DAC 6 and the alternative funds landscape - Are you prepared?

The DAC 6 reporting deadlines

The new DAC 6 reporting deadlines in Ireland are: 

• 28 February 2021 for cross border arrangements implemented in the transitional period (25 June 2018 to 30 June 2020);
• 31 January 2021 for cross border arrangements entered into between 1 July 2020 and 31 December 2020; 
• 30 days after a reporting obligation is triggered when that triggering event occurs on or after 1 January 2021. 

The scope of EU DAC 6 reporting

As the first reporting deadline approaches, it is important to consider the scope of the DAC 6 reporting obligations as well as the technical and practical issues for  alternative asset managers. 

To begin, it should be noted that a DAC 6 reporting obligation may only arise for those deemed to be an “intermediary” to the transaction. An “intermediary” can be any person that designs, markets, organises, makes available for implementation or manages the implementation of a reportable cross-border arrangement. This includes tax advisors and lawyers. 

In addition to the obligations of a primary intermediary, where a person has sufficient knowledge that they have undertaken to provide aid, assistance or advice with respect to services that design, market, organise, make available for implementation or manage the implementation of a reportable cross-border arrangement, they will be classified as an “expanded intermediary” and a reporting obligation may also arise. The test of “sufficient knowledge” will be based on the relevant facts and circumstances, on available information and the relevant expertise and understanding required to provide such services. This is a very broad definition. In certain instances, an asset manager can also be deemed an intermediary to a transaction. 

Where no intermediary exists or where legal professional privilege is invoked, the taxpayer themselves may have the reporting obligation. 

Reporting obligations across jurisdictions

In practice, to the extent that a particular cross border transaction is reportable, this may result in multiple reporting obligations arising across varying jurisdictions. This can create quite a headache in terms of maintaining oversight of what would likely be considered “business as usual” transactions for an alternative asset manager. Helpfully, Ireland has introduced exemptions from reporting for an intermediary where another intermediary has completed the reporting in Ireland or another EU Member State. However, to avail of the exemption, written confirmation and certain other reporting information will need to be provided by the reporting intermediary. Given the tight timeframes for reporting from 1 January 2021 and the potential for a triggering event to occur at differing times for intermediaries, it remains to be seen how seamless the flow of information between intermediaries will be and whether it will result in a material reduction of multiple reports for the same arrangement if in scope. 

To date, alternative asset managers have typically focused on reviewing historic transactions that fall within the “transitional period”. However, over the past month the shift has focused towards taking the learnings from that historic review to create an ongoing impact assessment framework with a view to having that framework live from 1 January 2021. The scope and complexity of the impact assessment framework for an alternative asset manager should be driven off the quantum of transactions they believe will be in scope for DAC 6 reporting, the level of desired governance around external advisors reporting (which in our experience varies between asset managers) and the preferred governance model around internal team reporting processes. 

Technical considerations for the Irish Alternative Funds Industry 

Many alternative asset managers will hope that the majority of their transactions will not fall within one of the 15 hallmarks that trigger a potential reporting obligation. Cross-border arrangements will only be reportable to the extent that they feature a hallmark. It is important to note that there is a risk that many common  transactions that would not be aggressive or tax-motivated transactions may fall within one of the 15 hallmarks. Certain hallmarks contain a Main Benefit Test (MBT) whereby the transaction will only be reportable in a situation where the main benefit (or one of the main benefits) of the transaction is to obtain a tax advantage. In addition to the MBT, certain hallmarks also require the transaction to occur between “associated enterprises”. This has a similar definition as the one set out in Irish anti-hybrid legislation albeit some additional clarity may be forthcoming in this regard.  

Interestingly, the “tax advantage” referred to as part of the MBT relates solely to EU taxes. This is helpful given the broad international tax base to be considered in an alternative funds structure. 

