DAC 6 implementation in Luxembourg: What's important?

Only certain types of potential harmful arrangements need to be reported. Indeed, three conditions must cumulatively be complied with to fall within the scope of reportable arrangements within the meaning of the DAC 6 Law

What kind of arrangements need to be reported?

First, there should be a cross-border element, second only certain taxes are covered, and third specific hallmarks must be met.

1.1 Cross-border arrangements

Reporting obligations are limited to a cross-border arrangement, which means an arrangement which involves either two different EU Member States or an EU Member State and a third country. As such, it excludes purely domestic arrangements where all participants are resident of the same jurisdiction. However, the DAC 6 Law does not provide any guidance on the definition of participant. Hence, and in line with the Chamber of Commerce Opinion, the meaning of participant might be difficult to assess in some cases, resulting in uncertainties as regards the presence of potential reporting arrangements and thus related obligations.

1.2 Taxes targeted 

Only the taxes and duties targeted by article 1 of the amended Luxembourg law of 29 March 2013 on administrative cooperation in the field of taxation, which covers all types of taxes and duties levied by Luxembourg or another EU Member State, exclusive however of VAT, customs duties, excise duties and social security contributions. 

1.3 Hallmarks

Only cross-border arrangements meeting at least one of the hallmarks enumerated in the appendix to the DAC 6 Law, which is in essence identical to the hallmarks listed in appendix IV of DAC 6, will need to be reported. In brief, the DAC 6 hallmarks are indicators that a given operation may be potentially aggressive and as such represent a harmful tax practice leading to an unjustified erosion of the tax base.

There are five categories of hallmarks, and a number of them (in fact, all hallmarks of the first two categories, and some of the third category) are only applicable when the "main benefit" test is met. As such, it is crucial to understand such concept to properly assess whether certain hallmarks are given, especially as according to the DAC 6 Law, the mere presence of the indicators of the hallmarks of the third category requiring the additional main benefit test condition does not in itself establish the fulfilment of such main benefit test.

(a) The main benefit test

Notwithstanding the importance of the concept, the main benefit test is neither expressly defined in DAC 6 nor in the DAC 6 Law. However, the DAC 6 Bill commentaries are in this context expressly making reference to the BEPS Action 12 where it is stated that the main benefit test will be appreciated by comparing the value of the tax advantage with other benefits (e.g., commercial or economic) deriving from the arrangement, and as such relies on an objective evaluation of the tax advantages and such other benefits. 

Such assessment may be difficult to be made in certain situations. Indeed, sometimes the objective evaluation of the tax benefits of an arrangement (e.g., in the presence of a transfer of an intangible asset difficult to evaluate), respectively of the other benefits deriving from such arrangement (e.g., difficulties in the assessment of the real commercial benefits for a taxpayer, or expected long-term economic advantages) may be complicated. 

As such, the express reference to other criteria to measure whether the main benefit is or isn't met would have been helpful. For instance, the Dutch bill implementing DAC 6 provides that the main benefit test should not be met if there are valid economic reasons to justify the arrangement. The commentaries regarding the German bill implementing DAC 6 also provides that the tax advantage must be the principal purpose of an arrangement for the main benefit test to be met, and as such can be avoided by the presence of valid non-tax (in particular economic) reasons. The UK bill implementing DAC 6 requires the presence of an abuse, which would not be given if the arrangement would not go against the law or the intention of the legislator. 

Another (additional) criterion, as highlighted in the Chamber of Commerce Opinion, could have been to exclude explicitly arrangements whereby a foreign taxpayer would obtain a Luxembourg tax advantage, if the taxpayer may benefit from similar advantages in its country of residence.

Some other countries (e.g., Poland) have taken the approach to implement a white list of transactions which are not subject to reporting, which provides legal certainty as regards certain arrangements and avoids reporting of useless information. 

Considering the limited time during which the cross-border arrangement should be reported, and the difficulties to assess and compare, at least for certain transactions, the tax advantages versus other benefits, hallmarks requiring the fulfilment of the main benefit test may very likely be reported systematically in the presence of the mere hallmark, even though there might be good arguments that the main benefit test would not be met.

As such, it seems crucial that written clarifications or guidance are provided on this concept, which is key for the assessment of around half of the hallmarks, to avoid the reporting of completely harmless tax arrangements. 

(b) What are the hallmarks leading to a report?

A. Generic hallmarks linked to the main benefit test 

Broadly speaking, this category encompasses (i) arrangements where the taxpayer or a participant to the arrangement agrees to respect a clause of confidentially to no disclosure how the arrangement could secure a tax advantage, (ii) mechanisms whereby an intermediary is entitled to receive directly or indirectly a fee based on the tax advantage of a given arrangement, and (iii) arrangements that are standardised and do not require significant alterations for their implementation. 

