentiality condition aiming at protecting a commercial, industrial or professional secrecy is not concerned by this hallmark, as well as legal and ethical obligations binding on regulated professions regarding confidentiality.

The FTA also provide examples of situations that fall within hallmark A.1.

According to HMRC (Consultation document, § 8.5 et seq.; IEIM642010), any confidential condition does not have to explicitly specify that it applies to the tax administration or to other intermediaries or types of intermediary – a general confidentiality which prevented disclosure to anyone would equally be caught.

The condition particularly looks at confidentiality around how the arrangements could secure a tax advantage. Commercial confidentiality conditions that do not relate to how the arrangement secures a tax advantage will not be caught under this hallmark, but wide-ranging confidentiality clauses which prevent disclosure of how the arrangement could obtain a tax advantage, as well as other matters, would still be caught.

Evidence of a confidentiality condition includes: 

1. non-disclosure agreements;
2. written correspondence including a requirement, which may be explicit or implicit, that details of the arrangement should not be disclosed or shared more widely; or
3. evidence from users or potential users or verbal or other agreements, implied or otherwise, of confidentiality requirements.

However, evidence may also be more circumstantial. It could include: 

1. discouraging users or potential users from retaining promotional material or other details of the arrangement’s operation;  
2. requirements that all correspondence, especially with HMRC, be directed to the promoter or other nominated person; 
3. discouraging potential users from taking external advice;  
4. prohibitions on responding to the tax authorities’ requests for information, unless the request is made under a statutory notice;
5. promotional material with reference to non-disclosure; or
6. evidence of pressure from the promoter not to disclose details of the arrangements, including possible sanctions, such as restricting access to legal advice or support. 

The above list is not exhaustive, and other evidence of the existence of confidentiality requirements should also be taken into account in considering whether hallmark A.1 is triggered. 

According to the Polish administrative guidelines of 31 January 2019, the confidentiality condition shall not, in principle, apply to arrangements which pattern of conduct is known to the professional community.

According to the Italian Ministry of Economics and Finance, a “confidentiality condition” is defined as a contractual clause which binds the intermediary or the taxpayer not to disclose to any third party one or more features of the marketed or tailored arrangement.

An arrangement where the intermediary is entitled to receive a fee (or interest, remuneration for finance costs and other charges) for the arrangement and that fee is fixed by reference to:

1. the amount of the tax advantage derived from the arrangement; or
2. whether or not a tax advantage is actually derived from the arrangement. This would include an obligation on the intermediary to partially or fully refund the fees where the intended tax advantage derived from the arrangement was not partially or fully achieved.

This hallmark refers to “premium fees” or “contingent fees”, where the amount that the client pays for the advice provided by the intermediary can be attributed to the value of the tax benefits obtained under the scheme.

The FTA provide the example of a reportable arrangement where the amount of a tax lawyer’s fee is calculated on the basis of a percentage of the tax savings achieved through the scheme. It specifies that a direct link between the tax advantage and the fees charged is required (BOI-CF-CPF-30-40-30-10, § 60 and 70).

However, we tend to think, as the Belgian tax authorities rightly believe (Q&A, § 4.1.4), that success fees depending on the issue of a case settled by a jurisdiction or an administrative procedure are not triggered by this hallmark.

According to the Polish administrative guidelines of 31 January 2019, the remuneration size, which may vary in economic practice, is irrelevant to the identification of this hallmark. This hallmark also does not apply to the remuneration, the calculation of which is based solely on the number of analytical hours or working hours spent by individual project team members, however the actual nature of the remuneration related to the arrangement must be assessed.

An arrangement that has substantially standardised documentation and/or structure and is available to more than one relevant taxpayer without a need to be substantially customised for implementation._{[Definition taken from Council Directive (EU) 2018/822]}

The directive does not give a definition of the concept of “standardised documentation”.

Hallmark A.3 is inspired by the concept of “mass-marketed schemes” used by the OECD to define “standardised tax product” (Final report on Action 12) and which existed in UK and Irish legislations prior to DAC6. A mass-marketed scheme is an arrangement that is made available to more than one person and that uses standardised documentation that is not tailored to any material extent to the client’s circumstances.

The fundamental characteristic of such schemes is their ease of replication so that the implementation of the scheme does not require significant additional professional advice or services.

It is interesting to note that according to HMRC (Consultation document, § 8.14; IEIM642030), many standardised tax products which could fulfil the conditions of hallmark A.3 would not be reportable anyway, because “these kinds of products are not inherently caught by the main benefit test, as the tax outcome they achieve is consistent with the purpose of the legislation”. This finding can be replicated in all countries where a narrow interpretation of the main benefit test is accepted by tax authorities (see above).

According to the European Commission Services’ summary record of 24 September 2018, standard banking contracts, such as mortgages, would not need to be reported, because the tax advantage is an insignificant benefit as compared to other main benefits, like satisfaction of housing needs.

This analysis is shared by the German tax authorities, which state in their comments (§ 118) that many transactions resulting from legal or tax advice are documented in a standardised manner but that, insofar as they can be implemented in an isolated manner, they often have no connection with the pursuit of a tax advantage and therefore do not fall within the scope of hallmark A.3. This applies to the standardised documents linked to the following operations:

• incorporation of companies or groupings;
• granting of loans;
• licensing;
• secondment of staff;
• service provision agreement;
• opening a bank account; or
• carrying out standard banking transactions, such as the acquisition of financial instruments on the stock exchange.

The comments made by the German tax authorities also contain interesting remarks on the concept of “standardised documentation” for the purposes of hallmark A.3 (§ 112). For example, they consider that only standardised documentation in connection with an arrangement is concerned. Standardised documentation that exclusively pursues non-tax purposes is not triggered by hallmark A.3. This applies, for example, to conditions for the issuance of financial instruments, the purpose of which is to regulate the civil rights and obligations of the issuer and the purchaser, or the investment conditions of investment funds, specialised investment funds or other fund structures, which serve not only to regulate legal relationships but also to protect the investor. Even issue prospectuses (sales prospectuses), in which the prospects of gains and risks are presented, do not meet the requirements of this hallmark.

The Belgian tax authorities specify (Q&A § 4.1.5) that this hallmark does not apply to:

• internal working documents which merely reflect unfinished ideas or concepts;
• arrangements for which the taxpayer first needs essential tailor-made advice based on a detailed analysis of the individual situation before the arrangement can be set up;
• newsletters, brochures or leaflets aimed at providing very general information on a scheme.

According to the Polish administrative guidelines of 31 January 2019, this hallmark does not refer to standard models of resolutions prepared for adoption by partnerships and companies for standard business purposes or legal opinions which are based on standards of expression on a given issue. Evidence of standardised documentation may include:

1. documentation or agreements created and used for the conclusion of specialised banking agreements or other agreements on financial matters;
2. a situation in which the promoter has provided the relevant taxpayer with documentation on the grounds for applying 50% of the tax-deductible costs.

According to the Italian Ministry of Economics and Finance, this hallmark does not apply if the aim of the arrangement is to benefit from a tax relief under Italian law.

Lastly, the scope of hallmark A.3 raises issues in the case of arrangements whose structure and/or documentation may be duplicated but which are adapted depending on the circumstances. This is the case, for instance, of arrangements relating to management fees or licensing of brands or other intangible assets. Although, in practice, they may be duplicated for a great number of entities within the same group, one might take the view that they should fall outside the scope of A.3 where they are tailored to the needs of each specific group. One might also consider that A.3 should not apply where it appears that the intermediary should be consulted on the customisation of the arrangement upon its implementation in the different entities of a given group.

An arrangement whereby a participant in the arrangement takes contrived steps which consist in acquiring a loss-making company, discontinuing the main activity of such company and using its losses in order to reduce its tax liability, including through a transfer of those losses to another jurisdiction or by the acceleration of the use of those losses._{[Definition taken from Council Directive (EU) 2018/822]}

It is difficult to find relevant information on the exact meaning of this hallmark. The OECD report on Action 12 of the BEPS action plan mentions several legislations as a possible source of inspiration regarding the use of losses but none of them refers to a kind of arrangement similar to DAC6.

