Alternative fund administrators in Luxembourg should ensure they are alert to any requirement to submit a report to the tax authorities on cross-border transactions that could give rise to tax avoidance, according to an L3A position paper.
Administrators are unlikely to act as primary intermediaries active in the creation, distribution or implementation of schemes that fall under the scope of the EU legislation and the corresponding Luxembourg law, but they might be seen as secondary intermediaries providing aid, advice or assistance in these activities. Additionally, employees of administration firms who act as directors of client companies in Luxembourg could face reporting obligations in their personal capacity.
The Mandatory Disclosure Regime (MDR) for exchange of information on taxation in relation to reportable cross-border arrangements was introduced by Council Directive (EU) 2018/822 of May 25, 2018, better known as DAC 6. It was transposed into Luxembourg legislation, largely word for word, by the Grand Duchy's law of March 25, 2020.
The regime aims to increase transparency by providing tax authorities with advance warning of potentially aggressive or abusive tax planning schemes and to identify their promoters and users. Responsibility to report such schemes to the appropriate body is mostly on tax intermediaries, which include tax advisers, lawyers and other service providers involved in the design or implementation of cross-border arrangements, and in some cases the taxpayers themselves.
Hallmarks of tax avoidance
Reporting obligations are restricted to cross-border arrangements involving either more than one EU member state or a member state and a third country.
So-called hallmarks - features or characteristics of a cross-border arrangement that indicate a potential risk of tax avoidance - may trigger reporting obligations under the regime. These include generic hallmarks indicating features that are common to promoted avoidance schemes, such as the requirement for confidentiality or payment of a premium fee, covering both innovative tax planning arrangements and mass-marketed transactions. There are also specific hallmarks involving targeting of known vulnerabilities in the tax system and common tax avoidance techniques, such as the acquisition of loss companies or income conversion schemes.
The legislation includes a threshold condition, the main benefit test, intended to filter out irrelevant or defensive disclosures and reduce some of the regime's compliance and administrative burdens. The test is met if it can be established that one of the main benefits that can reasonably be expected from an arrangement is to obtain a tax advantage. This requires a comparison of expected tax advantages with other likely benefits from the transaction.
The disclosure regime applies to taxes of all kinds levied by an EU member state or its authorities, apart from value-added tax, customs duties, compulsory social security contributions or excise duties covered by other EU legislation on administrative co-operation.
Potential reporting obligations
Since alternative fund and asset administrators in Luxembourg often assist investors and fund managers with the implementation and management of international investments, it is vital that they consider their own potential reporting obligations, as well as helping clients to comply with their requirements in Luxembourg and other EU member states.
Potential reporting obligations under the MDR should be an integral part of every tax analysis, considered at an early stage when taxpayers are deciding whether or not to implement a cross-border arrangement. This is part of the aim of the legislation - to deter intermediaries and taxpayers from conducting transactions that might give rise to reporting.
However, some of the definitions and concepts in the law are vague, making it difficult for practitioners to determine whether a particular cross-border arrangement is reportable - especially for intermediaries that are not international tax specialists. But since administrators are involved in a large number of cross-border arrangements, they need to devote adequate resources to ensuring compliance.
The L3A position paper says that while alternative administrators should generally not qualify as primary intermediaries active in designing, marketing or implementing potentially reportable schemes, they may be secondary intermediaries that provide aid, advice or assistance to them.
A knowledge test gives intermediaries the right to provide evidence that they did not and could not reasonably be expected to recognise their involvement in a reportable cross-border arrangement. However, the authors say: "This may be a grey area and could change as the cross-border arrangement is implemented, so it would be wise to consider potential reporting obligations systematically".
It may be reasonable for the taxpayer to appoint a primary intermediary to perform the MDR analysis out of the several intermediaries that typically will be involved - in Luxembourg or other EU jurisdictions. The analysis should be shared with all parties that may qualify as tax intermediaries under DAC 6.
When employees of alternative administrators are appointed as directors of Luxembourg companies involved in the implementation of cross-border arrangements, there is no reporting obligation for the administrator itself, but board members may have such responsibilities as a representative of the taxpayer company in cases where the reporting obligation is on them.
This can happen when the primary intermediary is not required to report because of professional secrecy rules and there is no other intermediary responsible for reporting under the MDR, where there is no intermediary with an EU nexus based on tax residency or place of incorporation, or where the taxpayer designs and implements a scheme in-house.
Robust compliance process
The L3A position paper urges administrators to adopt a robust compliance process documented in a policy and systematically followed in practice, defining the roles and responsibilities of employees, the firm's approach to MDR compliance, the IT infrastructure that should be used to carry out and store the MDR analysis, and the training of staff: "It is crucial to raise awareness about the MDR's scope and mechanism, and the process implemented by the administrator".
In cases where multiple intermediaries may fall under the reporting responsibility, only one report should be filed to avoid multiple reporting of the same arrangement. However, an assurance that another intermediary has agreed to carry out reporting is not enough - liability may arise for an administrator or other service provider unless it can be shown that the reporting has actually been conducted.
Alternative administrators could take the initiative in assisting clients with co-ordination of the various intermediaries, encouraging designation of a primary intermediary to perform the MDR analysis and ensure that it is subsequently shared with and agreed upon by all the parties involved.
Timing is critical. The legislation stipulates that intermediaries must report on information about an arrangement the day after it is available or ready for implementation, or following the first step in implementation - whichever comes first. Secondary intermediaries must file information within 30 days of the day after they provide, directly or otherwise, aid, assistance or advice.
Under the legislation, penalties for non-compliance can reach €250,000 for both intermediaries and taxpayers, depending on the reporting obligation. The L3A experts expect the Luxembourg tax authorities to verify whether intermediaries and taxpayers adopt a proper process for ensuring compliance, and how it is managed on a day-to-day basis, but there is no one-size-fits-all approach.
They conclude: "When intermediaries and taxpayers dedicate appropriate resources to the implementation of a MDR process, including the training of staff, and use their best efforts for its systematic application (which should be properly documented), there should be a limited risk of penalties. But in the absence of appropriate efforts, the Luxembourg tax authorities may be expected to levy penalties in the event of failure to meet the reporting obligations".
L3A position paper: