Juncker Plans New Tax Transparency Rules from January 2019
Jean-Claude Juncker, President of the European Commission since November 2014, is preparing to crack down on lawyers running tax-avoidance schemes with the introduction of new transparency rules. The proposal raises a number of important issues for clients and their advisers.
Two days after the Brexit talks began in Brussels, on June 19, 2017, the European Commission issued a press release outlining detailed proposals for “tough new transparency rules for intermediaries—such as tax advisors, accountants, banks and lawyers—who design and promote tax planning schemes for their clients.”
The rationale for such rules, it explained, was driven by “recent media leaks such as the Panama Papers (which) have exposed how some intermediaries actively assist companies and individuals to escape taxation, usually through complex crossborder schemes. Today’s proposal aims to tackle such aggressive tax planning by increasing scrutiny around the previously unseen activities of tax planners and advisers.”
The impact of new transparency rules would be significant, as confirmed by the EC wording: “The proposal has a very wide scope, covering all intermediaries and all types of direct taxes (income, corporate, capital gains, inheritance, etc.).”
Setting implementation to one side, the proposal raises a number of important issues for clients and their advisers. First and foremost is the distinction between tax evasion and tax avoidance. Second, the threat it presents to confidentiality as determined in the U.K. by legal professional privilege (“LPP”). And third, the enormous compliance challenge of how and where such rules will be applied, who would enforce them, and how.
Before addressing these points, it is worth looking at the man with the plan: Jean-Claude Juncker, President of the European Commission since November 2014 and before that, Prime Minister of Luxembourg for 18 years. Juncker had been a popular PM, not least because his economic policies left Luxembourgers as the richest citizens in the EU. Those policies included making his small country of 600,000 citizens very attractive to foreign multinationals, investment funds and high net worth individuals all of whom sought an ultra-low tax, light touch regulatory environment within the EU. Indeed, in 2014, his rivals for the Commission presidency accused him of presiding over a tax haven.
After he became President, Juncker was immediately hit by what became known as Lux Leaks: documents leaked to the media, that revealed in detail how, under his premiership, Luxembourg became a major European centre of corporate tax avoidance. Aided by the government and in particular the tax rulings offered by the Ministry of Finance, multinationals established Luxembourg structures that were routinely subject to effective tax rates of well under 1 percent.
Sharply criticized over his role in allowing these tax avoidance schemes “on a massive scale,” Juncker dismissed it as merely “an oversight.” A further leak of diplomatic cables in 2017 showed that, as Prime Minister, he had repeatedly blocked EU efforts to fight tax avoidance by dozens of multinational corporations.
As a precursor to the EC press release on tax transparency in June, Juncker told MEPs that he would table a draft law designed to uncover those who assist clients by exploiting tax laws and shifting money to offshore tax havens. He identified lawyers, accountants and other financial experts (the latter two categories not benefiting from LPP of course) who devise complex tax avoidance schemes as a “real problem”, adding: “You can’t simply hide behind lawyers’ confidentiality. We are working on that. There is progress being made.” The draft proposal would need to be approved by every EU Member State before coming into force in January 2019.
For some, Juncker’s sudden volte face in attempting to clamp down on intermediaries who advise clients on how to legitimately mitigate their tax liability might appear to be rank hypocrisy of the highest order—not least when he has spent a political lifetime as Luxembourg Prime Minister doing the exact opposite.
So What of the Proposals Themselves?
“The Commission is tackling the central role played by intermediaries in international tax avoidance and evasion,” states the press release. It continues: “Most services provided by intermediaries, such as tax advisors, accountants, financial institutions, law firms, are legitimate. However, certain intermediaries actively design, promote and sell schemes with the specific aim of helping their clients to escape taxation.”