However, this hallmark should apply rarely. The acquisition of a company puts an end to the carry-forward of prior losses of the target in those Member States where the change of control triggers those effects (e.g. in Germany). In the case where, after the acquisition, a merger takes place, some Member States make the transfer of the deficit to the absorbing company subject to approval (e.g. France, where the government checks the absence of primarily tax purpose). Finally, it can be observed that if the acquisition price of a target takes into account the deferred tax which mirrors the carried-forward loss, it does not necessarily follow that the acquirer can be considered, as required by hallmark B.1, as “using its [the target’s] losses in order to reduce its tax liability”.

In order to define the concept of “contrived steps” used by this hallmark, the FTA refer to their guidelines concerning the general anti-avoidance rule applicable to corporate income tax and transposed in the foreign tax credit (FTC) following the Council Directive (EU) 2016/1164, also known as the ATAD Directive. Thus, the “contrived steps” are defined as “non-genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality”.

Finally, one may observe that the notion of “loss” seems to refer, within the meaning of this hallmark, to both accounting and tax losses. In other words, a company that does not have an accounting loss in the financial year preceding its acquisition but has tax losses carried forward falls within the scope of hallmark B.1. (see the aforementioned Q&A published by the Belgian administration, § 4.2.3.2).

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.

The purpose of this hallmark is to capture arrangements which have the effect of converting income into other categories of revenue which are taxed at a lower rate or exempt from tax.

This hallmark must be combined with the main benefit test so that the simple fact of converting income into capital would not fall within the scope of DAC6.

The wording of hallmark B.2 is not entirely clear in many respects. In particular, to qualify under the hallmark “income must be converted into capital, gifts or other categories of revenue which are taxed at a lower level or are exempt from tax” (emphasis added). The question is whether the emphasised part only refers to “other categories of revenue” or also includes capital and gifts. The most plausible answer seems to be that it is always required, for the hallmark to be applicable, that the outcome of the conversion (into capital, gifts or other categories of revenue) entails a reduction of the tax burden.

One may also note that this hallmark, opposite to most others, is likely to apply to natural persons. This is particularly the case in situations where an arrangement has the effect of transforming ordinary income (wages, independent income) into capital gains or dividends taxed under more favourable conditions.

Although the wording of the Directive is not clear in this respect, this hallmark also seems to apply under circumstances where the change of characterisation of the income involves a change of the competent jurisdiction under a tax treaty, with the result that a lower (or no) tax is due.

Lastly, one of the main difficulties in interpreting this hallmark is whether the “conversion” must consist in the change of an existing situation or whether an arrangement which is set up from the start with the intention of avoiding a certain characterisation of income may be considered as a “conversion”.

An interesting example provided by HMRC illustrates this problem.  According to HMRC (Consultation Document, § 9.4 et seq.; IEIM643020), when a person is employed by a company that is resident in a different jurisdiction, and as part of their remuneration package they are given share options, exercisable at a later date, any increase in value could be taxed as a capital gain, depending on the jurisdiction of residence. In this example, although the remuneration package could have consisted entirely of salary income, share options are a legitimate commercial choice to remunerate employees. There is no conversion of income into capital, there has simply been a choice made between different options, which are widely used and have an underlying commercial rationale.

The Belgian tax authorities consider that “there should always be a conversion from a pre-existing income category to another income category taxed at a lower rate. The assessment between the different categories of income involving the application of usual commercial practices in order to obtain lower taxed income is not triggered by hallmark B.2” (Q&A mentioned above, § 4.2.4.1).

They also state that the reduction of equity (reduction of capital or payment of dividends) of a company which takes out a loan to finance the payment of a dividend to its foreign shareholder does not concern a conversion of income and does not fall within the scope of hallmark B.2, even if it may result in a lower taxable result for the taxpayer (Q&A § 4.2.4.5).

This point of view does not seem to be shared by the FTA, which announced during a conference organised by the International Fiscal Association that the conversion should not necessarily require that an existing situation is transformed into another one. According to this approach, a “conversion” also takes place where a taxpayer opts for an arrangement from the outset, where that arrangement is less “natural” than another hypothetical arrangement having the same economic effect and triggers a tax characterisation which is more favourable to the taxpayer.

However, this approach does not appear explicitly in the guidelines published by the FTA, which rather proceed by way of example as follows:

Company F, established in France, is the holding company of a French operating group, and receives consulting services that contribute to the group’s value creation. These services are provided by independent professionals working on a freelance basis whose income is normally taxed in the non-commercial profits category as taxpayers domiciled in France for tax purposes.

The service providers hold shares in holding company A, established in another EU Member State. The latter subscribes to a capital increase in preference shares (at nominal value) of holding company B, established in a third EU Member State.

B holds preference shares in holding company F of the French operating group to which the services have been rendered.

B receives, in respect of the preference shares it holds, a preference dividend from F, which is itself redistributed to A.

Thus, the mechanism set up enables the taxpayers who provided the services to F to be remunerated, under cover of dividends received by A, for the services that contributed to the group’s value creation:

• without any effective taxation at the time of the distribution to A;
• any subsequent distributions by A to its French associates who are, in addition, taxed at a lower effective rate than the taxation of their non-trading profits.

According to the Polish administrative guidelines of 31 January 2019, the obligation to report may be covered by an arrangement in which, in order to obtain a tax advantage, the contract is artificially broken up with a view to several affiliated companies benefiting from a preferential tax rate or there is a change in the form of employment.

An arrangement which includes circular transactions resulting in the round tripping of funds, namely through involving interposed entities without other primary commercial function or transactions that offset or cancel each other or that have other similar features.

For this hallmark to apply, there must be circular transactions resulting in the round tripping of funds, and any of the three additional conditions should be met:

1. There are interposed entities without primary commercial function;
2. There are transactions that offset or cancel each other; or
3. There are other similar features to these.

According to HMRC (consultation document, § 9. 10 et seq.; IEIM643030), this hallmark will commonly apply to arrangements whereby funds are routed via an offshore jurisdiction, despite having a domestic origin, in order to benefit from preferential tax treaty terms or other similar benefits.

The FTA state in their guidelines that this hallmark is generally aimed at schemes in which funds originating from a Member State transit through conduit companies established in foreign jurisdictions (inside and outside the EU) in order to benefit from advantageous tax treatment (tax treaty or other similar advantages) and return to the Member State of origin (BOI-CF-CPF-30-40-30-10 § 220).

The German tax authorities, for their part, give the example of leaseback and cashpooling (§ 138). However, the Belgian tax authorities state in the abovementioned Q&A that a sale and leaseback transaction is in principle not subject to this hallmark, insofar as this transaction is not part of a larger set of steps or parts that can in their entirety be considered as a cross-border arrangement, if it corresponds to the economic reality and insofar as the agreed price has been determined in accordance with the arm’s length principle.

Whether or not entities have a primary commercial function is not easy to determine, because of the ambiguity of the adjective “primary”.

The FTA consider in its guidelines that it should be understood as “principal” (BOI-CF-CPF-30-40-30-10, § 200).

The criteria linked to the mutual offset or cancellation of the operations is not clear either:

• First, it is questionable whether the flows that offset or cancel each other should be of comparable amounts. It seems logical to answer in the affirmative, which would have the effect of excluding from the scope of this hallmark financing transactions in which the capital provider or lender only receives in exchange the remuneration to which it is entitled (dividends or interest).
• One may wonder within which time frame the compensation between flows should take place. For example, is there compensation when a company finances the R&D expenses of a subsidiary and subsequently receives royalties from the subsidiary for the intangible generated by the research? The German tax authorities’ guidelines state that “the time period between individual transactions is irrelevant as long as, in accordance with the aim pursued, they form part of an overall plan” (§ 134). However, the German tax authorities concede that “the longer the period between each transaction, the greater the tax authority’s burden to prove effort to identify an obligation to declare” (ibid.).
• Another question that may arise concerns the persons between whom the offsetting or cancellation of flows takes place. The question related to the assessment of circularity arises, for example, in the case of group financing centres through which financial flows flow from and to entities of the same integrated group. For example, in the case of a French company financing a foreign entity that lends all or part of the funds to French entities that are members of the same tax group as the initial lender, one may wonder if the compensation is assessed at the level of the legal entity or the tax group? The question is currently open.
• Finally, it can be assumed, as does the commentary of the German tax authorities (§ 135), that in order for transactions to be cancelled or netted within the meaning of the hallmark, such compensation must not be prescribed by law.

