Reporting Obligations for Cyprus Lawyers under DAC6: Navigating Cross-Border Tax Arrangements

Introduction

The Directive on Administrative Cooperation (DAC6), formally known as EU Directive 2018/822, establishes comprehensive reporting requirements aimed at addressing aggressive cross-border tax planning and avoidance schemes. Cyprus, as an EU Member State, implemented DAC6 through the amendment of Law 205(I)/2012 via Law 41(I)/2021. These obligations notably affect lawyers who advise on cross-border tax arrangements, requiring them to disclose specific information to the tax authorities or notify other relevant parties.

Understanding DAC6

DAC6 introduces mandatory disclosure rules for cross-border tax arrangements involving EU Member States and potentially third countries. Lawyers who provide legal advice, assistance, or support in developing, marketing, or implementing such arrangements are classified as “intermediaries.” DAC6 seeks transparency by mandating the disclosure of arrangements exhibiting certain characteristics, referred to as “hallmarks,” indicative of potential tax avoidance.

Legislative Background and Objectives

DAC6 amends the Directive on Administrative Cooperation (Council Directive 2011/16/EU) and was adopted to address the challenges posed by cross-border tax arrangements that exploit disparities in national tax systems. Its provisions became applicable from 25 June 2018, with the first reporting obligations taking effect on 1 July 2020. However, due to the COVID-19 pandemic, the EU permitted an optional six-month deferral under Council Directive (EU) 2020/876, pushing initial reporting deadlines in Cyprus to 31 January 2021 for arrangements implemented between 25 June 2018 and 30 June 2020, with ongoing arrangements reportable from 1 March 2021 onwards.

The Directive’s primary aim is to enable tax authorities to identify and scrutinise potentially aggressive tax planning schemes at an early stage. Information reported under DAC6 is shared among Member States via a centralised database, fostering cooperation to ensure tax fairness. In Cyprus, the Cyprus Tax Department oversees compliance, issuing guidance to clarify reporting timelines and requirements.

Scope of DAC6: Defining Reportable Arrangements

The scope of DAC6 is deliberately broad, encompassing any “cross-border arrangement” that involves either more than one EU Member State or an EU Member State and a third country, provided it meets one or more of the specified hallmarks. A cross-border arrangement is defined under Article 3(18) of Directive 2011/16/EU as an arrangement concerning either multiple Member States or a Member State and a non-Member State, where at least one participant is tax resident in a different jurisdiction or where the arrangement has a potential impact on tax obligations across borders.

The hallmarks, outlined in Annex IV of DAC6, are categorised into five groups (A to E), each identifying characteristics commonly associated with tax avoidance. Some hallmarks require an additional test of a “main benefit,” meaning that obtaining a tax advantage must be one of the primary purposes of the arrangement. For example:

  • Hallmark A(1) addresses arrangements where participants undertake confidentiality obligations to conceal tax benefits from tax authorities. This hallmark targets schemes designed to operate discreetly, preventing tax authorities from detecting the tax advantage sought. For instance, an agreement requiring participants to withhold details of a tax structure from regulators would trigger this hallmark, regardless of its legality, highlighting the emphasis on transparency.
  • Hallmark A(3) pertains to arrangements involving standardised documentation or structures marketed to multiple taxpayers without significant customisation. This captures mass-marketed tax products that may prioritise tax savings over tailored economic substance.
  • Hallmark C(1)(a) involves deductible cross-border payments where the recipient is resident in a jurisdiction with no corporate tax or a near-zero rate. This targets arrangements exploiting low-tax jurisdictions to reduce taxable income in higher-tax regions.
  • Hallmark C(1)(b) concerns cross-border payments between associated enterprises where the recipient is resident in a jurisdiction with no or almost no corporate income tax. This hallmark, closely related to C(1)(a), focuses on transactions within corporate groups, aiming to prevent profit shifting to tax havens. For example, a Cyprus company paying a deductible fee to a subsidiary in a zero-tax jurisdiction would fall under this category, prompting scrutiny of the arrangement’s economic purpose.
  • Hallmark D(1) addresses arrangements undermining reporting obligations under the Common Reporting Standard (CRS), such as those obscuring beneficial ownership through complex structures.
  • Hallmark E(3) targets the use of jurisdictions with weak anti-money laundering regimes to obscure beneficial ownership. This hallmark reflects DAC6’s intersection with broader financial transparency goals, capturing arrangements that leverage lax regulatory environments to hide the true beneficiaries of tax advantages. An example might include routing funds through a jurisdiction with minimal oversight to mask ownership, thereby complicating tax authority investigations.