The deliberate elision of activity which is legal (avoidance) as opposed to illegal (evasion) is both irresponsible and flawed. Tax evasion and avoidance may be notoriously difficult to quantify and detect, but not to determine. Tax evasion is a crime with sanctions including fines and lengthy prison sentences. Tax avoidance is legal, although it unfortunately covers a broad moral spectrum of activity. Millions of U.K. citizens legally avoid tax by taking steps to minimize their tax bill. Indeed, it is encouraged by the government through pension schemes, vehicles such as ISAs which allow investors to avoid income tax or capital gains tax and specific incentives such as the EIS.
Conversely, it is true to say that the U.K., from the mid-70s until very recently had a tax avoidance industry like no other. Tax planning schemes were devised that often had little or no commercial merit, were almost always backed by an opinion from a QC and sold via a distribution network of financial advisers and accountants. This has resulted in many individuals, including high profile sportspersons and entertainers, falling foul of the tax courts and the new purposive approach to interpreting tax legislation.
The key point is that the law is perfectly transparent as to whether something is legal or illegal while the current regulatory framework has adequate mechanisms to decide if avoidance schemes are legitimate or not. The move to lift the veil on the confidential advice given by intermediaries to their clients adds nothing to either determination. However, the desire for transparency does a great deal in destroying client confidentiality: the cornerstone of the relationship between an intermediary and their client.
According to the EC Fact Sheet on the new proposal “Intermediaries will have to report any crossborder tax planning arrangement that they design or promote if it bears any of the features or ‘hallmarks’ defined in the Directive. They must make this report to their tax authorities within five days of giving such an arrangement to their client.” Hallmarks are defined as “features or characteristics in a transaction that could potentially enable tax avoidance” and include arrangements which:
- involve a cross-border payment to a recipient resident in a no tax country;
- involve a jurisdiction with inadequate or weakly enforced antimony laundering legislation;
- are set up to avoid reporting income as required under EU transparency rules;
- circumvent EU information exchange requirements for tax rulings;
- have a direct correlation between the fee charged by the intermediary and what the taxpayer will save in tax avoidance;
- ensure that the same asset benefits from depreciation rules in more than one country;
- enable the same income to benefit from tax relief in more than one jurisdiction; and
- do not respect EU or international transfer pricing guidelines.
Worryingly, the use of the word “potentially” provides for the broadest possible interpretation. Given such latitude, any discussion with a client that could in any way be seen to “enable tax avoidance” would therefore have to be reported by the intermediary. At a stroke LPP would be destroyed.
In the U.K., LPP is regarded as fundamental to the administration of justice. The vast majority of transactions, whether commercial or personal, are dealt with through the use of advisers. Tax efficiency is often a key consideration. At its most fundamental, LPP requires a client’s willingness to discuss their circumstances, often involving personal or commercially sensitive information. If clients no longer have confidence that communication with their advisers is confidential, the bond of trust will be broken.
One hopes that the primary objective of the EC proposals is to stem the use of offshore structures for tax evasion purposes and egregious tax planning that has no commercial merit. In order to achieve this, it is likely that Juncker’s proposals will have to be significantly tightened to achieve their objective.
The final element of the equation—how rules might be applied and enforced—may be more farce than force. It is neither pragmatic nor desirable for every conversation or email between a client and their adviser about possible cross-border arrangements that could “potentially enable tax avoidance” to be recorded and reported. Across the EU, this would require a large army of enforcement officials to screen every conversation and email. And of course, it does not allow for unrecorded conversations.
At a practical level, the U.K. is already way ahead of the EU in its targeted anti-avoidance rules, advance payment notice regime and DOTAS provisions that have been very successful in closing down the tax avoidance industry referred to above. When it comes to the political issue of fair tax competition, which is central to Juncker’s argument, there is no such thing. You either have tax competition or you do not. The EU may want a harmonized tax system and an end to tax competition, but the Anti-Tax Avoidance Directive already goes a long way to creating that.
The only law that may benefit as a result of new EU tax transparency rules is that of unintended consequences: the biggest tax avoiders (and evaders) will simply get their tax advice elsewhere.
This article was first published in Bloomberg BNA
Reproduced with permission from Copyright 2017 The Bureau of National Afairs, Inc. (800-372-1033) www.bna.com