Hallmark C is partly subject to the main benefit test. Arrangements concerned involve deductible cross-border payments made between two or more associated enterprises where:

• the recipient is resident for tax purposes in a jurisdiction which does not impose any corporate tax or imposes corporate tax at the rate of zero or almost zero (C.1 b)i)) ; or
• the payment benefits from a full exemption from tax in the jurisdiction where the recipient is resident for tax purposes (C.1 c)); or
• the payment benefits from a preferential tax regime in the jurisdiction where the recipient is resident for tax purposes (C.1 d)).

For hallmark C.1 to apply the two conditions must be met:

• a deductible cross-border payment has to be made;
• between associated enterprises.

These two conditions will be examined first. We shall then turn to the description of the features of arrangements concerned.

Deductible payment: whether or not a payment is deductible will depend on the facts, and the application of relevant law in the payer’s jurisdiction.

The FTA specify in their guidelines that the notion of payment covers “any payment received or to be received” (BOI-CF-CPF-30-40-30-20 § 20). This wording seems to exclude notional payments.

According to HMRC (consultation document, § 10.6; IEIM644010), an intermediary will not always know whether a payment is deductible, particularly an intermediary which is a ‘service provider’. If an intermediary does not know, and could not reasonably be expected to know, what the effect of a payment will be, then it will not be required to make a report. Whether an intermediary could reasonably be expected to know the effect of a transaction will always depend on the facts and circumstances of the situation.

Between associated enterprises: hallmark C.1 requires the payment to be made “between” two or more associated enterprises.

In simple situations, there is no doubt about the meaning of “between” because the payment is made from a corporate entity to another one.  Problems may however arise when the payment is made to an entity which has no legal personality or no tax personality.

This may involve looking at the question of whether partnerships or other hybrid entities are recognised for tax purposes.

The interpretation of the word “between” is therefore likely to be different in every jurisdiction. For those which consider partnerships to be transparent vehicles, the partners will be considered as the recipients for the purposes of judging whether the payment is made “between” associated enterprises (see for instance HMRC’s consultation document, § 10.7; IEIM644030).  In cases where transparent entities (such as partnerships) receive cross-border payments, the European Commission (Working Party IV – Direct taxation, Summary Record, 24 September 2018) states that the conditions of hallmark C must be complied with at the level of the partners. 

This is also the position of the FTA, which state in their guidelines that “in the case of fiscally transparent companies, the beneficiary will be the shareholder(s) of that fiscally transparent company” (BOI-CF-CPF-30-40-30-20 § 20).The concept of associated enterprises is defined in part 5 of this document (see above).

Hallmarks C.1 all refer to the notion of tax residence. The FTA specify in their comments that tax residence must be determined by application of bilateral tax treaties or, in the absence of a bilateral treaty, by reference to the criteria of Art. 4 of the OECD Model Convention (BOI-CF-CPF-30-40-30-20 § 20).

According to the European Commission (Working Party IV – Direct taxation, Summary Record, 24 September 2018), the tax at the rate of almost zero broadly refers to a nominal rate below 1%. This position is shared by Finland, the Netherlands, Portugal, Spain and the UK.

The FTA adopted a tougher position considering that the rate of almost zero refers to an effective rate under 2%. A 4% rate is adopted in Germany; it is 5% in Poland.

The Italian Ministry of Economics and Finance has specified that transparent entities are not to be taken into consideration for the purpose of determining if the recipient is not subject to corporate income tax or is subject to corporate income tax at the rate of zero.

This hallmark seems to refer mainly to hybrid schemes described by the OECD report on Action 2 of the BEPS Action Plan.

Example:

A company resident in country B (“B Co”) is funded by a company resident in country A (“A Co”) with an instrument that qualifies as equity in country A but as debt in country B. If current payments are made under the instrument, they are deductible interest expenses for B Co under country B tax law. The corresponding receipts are treated as exempt dividends for country A tax purposes.

As a result, a net deduction arises in country B without a corresponding income inclusion in country A.

Within the European Union, such arrangements should generally not be reportable any longer because a deduction/non-inclusion scheme is neutralised by ATAD 1 and 2. However, these arrangements may still be effective in situations involving third countries.

More generally, hallmark C.1 c) (as well as C.1 d)) requires a “payment” to be made. If no payment takes place, it does not apply. This seems to exclude “notional” deductions, which exist in a variety of jurisdictions, from the scope of this hallmark, as long as these jurisdictions do not provide that such deductions stem from “deemed” payments.  It is therefore necessary to assess whether a notional deduction is or is not attributed to a deemed payment.

Moreover, the payment must benefit from a “full” exemption. In a case where the recipient is a parent company established in a jurisdiction which applies a 100% exemption on the dividend but exercises the option provided by Art. 4.3 of the parent-subsidiary directive (2011/96/EU), i.e. refuses to allow the deduction of any charges relating to the holding (up to a cap of 5% of the distributed dividend), it seems that the payment should still be considered as “fully” exempt although it is economically subject to taxation up to 5% of its amount.

The FTA consider that a tax exemption is deemed to exist where payments are not entirely taxed because of a tax allowance, compensation or deduction of losses or other deductible expenses, the deduction or imputation of taxes paid abroad or tax sparing credits. Furthermore, the exemption could result from the legislation in force or from a cross-border advance tax ruling under DAC3 (BOI-CF-CPF-30-40-30-20 § 20).

The concept of “preferential tax regime” is not defined by the Directive.

According to the European Commission (Working Party IV – Direct taxation Summary Record, 24 September 2018), the concept of “preferential” regime is wider than a “harmful” regime.

The concept of “preferential tax regime” seems to refer to a tax regime which does not necessarily provide full exemption (as this is targeted by hallmark C.1 c) but rather establishes a tax treatment which derogates from the ordinary rules. A lower tax rate applied to certain categories of income (such as interest or royalties) may therefore be considered as a preferential tax regime. The same may be said about a lower tax burden granted to enterprises established in special economic zones.

However, one should remember that as a follow-up to the BEPS Action Plan, many countries have now introduced severe limitations on preferential tax regimes, based notably on the concept of “nexus”. Therefore, if a payment is made to an entity which enjoys a preferential tax regime which is in line with the OECD recommendations, there is a strong case for arguing that this is perfectly in line with the main benefit test which is applicable to hallmark C.1.d. Spain seems to go along this line by considering that tax regimes approved by the European Union should be outside the scope of DAC6.

The French guidelines (BOI-CF-CPF-30-40-30-20 § 20) refer to action 5 of the BEPS report to define the notion of preferential tax regime.

The guidelines specify that “a tax regime is considered preferential if it offers a certain form of tax preference compared to the general principles of taxation in the country concerned. This preference may take various forms”.

In this respect, “the reduction of the tax rate or tax base or preferential conditions for the payment or refund of taxes may be considered as preferences. A low level of preference is sufficient to classify a scheme as preferential”.

Furthermore, “the scheme must be preferential in comparison with the general principles of taxation in the jurisdiction concerned and not in comparison with the principles applied in other jurisdictions”. Such a regime may result, inter alia, from legislation in force or from a cross-border advance tax ruling.

The following hallmarks are not linked to the main benefit test.

As mentioned above, C.1 a) and b) ii) are not subject to the main benefit test.

Specific hallmarks related to cross-border transactions

An arrangement that involves deductible cross-border payments made between two or more associated enterprises where at least one of the following conditions occurs:

1. the recipient is not resident for tax purposes in any tax jurisdiction;
2. although the recipient is resident for tax purposes in a jurisdiction, that jurisdiction either:

This hallmark refers to the situation where no jurisdiction considers that income is attributable to one of its residents. 

It is likely to raise questions where a payment is paid to a transparent partnership in different situations (depending whether the partners are resident in the same jurisdiction or not).