These hallmarks do not inherently imply illegality; rather, they serve as indicators of arrangements that may warrant scrutiny by tax authorities. This distinction is critical, as it separates lawful tax avoidance—structuring affairs within the bounds of the law to minimise tax liability—from tax evasion, which involves illegal methods to evade tax obligations.

Lawyers as Intermediaries: Obligations and Exemptions

Under DAC6, an “intermediary” is broadly defined in Article 3(21) as any person who designs, markets, organises, makes available, or manages the implementation of a reportable cross-border arrangement, or who provides aid, assistance, or advice in relation thereto. Lawyers, by virtue of their advisory role in tax planning, often fall within this definition, particularly when advising clients on cross-border transactions or structures.

In Cyprus, intermediaries, including legal practitioners, are required to file a report with the Cyprus Tax Department within 30 days of the arrangement becoming reportable—typically when it is made available for implementation, is ready for implementation, or when the first step of implementation occurs (Article 8ab(7) of Directive 2011/16/EU). The report must include detailed information, such as the identities of all intermediaries and relevant taxpayers, a description of the arrangement, the hallmarks triggered, and the expected tax advantage.

However, lawyers are afforded a significant exemption under Article 8ab(5) of DAC6 where reporting obligations conflict with legal professional privilege (LPP). In Cyprus, LPP is enshrined in Section 33 of the Advocates Law (Cap. 2), which protects confidential communications between lawyers and clients made for the purpose of legal advice or litigation. Where LPP applies, we, as legal practitioners, are not obliged to disclose reportable arrangements directly to the Tax Department. Instead, the Directive mandates that we notify other intermediaries involved in the arrangement—or, if none exist, the taxpayer—of their reporting obligations within the same 30-day period.

This exemption reflects a balance between the EU’s transparency objectives and the fundamental right to confidentiality under Article 7 of the Charter of Fundamental Rights of the European Union. However, its application has not been without controversy, as discussed further below.

Tax Avoidance vs. Tax Evasion: Legal and Ethical Considerations

A key aspect of DAC6 is its focus on tax avoidance rather than tax evasion, though the distinction between the two is nuanced and merits careful consideration. Tax avoidance involves the lawful use of tax legislation to reduce tax liability, often through exploiting loopholes or structuring transactions to achieve a tax advantage. The European Court of Justice (ECJ) has consistently upheld the principle that taxpayers are entitled to arrange their affairs within the law to minimise tax, provided such arrangements are genuine and not abusive (see Cassis de Dijon, Case 120/78).

Tax evasion, conversely, is a criminal offence under both EU and Cypriot law, involving deliberate misrepresentation or concealment of taxable income or assets. In Cyprus, tax evasion is governed by the Assessment and Collection of Taxes Law (Law 4/1978), as amended, with penalties including fines and imprisonment under Section 51. The EU has also criminalised certain forms of tax evasion through Directive (EU) 2017/1371 on the fight against fraud to the Union’s financial interests by means of criminal law.

DAC6 primarily targets tax avoidance by requiring disclosure of arrangements that, while legal, exhibit hallmarks of aggressive tax planning. However, the reporting obligation indirectly aids in identifying potential tax evasion, as unreported arrangements may trigger audits revealing illegal activity. For lawyers, this dual focus necessitates a careful assessment of each arrangement to determine its legality and reportability, balancing client interests with statutory duties.

The ECJ Ruling on DAC6 and Legal Professional Privilege

The interplay between DAC6 reporting obligations and LPP came under scrutiny in the landmark ECJ decision in Orde van Vlaamse Balies and Others (Case C-694/20), delivered on 8 December 2022. The case arose from a challenge by Belgian bar associations to the requirement under Article 8ab(5) that lawyers subject to LPP notify other intermediaries of their reporting duties. The ECJ ruled that this obligation infringed Article 7 of the Charter, which guarantees respect for private and family life, including the confidentiality of lawyer-client communications.