It is useful to note that Irish Revenue have clarified that DAC 6 reporting is focused on non-routine transactions which can significantly reduce the related administrative burden. Without further clarity on this statement it may be difficult for alternative asset managers to place any significant reliance on this point.  

Irish Revenue have also recently published detailed guidance notes in support of the rules. These  help to clarify a number of points which were ambiguous in the Directive. We have set out below a selection of the key considerations relevant to those in the Irish Alternative Funds industry, supported by some helpful clarifications set out in Irish Revenue guidance.

• Hallmark A.3. targets arrangements that contain substantially standardised documentation which is made available to more than one taxpayer. While standardised documentation would be quite common in terms of investor communications (e.g. offering documentation etc.), it should be noted that this hallmark does contain a MBT, scoping out documentation used for legal/regulatory purposes. Finance Bill 2020 has also put a number of A.3. exemptions on a legislative footing, which provides welcome certainty in this regard. 
• Hallmark B.2. relates to the conversion of income into capital or other categories taxed at a lower rate. This is particularly relevant for investment funds that contain accumulating share classes which enables investors to generate a capital return, notwithstanding that income is received from the underlying investments. Interestingly, Irish Revenue guidance specifically name-checks investments funds as a method for converting income into capital/other types of income. It is important to point out that the MBT is also applicable for B.2.  
• Hallmark C specifically targets deductible cross-border payments between associated enterprises,  which are essential to the extraction of finance in a typical alternative investments structure. We have set out the most relevant areas as follows;
  • Payments to low or no tax jurisdictions are reportable where the MBT is satisfied. A jurisdiction that imposes a less than 1% rate of corporation tax would be considered a low or no tax jurisdiction. This would include common alternative investment fund locations such as the Cayman Islands. 
  • Payments to jurisdictions assessed as “non-cooperative” by the EU/OECD are reportable provided the jurisdiction is listed as “non-cooperative” at both the date of the transaction and the date of reporting. It should be noted that the Cayman Islands has now been removed from this list. This is very helpful in the context of alternative investments as it is not expected to be blacklisted at the date of the initial reporting. 
  • Payments that are exempt from taxation on receipt in the payee jurisdiction are reportable where the MBT is satisfied.
  • Payments that are subject to a “preferential tax regime” in the payee jurisdiction are reportable. Irish Revenue guidance has indicated that from an Irish perspective, such a regime need not be “harmful” to be deemed to be “preferential” but have unfortunately declined to provide examples of such regimes in foreign jurisdictions. 
• A number of alternative fund structures would contain an Irish Section 110 company funded via a Profit Participating Note (PPN). It is useful to note that PPNs entered into pre-25 June 2018 will not be subject to EU DAC 6 reporting requirements, provided that no changes have been made to the funding agreement since 25 June 2018 that would lead it to be considered a new arrangement. 
• Similarly, it is quite common that an alternative fund structure would contain a number of transparent or disregarded entities such as limited partnerships and US LLCs. Irish Revenue have helpfully clarified that it is necessary to trace through these intermediary entities to their members when applying the hallmarks to the transaction.  

What does this mean for you?

Given the complexity of multi-tiered and cross-jurisdictional investment structures together with the existence of multiple intermediary entities within the Alternative Funds industry, it is clear that the introduction of EU DAC 6 reporting will require implementation of clear and robust internal processes to ensure all obligations are met. 

The penalties for non-compliance can be significant. An analysis of the hallmarks that may trigger reporting is a complex exercise. It may need to be assessed across multiple EU territories, each of whom have transposed a unique set of rules under domestic law. The rules are such that compliance obligations can extend beyond the tax function with input required from operations and deal teams, particularly given the tight reporting timelines. We recommend that asset managers take immediate action to develop a governance framework to assess business impacts and implement robust policies and procedures to manage their compliance obligations.

We are here to help you

We are happy to discuss the implications for DAC 6 reporting for your business and the processes and procedures you may need to implement in more detail. Please reach out to the PwC Alternative Investments Tax team for any help you require.  Contact us today.