Hallmark C.1 b) ii) refers to deductible cross-border payments between two or more associated enterprises and a recipient who is established in a non-cooperative jurisdiction as included on the EU list and/or the OECD list.

The EU list is available on this website.

As of 6 October 2020 (2020/C 331/03), the EU list is composed of:

1. American Samoa;
2. Anguilla;
3. Barbados;
4. Fiji;
5. Guam;
6. Palau;
7. Panama;
8. Samoa;
9. Seychelles;
10. Trinidad and Tobago;
11. US Virgin Islands; and
12. Vanuatu.

The FTA state in their guidelines (BOI-CF-CPF-30-40-30-20, n° 20) that non-cooperative jurisdictions according to the OECD are those that are assessed as “non-compliant” or “partially compliant” by the OECD under the Global Forum on Fiscal Transparency.

The list of those jurisdictions is available on this website.

Based on the wording of the Directive, there is no need to report arrangements involving jurisdictions which are included on a domestic list as non-cooperative unless these are also included on the EU or OECD list. However, domestic practices seem to vary significantly.

Like the Dutch tax authorities, the FTA (BOI-CF-CPF-30-40-30-20 § 20) and HMRC (consultation document, § 10.12; IEIM644040), the relevant list of non-cooperative states should be examined on the date that the reporting obligation arises. Where the countries on the lists subsequently change, there is no need to re-evaluate whether or not the hallmark is met.

Deductions for the same depreciation on the asset are claimed in more than one jurisdiction.

This hallmark is intended to counter the “double dip” effect which may exist in leasing transactions whereby the same asset may be depreciated twice by virtue of the combination of two domestic systems which do not follow the same approach regarding the entitlement to depreciate (because one is faithful to the idea that only the legal owner is entitled to depreciation whereas the other extends this to the economic owner).

The concept of “depreciation” itself may be subject to discussion. The French version of DAC6 uses the word “amortissement”, which seems narrower than the English word “depreciation” (which includes non-regular depreciation of assets which do not lose value by virtue of their nature).

Let it be reminded in this respect that it is settled case law of the European Court of Justice (ECJ) that EU law provisions must be interpreted and applied uniformly in the light of the versions existing in all the EU languages. Where there is divergence between the various language versions of a EU text, the provision in question must be interpreted by reference to the purpose and general scheme of the rules of which it forms part (see for instance ECJ 8 December 2005, Jyske Finans, C-280/04, § 31). In light of this principle, a broad definition of “depreciation” (including, but not limited to, amortisation) should be adopted.

According to the European Commission, hallmark C.2 does not apply where “deduction for the same depreciation on an asset” is claimed both in the State of the permanent establishment and in the State of the head office which taxes the permanent establishment profits and gives relief for double taxation by credit. The same exclusion should reasonably apply in case the depreciation of an asset is taken into account twice by virtue of a controlled foreign corporation (CFC) rule in the State of a parent company.

One may also wonder if this hallmark applies to a situation where a company located in country A owns a 100% participation in a subsidiary located in country B. Suppose that the subsidiary depreciates an asset and that, as a consequence, the parent depreciates its participation in its subsidiary. Assuming that the latter depreciation is actually deductible for tax purposes in the country of the parent company (which is generally not the case because non-deductibility of depreciation is the counterpart of the participation exemption), does this double depreciation fall within the scope of C.2? Probably not because the two depreciations do not legally have the same object: while the depreciation made by the subsidiary bears on the asset, the depreciation made by the parent is related to its participation (even though both depreciations have a common cause which is the loss of value of the asset owned by the subsidiary).

The FTA provide an example of a disclosable arrangement under hallmark C.2 (BOI-CF-CPF-30-40-30-20 § 40):

Company A established in France owns a fully equipped industrial facility in State B, which it rents to Company C established in State B. A considers that the corresponding rents are exclusively taxable in State B, in accordance with the provisions of the bilateral tax treaty relating to income from immovable property. A deducts depreciation relating to assets leased to C for the purpose of calculating its taxable income in France, even though the rents taxed in State B are taxed on a net basis of depreciation costs.

Relief from double taxation in respect of the same item of income or capital is claimed in more than one jurisdiction.

This hallmark seems to address triangular situations in which both the country of the head office of a company (country A) and the country of a permanent establishment of that company (country B) credit foreign withholding tax levied by a third country (country C).

The FTA provide an example of a reportable arrangement under hallmark C.3 (BOI-CF-CPF-30-40-30-20 § 80):

Company A, resident in State V, has entered into a securities lending agreement with French bank B for shares in company C, resident in State W: A is the lender, B is the borrower.

The loan covers a period during which C pays a dividend. Bank B, to whom the securities have been lent, collects this dividend net of the withholding tax that has been levied in State W and pays the amount to A as a “compensation payment” or “manufactured dividend”.

A sets off the withholding tax levied in State W against its corporate income tax liability in State V.

Bank B sets off the same tax credit against its tax liability in France.

The effect of this decision is to obtain tax relief in several jurisdictions (France and State V) for the same item of income, the dividend from State W.

There is an arrangement that includes transfers of assets and where there is a material difference in the amount being treated as payable in consideration for the assets in those jurisdictions involved. 

This hallmark implies a “transfer” of assets. One may wonder if it applies to transfers between different legal entities or only within a sole legal entity. This latter approach is supported by analogy by the wording of ATAD which defines “transfer of assets” as “an operation whereby a Member State loses the right to tax the transferred assets, whilst the assets remain under the legal or economic ownership of the same taxpayer” (Art. 2 (6)). If that is the case, then this hallmark only applies to transfers between head office and permanent establishment (PE).  A third approach would favour a broad definition encompassing both a transfer between separate legal entities and a transfer between head office and PE.

The FTA consider that the transfer of assets could take place within the same legal entity, which is the case when assets are transferred between a registered office and its permanent establishment (BOI-CF-CPF-30-40-30-20 § 120). In view of the use of the verb “can”, they seem to adopt the third approach described above.

They add that this hallmark does not apply to mergers and similar operations in accordance with Directive 2009/133/EC of 19 October 2009 on the common system of taxation applicable to mergers, divisions, partial divisions, transfers of assets and exchanges of shares concerning companies of different Member States and to the transfer of the registered office of an SE or SCE between Member States (ibid).

This hallmark also requires a material difference regarding the amount payable in consideration of the transfer of assets in the jurisdictions involved. The FTA specify in this respect that this hallmark concerns any arrangement that includes transfers of assets for which the value of the consideration obtained or to be obtained differs according to the jurisdictions concerned (ibid., § 110).

They provide an example of a reportable arrangement under this hallmark as follows:

An arrangement involving the transfer of a technology licence between an enterprise (A) established in State Y and a related enterprise B established in State Z. The consideration for the transfer is the allocation of shares in B.

At A’s level, the disposal is recognised at book value, while at B’s level the asset acquired is recognised at market value.

One may think that this hallmark applies in the case of capital contributions that are valued differently in the State of the contributor and in the State of the recipient of the contribution (taking into account the book value in the State of the contributor avoids recording a capital gain, while taking into account the market value in the State of the recipient company generates a step-up). A comparable situation may arise in the case of a transfer of assets between a registered office and a foreign permanent establishment or in case of a transfer of the registered office.

This hallmark also seems to refer to situations where a cross-border transaction gives rise to a deduction of a certain amount in the payer’s jurisdiction, while the recipient’s jurisdiction considers that the taxable amount is less than the amount allowed for deduction in the payer’s jurisdiction.

HMRC takes the view that the amount “treated as payable in consideration” is the amount treated as payable for tax purposes, rather than the amount treated as payable for accountancy purposes (consultation document, § 10.22; IEIM644080).

The Italian Ministry of Economics and Finance has specified that the difference considered in this hallmark is to be intended as the difference between the consideration paid for the assets transferred and their fair market value, to be determined pursuant to the arm’s length principle.

The difference between the two amounts must be “material”, i.e. of a certain importance. Whether a difference is “material” is not clear. We find no clear explanation of this concept in the BEPS report on Actions 8-10 on Transfer pricing.