Whilst hallmarks (i) and (ii) do seem more uncommon in ordinary transaction (except in the context of litigation where the fees may be based on the outcome as regards a certain tax matter), hallmark (iii) may represent a danger for the Luxembourg market as certain structuring arrangements are rather standardised whilst not constituting generally an harmful tax practice. 

In this respect, BEPS Action 12 commentaries specify that hallmark (iii) of this category of arrangements targets mass-marketable schemes or prefabricated products which do not need significant adaptation for the needs of a client, and as such can be massively damaging for the internal market. However, as outlined in the Chamber of Commerce Opinion, more a financial product is simple, the more the documentation is standardised, which does not make such instrument aggressive from a tax perspective. Based on the UK guidance in respect of its rules on the DOTAS financial products would for instance not fall within the scope of this hallmark provided that the tax advantage deriving therefrom does not go against the spirt of the law. Yet, in Luxembourg, such arrangement would be reportable if the main benefit test would be met. This assessment may however not always be obvious as highlighted above. 

Written clarification or guidelines would be helpful in this context considering the use in Luxembourg of such standardised documentation as regards certain types of structures.

B. Specific hallmarks linked to the main benefit test 

This category encompasses mainly (i) loss-buying companies, (ii) conversion of income into any kind of other revenue taxed more favourably, and (iii) circular transactions resulting in the round-tipping of funds.

Hallmark (iii) could potentially also result in some difficulties for the Luxembourg market. For instance, do refinancing arrangements or back-to-back financing structures fall within this type of reportable arrangements? Whilst the main benefit test would need to be met here as well, its assessment, as already mentioned, may not always be obvious. 

C. Specific hallmarks related to cross-border transactions 

This category notably encompasses (i) transactions with tax deductible cross-border payments between two or multiple associated enterprises where the beneficiary is a tax resident in no jurisdiction, a low (or nil) tax jurisdiction, or a blacklisted jurisdiction, respectively where the payment is tax exempt or benefits from a beneficial tax regime, (ii) deduction for the same amortisation in more than one jurisdiction, (iii) tax credit as regards double taxation is requested for the same income or capital in several jurisdictions, and (iv) transfer of assets when there is a discrepancy in the amount to be paid from one country to another.

Transactions with tax deductible cross-border payments between two or multiple associated enterprises where the beneficiary is a tax resident in a low (or nil) tax jurisdiction, respectively where the payment is tax exempt or benefits from a beneficial tax regime are considered hallmarks for the purposes of the DAC 6 Law only if the main benefit test is met.

Considering that a lot of, for instance, private equity or real estate transactions involve distributions to funds located in the Cayman Islands, BVI or other offshore countries, the main benefit test is again key here. As highlighted above, it is important to keep in mind that the mere presence of the indicators of these hallmarks does not in itself establish the fulfilment of the main benefit test. As such, written clarification or guidelines would be extremely useful in this context considering the magnitude of transactions that may fall within this category.

As regards the concept of associated enterprise, its definition within the DAC 6 Law is in line with the one included in DAC 6 and comprises a person that holds more than 25% of the voting rights in another person, owns more than 25% of the share capital of another person, or is entitled to 25% or more of the profits of another person, as well as a person that participates in the management of another person by being in a position to exercise a significant influence over the other person. Interestingly, the definition of associated enterprise includes the concept of "significant influence", which can also be found in the Luxembourg law implementing into domestic law ATAD 2. However, contrary to the definition of associated enterprise as provided for by the Luxembourg laws implementing ATAD 1 and ATAD 2 where the threshold regarding voting rights, share capital and profits is met as of 25% (or more), the threshold regarding voting rights or share capital for DAC 6 and the DAC 6 Law is only met if the 25% is exceeded.

D. Specific hallmarks concerning automatic exchange of information and beneficial ownership 

This category would focus on arrangements aiming to (i) avoid automatic exchange of information obligations regarding financial accounts, and (ii) prevent the exposure of the beneficial ownership. As such, this category includes for instance the transfer of a Luxembourg financial account to a Panama branch to avoid Luxembourg country-by-country reporting or common reporting standards obligations, as well as complex opaque holding structures with no real commercial purpose and insufficient substance rendering the identity of the ultimate beneficial owners impossible.

E. Specific hallmarks concerning transfer pricing

Finally, this category notably encompasses (i) the use of unilateral safe harbour rules, (ii) transfers of hard-to-value intangibles, and (iii) certain intragroup cross-border transfers of functions/risks/assets resulting in a decrease of more than 50% of earnings during the next three years.

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