The Court reasoned that, while combating tax avoidance is a legitimate objective of general interest, the notification requirement imposed on lawyers was disproportionate. It compelled lawyers to disclose privileged information indirectly, undermining the trust essential to the lawyer-client relationship, without being strictly necessary to achieve DAC6’s aims. Consequently, the ECJ declared Article 8ab(5) invalid insofar as it applied to lawyers bound by LPP.

In Cyprus, this ruling has significant implications. While the core reporting obligations under DAC6 remain intact, we are no longer required to notify other intermediaries or taxpayers when LPP prevents direct reporting. Instead, the burden shifts to other intermediaries not bound by privilege or, failing that, to the taxpayer. This adjustment reinforces the protection of LPP under Cypriot law while maintaining the Directive’s transparency goals through alternative reporting channels.

Practical Implications for Lawyers in Cyprus

For legal practitioners at Chambers & Co., compliance with DAC6 requires a structured approach to identifying and managing reportable arrangements. We must first determine whether an arrangement falls within the Directive’s scope by assessing its cross-border nature and the presence of hallmarks. This involves a detailed review of client transactions, often in collaboration with tax advisors or accountants who may also qualify as intermediaries.

Where an arrangement is reportable, we evaluate the applicability of LPP. If privilege applies, we refrain from reporting and, post-ECJ ruling, are relieved of the notification obligation. In such cases, we advise clients of their potential reporting duties under Article 8ab(6) of DAC6, ensuring they are aware of the need to file directly with the Cyprus Tax Department if no other intermediary is involved.

Non-compliance with DAC6 carries significant penalties under Cypriot law. Section 51A of Law 205(I)/2012, as amended, imposes fines of up to €20,000 for failure to report, with additional daily penalties of €100 for delays exceeding 90 days. These sanctions underscore the importance of robust internal processes to track and document cross-border arrangements.

Challenges and Ethical Dilemmas

The implementation of DAC6 presents several challenges for lawyers. The breadth of the hallmarks and the subjective “main benefit” test can lead to uncertainty, requiring us to exercise professional judgement in borderline cases. Over-reporting risks overburdening tax authorities with benign arrangements, while under-reporting may expose us to liability.

Ethically, we must navigate the tension between transparency and client confidentiality. While DAC6 aligns with the EU’s public policy goal of fair taxation, it may strain client relationships, particularly where clients perceive reporting as a betrayal of trust. We mitigate this by maintaining open communication, explaining the legal basis for our actions, and ensuring compliance does not compromise our duty of loyalty under the Cyprus Advocates’ Code of Conduct.

The Broader EU Context: ATAD and Beyond

DAC6 operates within a broader suite of EU anti-tax avoidance measures, notably the Anti-Tax Avoidance Directive (ATAD, Council Directive (EU) 2016/1164). ATAD addresses specific avoidance practices, such as hybrid mismatches and interest deduction limitations, complementing DAC6’s disclosure regime. Together, these directives form a comprehensive framework to deter aggressive tax planning, with Cyprus implementing ATAD through amendments to the Income Tax Law (Law 118(I)/2002).

Looking ahead, the EU continues to refine its approach. Proposals such as DAC7 (Council Directive (EU) 2021/514) extend reporting obligations to digital platforms, while the Unshell Directive (COM(2021) 565 final) targets shell entities lacking economic substance. These developments signal an ongoing commitment to transparency, requiring us to remain vigilant and adaptable in our practice.

Conclusion

DAC6 represents a pivotal shift in the EU’s tax landscape, placing lawyers at the forefront of efforts to combat tax avoidance while preserving the integrity of legal practice. In Cyprus, we are committed to navigating these obligations with precision, leveraging our expertise in Cyprus and EU law to ensure compliance without compromising client interests. The ECJ’s ruling on LPP reinforces the balance between transparency and confidentiality, offering clarity for practitioners while upholding fundamental rights. As the regulatory environment evolves, we remain dedicated to providing informed, strategic advice, ensuring our clients are well-positioned to meet their obligations in an increasingly scrutinised tax arena.