The German tax authorities clarified in their guidelines (§ 160) that where the gap does not exceed 10%, it is considered insignificant.

Lastly, it is also unclear whether this hallmark may apply to any kind of “asset”. For instance, in the event of an interest-free cross-border loan, the lender’s jurisdiction may waive its taxing right on the ground that there is a commercial justification for providing a free loan, while the borrower’s jurisdiction will allow a lump-sum deduction of a certain interest rate. If money is an “asset”, then the hallmark is likely to apply.

This hallmark is strongly inspired by the OECD work, in particular by the Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures (2018) (hereafter “MDR”). It may be of particular importance for natural persons.

DAC6 and the MDR are obviously entirely separate instruments. However, Recital n^o 13 to DAC6 makes clear that the MDR, and the guidance and commentary which accompany those rules, are a source of illustration and interpretation for hallmarks under Category D of DAC6.

According to the European Commission, Member States which comply with the OECD guidance on the model rules for mandatory disclosure against circumvention of the common reporting standard (CRS) shall also be compliant with the hallmarks under category D of DAC6.

An arrangement which may have the effect of undermining the reporting obligation under the laws implementing EU 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. Such arrangements include at least the following:

1. the use of an account, product or investment that is not, or purports not to be, a Financial Account, but has features that are substantially similar to those of a Financial Account;
2. the transfer of Financial Accounts or assets to, or the use of, jurisdictions that are not bound by the automatic exchange of Financial Account information with the State of residence of the relevant taxpayer;
3. the reclassification of income and capital into products or payments that are not subject to the automatic exchange of Financial Account information;
4. the transfer or conversion of a Financial Institution or a Financial Account or the assets therein into a Financial Institution or a Financial Account or assets not subject to reporting under the automatic exchange of Financial Account information;
5. the use of legal entities, arrangements or structures that eliminate or purport to eliminate reporting of one or more Account Holders or Controlling Persons under the automatic exchange of Financial Account information;
6. arrangements that undermine, or exploit weaknesses in, the due diligence procedures used by Financial Institutions to comply with their obligations to report Financial Account information, including the use of jurisdictions with inadequate or weak regimes of enforcement of anti-money laundering legislation or with weak transparency requirements for legal persons or legal arrangements.

 A few details on some hallmarks connected to D.1 are given below.

(a) The use of financial investments that are not financial accounts, but has features that are substantially similar to those of a Financial Account:

1. According to the MDR commentary (§ 9), this hallmark covers those cases where a person offers a financial product that provides the investor with the core functionality of a financial account but which includes features that are designed to take it outside the definition of a “Financial Account” for CRS purposes. This specific hallmark could cover, for instance, the use of certain types of e-money or the issuance of certain types of derivative contracts by financial institutions. The hallmark refers to the “use” of such a product and would therefore cover the offering of such products as well as arrangements to transfer funds into such an investment.

According to the FTA the following arrangements are reportable under hallmark D.1 a) (BOI-CF-CPF-30-40-30-20 § 200):

• The use of certain types of electronic money as alternatives to the use of a deposit account, or the issuance of certain types of derivative contracts by Financial Institutions which are outside the scope of the legislation implementing the CRS, but which reproduce the characteristics of the underlying financial assets covered by that legislation.
• A German tax resident holding a deposit account with a banking institution in France makes a withdrawal for the purchase of physical gold from a specialised company. As the funds are intended to be invested in a non-reportable asset within the meaning of Council Directive 2014/107/EU of 9 December 2014 (known as “DAC2”/Common Reporting Standard [CRS]), the characteristics of the hallmark D.1 a) are met. However, the French bank holding the deposit account is not required to report under Council Directive 2018/822 of 25 May 2018 amending Directive 2011/16/EU as regards the automatic and compulsory exchange of information in the field of taxation in relation to cross-border arrangements that are subject to a declaration (known as “DAC6”), provided that it does not know or has no reason to know that the funds are intended to be invested in an asset that is not reportable under the DAC2/CRS regulations.

(b and d) The transfer of funds outside the scope of reporting obligation:

Paragraph b) of hallmark D.1 looks to the jurisdiction where the financial product is offered and the domestic exemptions from reporting within that jurisdiction to identify arrangements that give rise to a reporting obligation avoidance risk.

According to the MDR commentary (§ 10), this hallmark would include moving money to a bank in a jurisdiction that is not exchanging information with the taxpayer’s country of residence for tax purposes.

The FTA rely on the approach adopted by the OECD. They indicate that this hallmark concerns the aforementioned transfers of funds as well as those made to an account that is not subject to the CRS, even though it is hosted by a financial institution in a partner jurisdiction, or strategies consisting, for example, in dividing the amounts held in a financial account in order to remain below the thresholds relating to the reporting obligations (BOI-CF-CPF-30-40-30-20 § 230). Other examples are provided in the French guidelines.

(e) The use of legal entities, arrangements or structures that eliminate or purport to eliminate reporting of one or more Account Holders or Controlling Persons under the automatic exchange of Financial Account information:

(f) Arrangements undermining the effectiveness of and exploiting weaknesses in due diligence procedures:

This hallmark applies to arrangements that can be used to avoid accurate and comprehensive reporting of information to the jurisdiction of residence of the account holder or controlling person.

The wording of hallmark D.1 f) does not follow exactly the MDR, although it is very close to Rule 1.1.e of the MDR, but it is relevant to take the MDR commentary of the Model into account to understand its inspiration.

In this respect, the MDR commentary (§ 13) provides that “arrangements undermining the effectiveness of due diligence procedures are those that frustrate the intended outcomes of those procedures (such as the misuse of residence certificates (…)). Arrangements exploiting weakness in due diligence procedures include those arrangements that rely on the absence or inadequate implementation of such due diligence procedures, for example by taking advantage of weak implementation of FATF 1  Recommendations, which are currently those of February 2012”.

The MDR commentary (§ 17) underlines that a number of jurisdictions offer tax incentives to individuals to encourage them to take up tax residence in that jurisdiction. These incentives may involve temporary or permanent exemptions from tax on foreign source income and obtaining such tax residency may only require the resident to have a minimal presence in that jurisdiction. A person who is tax resident in more than one jurisdiction may use such a certificate to hide the fact that he or she is a tax resident in another jurisdiction. Presenting such a certificate to a financial institution as proof of residence in order to undermine the financial institution’s due diligence procedures would fall within this hallmark.

The Belgian tax authorities specify (question 4.4.3.6. Q&A mentioned above), that the notion of “jurisdictions that inadequately or insufficiently apply the legislation relating to the fight against money laundering” refers to the States included in the blacklist or the grey list established by the FATF.

As of 21.02.2020, the countries on these lists were:

• Albania;
• the Bahamas;
• Barbados;
• Botswana;
• Cambodia;
• Ghana;
• Iceland ;
• Iran;
• Jamaica ;
• Mauritania ;
• Mongolia ;
• Myanmar ;
• Nicaragua ;
• North Korea;
• Pakistan ;
• Panama ;
• Syria;
• Uganda;
• Yemen;
• Zimbabwe.

The Italian Ministry of Economics and Finance has provided an extensive list of examples which are deemed to fall in the scope of hallmark D.1 It is also specified that, for the purpose of the information to be reported, the value of the arrangement to which this hallmark applies is the value of the financial account, to be determined according to the relevant CRS rules.

An arrangement involving a non-transparent legal or beneficial ownership chain with the use of persons, legal arrangements or structures:

1. that do not carry on a substantive economic activity supported by adequate staff, equipment, assets and premises; and
2. that are incorporated, managed, resident, controlled or established in any jurisdiction other than the jurisdiction of residence of one or more of the beneficial owners of the assets held by such persons, legal arrangements or structures; and
3. where the beneficial owners of such persons, legal arrangements or structures, as defined in Directive (EU) 2015/849, are made unidentifiable.

It is important to note that hallmark D.2 does not attempt to tackle CRS avoidance only. As the MDR commentary observes (§ 26), it also covers structures that hold assets other than financial accounts, i.e. those not reportable under the CRS (e.g. real estate).

This hallmark relies on the following concepts:

Non-transparent legal or beneficial ownership chain:

The concept of non-transparent legal or beneficial ownership chain is not defined by the Directive, but we can again refer to OECD MDR that describes vehicles, schemes and structures that are commonly used to hide the identity of the beneficial owner targeted by this hallmark.

Rule 1.2.d of the MDR uses the concept of “opaque structure” that may include, but is not limited to, a structure that has one or more of the following features:

• the use of nominee shareholders with undisclosed nominators: a nominee shareholder is any person that holds those shares on behalf of another person (the nominator). For example, a nominee could be operating as an agent or a trustee or could hold the shares on behalf of the purchaser under an uncompleted sale transaction.
• the use of means of indirect control beyond formal ownership: this criterion refers to the ability of a natural person to indirectly control an offshore entity under informal arrangements with persons with direct control over that entity. For example, a lawyer with a controlling interest in an entity or arrangement who habitually acts under instructions from his client could fall within the scope of this definition. It would also apply to an arrangement whereby a natural person provided funding to a non-affiliated company in exchange for an option to acquire all or substantially all of the assets of that company for a nominal sum. Such an arrangement would have the effect of providing the option holder with ultimate effective control over the company or those assets held by that company without being identifiable as their legal owner;
• the use of arrangements that provide a natural person with access to assets held by, or income derived from, the Ownership Structure without being identified as a Beneficial Owner of such structure; this would include the use of prepaid debit cards and interest-free loans;
• the use of Legal Persons in a jurisdiction where there is:
  • no requirement and/or mechanism to keep Basic Information and Beneficial Owner information on such Legal Persons accurate and up to date;
  • no obligation on shareholders or members of such Legal Persons to disclose the names of persons on whose behalf shares are held; or
  • no obligation on shareholders or members to notify such Legal Persons of any changes in ownership or control;
• the use of Legal Arrangements organised under the laws of a jurisdiction that do not require the trustees (or in the case of a Legal Arrangement other than a trust, the persons in equivalent or similar positions as the trustee of a trust) to obtain and hold adequate, accurate and current beneficial ownership information regarding the Legal Arrangement.

The Directive requires the non-transparent legal or beneficial ownership chain to use persons, legal arrangements or structures that comply with three characteristics:

• they do not carry on any substantive economic activity supported by adequate staff, equipment, assets and premises;
• they are incorporated, managed, resident, controlled or established in any jurisdiction other than the jurisdiction of residence of one or more of the beneficial owners of their assets; and,
• their beneficial owners are made unidentifiable.

Persons, legal arrangements or structures that do not carry on any substantive economic activity:

This expression is built upon Rule 1.2.b of the MDR which defines a “passive offshore vehicle” as “a legal person or legal arrangement that does not carry on a substantive economic activity supported by adequate staff, equipment, assets and premises in the jurisdiction where it is established or is tax resident”.

The MDR commentary (§ 28) indicates that all four elements (adequate staff, equipment, assets and premises) must be satisfied for an offshore vehicle to be treated as active (and therefore outside the scope of hallmark). It also makes clear that the combination of these four elements must be directly connected to the activities of the entity itself and not another party.
An entity established in Country A that invoices a related company for services supplied by a contractor in Country B would be considered “passive” under the definition above. Such an entity would not employ any staff or own any equipment, assets or premises from which the substantive economic activity is carried on. The recruitment of staff, purchase of assets or equipment or the leasing of premises should not be treated as giving rise to a substantive economic activity if this has been done solely for the purposes of avoiding the definition of a passive offshore vehicle.

They are incorporated, managed, resident, controlled or established in any jurisdiction other than the jurisdiction of residence of one or more of the beneficial owners of their assets

This condition defines what the MDR calls an “offshore vehicle”. 

According to the MDR commentary (§ 30): “The definition of “offshore” is drafted in such a way that if any Beneficial Owner is resident in a jurisdiction other than the jurisdiction where the vehicle is incorporated, resident, managed, controlled or established then that vehicle will be treated as offshore with respect to all its beneficial owners. This is to prevent tax planners setting up an offshore entity with one or more local Beneficial Owners, simply in order to circumvent the reporting requirements of the model rules. It also means, however, that an otherwise plain vanilla domestic family trust with a single non-resident beneficiary will fall within the offshore definition. Note however that the definition of Service Provider [in Rule 1.3 of MDR] applies where the person can reasonably be expected to know that the Structure is an Offshore Structure. This means that a trust that was not a Passive Offshore Vehicle at the time the trust was established would not become reportable simply because the person who set up the trust subsequently learns that one of the beneficiaries of the trust has moved to another country. If that person was, however, required to provide further services in respect of the same trust, then that person would then need to include facts in any assessment of whether the trust was required to be disclosed under these rules”.

Beneficial owner

D.2 hallmark refers to the Directive of 25 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, that defines the concept of beneficial owner in Art. 3 as:

Unidentifiable beneficial owners

The test in paragraph (c) of hallmark D.2 is whether beneficial owners can reasonably be identified by relevant tax authorities.

According to HMRC (consultation document, § 11.9 et seq.; IEIM645020), the identity of the beneficial owners does not have to be publicly available, although where such persons are listed on public registers of beneficial ownership, that will be sufficient for the hallmark not to be met. Examples where beneficial owners are made unidentifiable include where undisclosed nominee shareholders are used, or where control is exercised indirectly, rather than by means of formal ownership.

Beneficial ownership is also likely to be obscured where arrangements use jurisdictions where there is no requirement to keep information on beneficial ownership, or no mechanism to obtain it, or where there are no obligations or mechanisms to disclose the beneficial owners of shares held by nominees, or to notify the entity of changes in the ownership or control of the entity, or shares in it.

The FTA consider that institutional investors or persons, legal arrangements or structures wholly controlled by one or more institutional investors are not covered by this hallmark.

Similarly, persons, legal arrangements or structures where all the beneficial owners are tax residents of the jurisdiction of incorporation, residence, management, control or establishment of these entities are also excluded from the reporting obligation under this hallmark (BOI-CF-CPF-30-40-30-20 § 340).

The Italian Ministry of Economics and Finance has provided a sample list of arrangements which use an opaque offshore entity. An “opaque offshore entity” is defined as a passive offshore vehicle, the ownership of which is designed in such a way that the beneficial owner is unidentifiable or different than the identified one. A “passive offshore vehicle” is defined as an entity which does not carry out a substantial economic activity supported by adequate employees, equipment, assets and premises, and is incorporated, resident, managed or established out of the jurisdiction of residence of at least one of the beneficial owners of the assets held by the entity.

Specific hallmarks concerning transfer pricing are always to be reported. It is not necessary that the main benefit test is met.

1. An arrangement which involves the use of unilateral safe harbour rules.

Safe harbour rules: there is no definition of “safe harbour rules” in the Directive but considering the influence of OECD reports on the Directive, it is fair to be reminded that according to the 2017 version of the OECD transfer pricing guidelines, “a safe harbour in a transfer pricing regime is a provision that applies to a defined category of taxpayers or transactions and that relieves eligible taxpayers from certain obligations otherwise imposed by a country’s general transfer pricing rules. A safe harbour substitutes simpler obligations for those under the general transfer pricing regime. Such a provision could, for example, allow taxpayers to establish transfer prices in a specific way, e.g. by applying a simplified transfer pricing approach provided by the tax administration. Alternatively, a safe harbour could exempt a defined category of taxpayers or transactions from the application of all or part of the general transfer pricing rules. Often, eligible taxpayers complying with the safe harbour provision will be relieved from burdensome compliance obligations, including some or all associated transfer pricing documentation requirements” (§ 4.102) (…) “For purposes of the discussion in this Section, safe harbours do not include administrative simplification measures which do not directly involve determination of arm’s length prices, e.g. simplified, or exemption from, documentation requirements (in the absence of a pricing determination), and procedures whereby a tax administration and a taxpayer agree on transfer pricing in advance of the controlled transactions (advance pricing arrangements)” (§ 4.103).

“Unilateral” safe harbour rules: a unilateral safe harbour rule is a rule which is adopted unilaterally by a tax administration.

In order to understand why unilateral safe harbour rules are subject to reporting, one may recall that according to the OECD (transfer pricing guidelines, § 4.110), “the availability of safe harbours for a given category of taxpayers or transactions may have adverse consequences. These concerns stem from the fact that:

1. the implementation of a safe harbour in a given country may lead to taxable income being reported that is not in accordance with the arm’s length principle;
2. safe harbours may increase the risk of double taxation or double non-taxation when adopted unilaterally;
3. safe harbours potentially open avenues for inappropriate tax planning; and
4. safe harbours may raise issues of equity and uniformity”.

Given the rationale of hallmark E.1, it is reasonable to consider that unilateral safe harbor rules should only trigger reporting obligations if they are not foreseen in the international consensus stated in the OECD transfer pricing guidelines. This is in line with the Commission Services summary record of 24 September 2018.

This should imply, for example, that where a profit margin is used to determine the arm’s length price of low value-added intra-group services in accordance with Chapter VII of the OECD Transfer Pricing Guidelines (§ D), there should be no reporting obligation under hallmark E.1.

The Belgian tax authorities specify (Q&A, question 4.5.3.2) that bilateral or multilateral protection regimes are not covered by hallmark E.1. Furthermore, they state that “if the unilateral protection regime is based on a standard on which there is international consensus, such as the OECD’s “Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations” or the “EU Joint Transfer Pricing Forum”, it will not be considered as a unilateral safe harbour rule covered by hallmark E.1”.

According to HMRC, advanced pricing agreements (APAs) made between tax authorities and companies or groups are not unilateral safe harbour rules. Rather, they are agreements as to the correct pricing for transactions. As such, they do not, in their own right, fall to be caught under hallmark E.1 (Consultation document, § 12.6; IEIM646020).

The FTA provide the following example of a reportable arrangement under this hallmark (BOI-CF-CPF-30-40-30-20 § 410):

A company F established in France benefits from a loan granted by an associated company A established in State E. In return, F pays interest to A.

In order to calculate its taxable profit in State E, A takes advantage of a guideline published by the tax authorities of State E for group finance companies. This position specifies that companies which act as intermediaries in the field of intra-group financing may automatically be considered as receiving an arm’s length remuneration if their profit is equivalent to 2% of the assets financed, without it being necessary, with regard to the loans which the said companies grant or receive, to examine the conditions which would have been agreed upon by independent parties in comparable circumstances.

One may deduce from this example that FTA consider that a unilateral ruling in the field of transfer pricing should not be caught by hallmark E.1 provided that it is compliant with the arm’s length principle.

In addition, the Dutch tax authorities have confirmed that a transaction does not fall within the scope of this hallmark, if at the time of the entry into of the transaction, parties dispose of a benchmark study confirming the arm’s length nature of the consideration even if this consideration also falls within an applicable safe harbour rule (e.g. an intragroup loan).

According to the Polish administrative guidelines of 31 January 2019, the reporting obligation arises if an arrangement involves the use of unilateral safe harbour rules linked to the loans, credits and bond issues. This hallmark is not triggered if the safe harbour rules are linked to the low value-adding services.

The Croatian tax authorities state that the market interest rate prescribed by the Minister of Finance is considered a safe harbour rule. Thus, if a taxpayer calculates tax allowable interest/expense on an intra-group loan by applying that simplification, such transaction is reportable.

DAC6, Annex IV, PART II, E.2:

“An arrangement involving the transfer of hard-to-value intangibles. The term “hard-to-value intangibles” covers intangibles or rights in intangibles for which, at the time of their transfer between associated enterprises:

• no reliable comparables exist; and
• at the time the transaction was entered into, the projections of future cash flows or income expected to be derived from the transferred intangible, or the assumptions used in valuing the intangible, are highly uncertain, making it difficult to predict the level of ultimate success of the intangible at the time of the transfer”.

This definition is drawn from § 6. 189 of Chapter VI of the OECD Transfer pricing guidelines. Its interpretation should therefore be aligned with the content of these guidelines.

This hallmark raises several definitional issues.

Transfer: this notion has already been discussed concerning hallmark C.4 and seems to refer both to a transfer between legally distinct entities and to a transfer between a registered office and a permanent establishment. This is the position of the Belgian tax authorities (Q&A mentioned above, § 4.5.4.1).

Intangible: the concept of “intangible” is not defined by the Directive but issues relating to the identification of an “intangible” are described in Chapter VI of the OECD Transfer pricing guidelines (§ 6.5 et seq.). In particular, § 6.6 states that “in these Guidelines, therefore, the word “intangible” is intended to address something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances. Rather than focusing on accounting or legal definitions, the thrust of a transfer pricing analysis in a case involving intangibles should be the determination of the conditions that would be agreed upon between independent parties for a comparable transaction”.

Hard-to-value intangibles (HTVI):  in order to clarify the definition provided by the Directive, it is necessary to refer to Section D.4 of Chapter VI of the OECD Transfer pricing guidelines which provides an approach to pricing hard-to-value intangibles (§ 6. 186 to § 6. 195). Let us recall that this section of the Guidelines has taken on board the recommendations formulated in the 2015 final reports on Actions 8-10 of the BEPS action plan on “Aligning Transfer Pricing Outcomes with Value Creation”.

One may note, in particular, that in § 6. 190, the Guidelines provide that “Transactions involving the transfer or the use of HTVI in paragraph 6. 189 may exhibit one or more of the following features:

1. The intangible is only partially developed at the time of the transfer.
2. The intangible is not expected to be exploited commercially until several years following the transaction.
3. The intangible does not itself fall within the definition of HTVI in paragraph 6.189 but is integral to the development or enhancement of other intangibles which fall within that definition of HTVI.
4. The intangible is expected to be exploited in a manner that is novel at the time of the transfer and the absence of a track record of development or exploitation of similar intangibles makes projections highly uncertain.
5. The intangible, meeting the definition of HTVI under paragraph 6. 189, has been transferred to an associated enterprise for a lump sum payment.
6. The intangible is either used in connection with or developed under a capital cost allowance (CCA) or similar arrangements.

Please refer to the abovementioned paragraphs of the Transfer pricing guidelines for additional details on HTVIs.

Timing issue: according to HMRC (consultation document § 12.10: IEIM646030), where an intermediary or taxpayer considers that the hallmark is not met, and consequently no report is made to the tax authorities, it may subsequently turn out that the projections or comparables that were used prove to have been incorrect or unreliable. In such a situation, it will not necessarily follow that the decision not to make a disclosure was incorrect. The key question is whether the hallmark is met at the time the obligation to report would have arisen.

The Dutch tax authorities have clarified that the existence of a price adjustment provision in a sale and purchase agreement involving a HTVI, will not have an impact on the reporting obligation.

The FTA provide an example of a reportable arrangement under hallmark E.2 in their guidelines as follows (BOI-CF-CPF-30-40-30-20 § 440):

French company F transfers patents and other intangible assets related to a pharmaceutical preparation at an early stage of development to company M, established in State A. F and M are associated companies belonging to the same group.

Although M regards the transferred assets as likely to ultimately lead to the marketing of a drug with very high commercial potential, estimates of the future cash flows that M could derive from the exploitation of the transferred assets are highly uncertain.

F invoices M for the sale on the basis of the research costs incurred, plus a margin, F considering that no reliable comparables exist and that, at this stage of partial development of the pharmaceutical formula, it is not expected to be commercially exploited for several years.

 “An arrangement involving an intragroup cross-border transfer of functions and/or risks and/or assets, if the projected annual earnings before interest and taxes (EBIT), during the three-year period after the transfer, of the transferor or transferors, are less than 50% of the projected annual EBIT of such transferor or transferors if the transfer had not been made”.

“Intragroup” transfer: the Directive does not define “intragroup” but the European Commission’s Services summary record of 24 September 2018 clarifies that “intragroup” refers to the concept of “Associated enterprise” as provided in Art. 3 point 23 of the Directive.

The Belgian tax authorities adopt another approach, considering that for the purposes of hallmark E.3, the notion of associated enterprise refers to the definition provided by Art. 9 of the OECD Model Tax Convention (Q&A mentioned above, question 4.5.5.1).

Nature of the transfer: the wording of the hallmark only requires a cross-border transfer of functions, risks or assets. There is no need for the three kinds of items to exist simultaneously.

It should also be noticed that there is no requirement regarding the state where the transferee is established: hallmark E.3 therefore applies even if the beneficiary of the transfer is resident in a high-tax country.

EBIT: the FTA have specified that it is understood here as operating profit as defined by the general chart of accounts (BOI-CF-CPF-30-40-30-20 § 470).

It therefore seems that EBIT should be calculated without taking into account financial income and expenses, extraordinary income and expenses, employee profit-sharing and income tax.

Need to make a projection of future earnings: a cross-border restructuring is reportable “if the projected annual earnings before interest and taxes (EBIT), during the three-year period after the transfer, of the transferor or transferors, are less than 50% of the projected annual EBIT of such transferor or transferors if the transfer had not been made”. In order to assess whether this restructuring is reportable, it is therefore necessary to compare:

1. the projected EBIT after the transfer; and
2. the projected EBIT if the transfer had not been made.

Needless to say, this is a difficult exercise, as both elements of the comparison are theoretical. As HMRC’s consultation document and guidelines (IEIM646040) put it, “in applying hallmark E.3, the intermediary must consider the arrangement from the point of view of the hypothetical informed observer. Taking account of all the available facts and the circumstances as they are at the time, would a reasonable person consider that the earnings of the transferor during the three-year period after the transaction would, on the balance of probabilities, be less than 50% of what they would otherwise have been? There is evidently a degree of uncertainty in predicting both what the earnings will be, and what they would have been had the transaction(s) not gone ahead. This is why it is necessary to consider what an objective, informed observer would reasonably expect. Where, after the fact, it becomes apparent that the transferor’s EBIT is less than 50% of what it would have been, there will not be a failure to comply with the obligations in the regulations if the projections used in reaching a decision not to report were what an hypothetical, informed observer would reasonably have expected”.

The FTA state that the assessment of the decline in the operating profit is made on the basis of the information available at the time of the transfer (BOI-CF-CPF-30-40-30-20 n°460).

Guidance on how to compare both projections may be found in § 9.117 et seq. of the OECD Transfer pricing guidelines.

Examples of business restructurings: the interpretation of hallmark E.3 should be guided by Chapter IX of the OECD Transfer Pricing Guidelines which deals with business restructurings, intended as “the cross-border reorganisation of the commercial or financial relations between associated enterprises, including the termination or substantial renegotiation of existing arrangements”.

§ 9.2 of the same chapter notes that “business restructurings may often involve the centralisation of intangibles, risks, or functions with the profit potential attached to them”.

They may typically consist of:

• Conversion of full-fledged distributors (that is, enterprises with a relatively higher level of functions and risks) into limited-risk distributors, marketers, sales agents, or commissioners (that is, enterprises with a relatively lower level of functions and risks) for a foreign associated enterprise that may operate as a principal;
• Conversion of full-fledged manufacturers (that is, enterprises with a relatively higher level of functions and risks) into contract manufacturers or toll manufacturers (that is, enterprises with a relatively lower level of functions and risks) for a foreign associated enterprise that may operate as a principal;
• Transfers of intangibles or rights in intangibles to a central entity (e.g. a so-called “IP company”) within the group;
• The concentration of functions in a regional or central entity, with a corresponding reduction in scope or scale of functions carried out locally; examples may include procurement, sales support, supply chain logistics.

Finally, § 9.3 states that “there are also business restructurings whereby more intangibles or risks are allocated to operational entities (e.g. to manufacturers or distributors). Business restructurings can also consist of the rationalisation, specialisation or de-specialisation of operations (manufacturing sites and/or processes, research and development activities, sales, services), including the downsizing or closing of operations. 

Final comments: it is worth highlighting that as long as a business restructuring falls within the scope of hallmark E.3 by virtue of its intrinsic characteristics, there is no need to assess whether this transfer of assets, functions and/or risks is remunerated at arm’s length. In other words, the mere fact that this transfer entails a 50% decrease of EBIT means that it is reportable.

Arrangements other than those noted above may fall within the scope of hallmark E.3. The transfer of any asset that strongly contributes to a company’s EBIT may be caught, even though there is no aggressive tax planning.

The question of whether a cross-border merger may fall within the scope of hallmark E.3 is unclear at this stage, as this requires a definition of “transfer” (is a merger a “transfer”?). In our view, it is reasonable to consider that hallmark E.3 is based on the assumption that the transferor continues to exist for tax purposes after the transfer. A merger resulting in the disappearance of a company (and therefore of the EBIT it generates) cannot therefore a priori fall within the scope of this hallmark. Similarly, the closure of a permanent establishment (following its transfer to another State) should logically remain outside the scope of this hallmark because either the EBIT is assessed at the level of the head office (and the mere transfer of the permanent establishment has no impact), or the EBIT is assessed at the level of the original permanent establishment (but as we have just seen, it seems logical not to apply this hallmark in the event where the permanent establishment ceases to exist).

Incidentally, even assuming that the merger is an event which may fall within the scope of hallmark E.3, the question remains whether the transfer must have tax consequences in order for this hallmark to apply.

For instance, if company A located in a country absorbs company B located in another country and leaves a permanent establishment in that country, there is clearly a transfer of assets in favour of company A leading to a 100% decrease of B’s EBIT (since B disappears), but there is no loss of taxing right for the country of the absorbed company. However, in the Dutch guidelines this transaction is treated as reportable.

The Belgian tax authorities specify (Q&A, question 4.5.5.4) that the following transactions are in principle not considered as cross-border transfers of functions and/or risks and/or assets within the group and therefore do not fall within the scope of hallmark E.3:

• the administrative transfer of the registered office of a Belgian company to another European Member State, while retaining a permanent establishment in Belgium with the same functions and/or risks and/or assets;
• a tax-exempt cross-border merger between EU companies where all assets and liabilities remain linked to a permanent establishment of the acquiring company in the tax jurisdiction of the acquired company;
• the closure of a subsidiary or a branch (permanent establishment), in the context of a liquidation where the net assets are transferred to the shareholder without prior transfer of functions and/or risks and/or assets. However, if functions and/or risks and/or assets are transferred immediately prior to such liquidation (such as a sale of assets to the parent company, whether or not they are sold at market price), such transfers do fall within the scope of hallmark E.3.

The FTA state in this guidelines that this hallmark does not apply to mergers and similar operations in accordance with Directive 2009/133/EC of 19 October 2009 on the common system of taxation applicable to mergers, divisions, partial divisions, transfers of assets and exchanges of shares concerning companies of different Member States and to the transfer of the registered office of an SE or SCE between Member States (BOI-CF-CPF-30-40-30-20 n°460).

Lastly, certain kinds of transfers of assets seem to fall outside the scope of hallmark E.3, insofar as the revenue connected to these assets does not impact the EBIT. For instance, a transfer of shares does not seem to fall within hallmark E.3 because financial income such as dividends does not normally play a role in the computation of EBIT.

The FTA give an example of a reportable arrangement under hallmark E.3:

French company F is a wholly-owned subsidiary of company G established in Member State X.

Since its creation several decades ago, F has been the exclusive distributor in France of products manufactured by G, which owns the brand; F bought products from G, imported them and then resold them in its own name to a broad network of dealers that it had itself set up and developed. For this activity, F’s remuneration was determined by applying the resale price method less 20% (gross margin).

A group reorganisation transformed F into a sales agent (it no longer buys or sells, its action is limited to product promotion and market research). It is now G that supplies dealers directly, owns the stocks and manages trade receivables. Under this new organisational structure, F is remunerated by a commission calculated to enable it to achieve a 2% margin on its own costs.

The transfer of functions, risks and assets has the effect of reducing F’s revenue from EUR 100 million to EUR 6 million per year, and its operating profit from EUR 2 million to EUR 0.7 million per year.

The transferor’s profit before interest or tax is thus more than 50% lower than it would be without the transfer.