Switch Pricing and DAC6—Going Past the Devoted Hallmarks

Council Directive 2018/822/EU of May 25, 2018, commonly referred to as “DAC6,” substantially amended Directive 2011/16/EU of February 15, 2011 on administrative cooperation in the field of taxation to introduce a mandatory reporting regime addressing potentially aggressive cross-border arrangements.

The Directive is inspired by Action 12 (Mandatory Disclosure Rules) of the Organization for Economic Co-operation and Development (OECD)/G-20 Base Erosion and Profit Shifting (BEPS) project. It complements the set of reporting obligations implemented in recent years, with a distinctive feature which is that it primarily targets “intermediaries” involved in the implementation of such arrangements.

DAC6 Purpose and Characteristics

One of the main purposes of DAC6 is to enable EU member states to react promptly to harmful tax practices, notably by increasing the effectiveness of tax audits in international matters, including with respect to transfer pricing—which has been subject to increasing focus recently.

DAC6 provides for a two-step reporting mechanism, composed of, first, the intermediary’s reporting, and second, the automatic exchange of the information reported by the intermediary between the member states concerned.

To determine whether an arrangement should be reported within the meaning of DAC6, a five-step process is applicable:

  • Is there an arrangement?
  • Does this arrangement involve any of the taxes covered?
  • Can this arrangement be qualified as “cross-border”?
  • Does this arrangement contain any of the “hallmarks” of tax avoidance?
  • Where applicable, is the main tax benefit test met?


DAC6 hallmarks correspond to a characteristic or a feature of an arrangement that presents an indication of a potential risk of tax avoidance. DAC6 provides for five categories of hallmarks (Categories A to E) allocated between two types of hallmarks:

  • autonomous hallmarks, i.e. whose mere existence entails the obligation to report the arrangement; and
  • hallmarks requiring the main tax benefit test, i.e. hallmarks which require to demonstrate that the main benefit or one of the main benefits reasonably expected to be derived from the arrangement is the obtaining of a tax advantage (see table below).

Regarding transfer pricing, category E provides for three specific hallmarks; arrangements containing one of these hallmarks must be disclosed, even if they do not meet the main tax benefit test. However, as described below, transfer pricing arrangements are not solely addressed by these three specific hallmarks. Other hallmarks of categories A, B and C may also be applicable to transfer pricing transactions, because they refer to transfer pricing either indirectly or incidentally.

Hallmarks Dedicated to Transfer Pricing—Category E

Category E hallmarks refer to the application of unilateral safe harbor rules (E1), the transfer of hard-to-value intangibles (E2) and intragroup cross-border transfers of functions and/or risks and/or assets resulting in a significant decrease in earnings before interest and taxes (EBIT) (E3).

Scope of “Transfer Pricing” Transactions Covered

Category E hallmarks are dedicated to transfer pricing. Within the meaning of DAC6, an “associated enterprise” is defined for DAC6 purposes as “a person who:

  • participates in the management of another person by being in a position to exercise a significant influence over the other person;
  • participates in the control of another person through a holding that exceeds 25% of the voting rights;
  • participates in the capital of another person through a right of ownership that, directly or indirectly, exceeds 25% of the capital;
  • is entitled to 25% or more of the profits of another person.”

Particular attention should be paid to possible differences that may exist between the definition of an “associated enterprise” within the meaning of DAC6 and its definition under domestic law. Where these definitions differ, it may be necessary to review additional transactions under DAC6, as compared to the transactions documented for transfer pricing purposes under domestic law.

For example, in France, “associated enterprises” within the meaning of transfer pricing legislation generally refers to a 50% ownership. Given that DAC6 covers 25% ownership situations, the scope of the DAC6 provisions is much wider than French transfer pricing legislation.

In any case, the fact that transactions are documented for transfer pricing purposes or that these transactions comply with the arm’s-length principle will not suffice to be exempt from DAC6 reporting, as long as the contemplated transaction meets one of the DAC6 hallmarks (either a transfer pricing hallmark or another).

Hallmark E1

This hallmark applies to any arrangement that involves the use of unilateral safe harbor rules.

“Safe harbor rules” are not defined by DAC6; but a safe harbor rule is defined in the 2017 OECD Transfer Pricing Guidelines (paragraph 4.102) as “a provision that applies to a defined category of taxpayers or transactions that relieves eligible taxpayers from certain obligations otherwise imposed by a country’s general transfer pricing rules. (…).”

Safe harbor rules should be distinguished from simplification measures which do not directly involve the determination of arm’s-length prices (e.g. simplified documentation requirements). On this basis, certain tax administrations, including the French tax administration, have expressly excluded advance pricing agreements from the scope of hallmark E1, as well as thin capitalization rules.

One example of a unilateral safe harbor rule (leading to a reportable arrangement) has been provided in the French tax administration guidelines, see below.

A French company (F) benefits from a loan granted by an associated company (A) established in state E. In return, F pays interest to A. In order to calculate its taxable profit in state E, A applies a circular issued by the tax authorities of that state which is applicable to group finance companies. This circular specifies that companies that act as financing intermediaries within a group may automatically be regarded as receiving an arm’s-length remuneration if their profit is equivalent to 2% of the assets financed, without it being necessary, with regard to the loans granted or received by the said companies, to examine the conditions which would have been agreed upon by independent parties in comparable circumstances.

The unilateral safe harbor rule is the rule by which a finance company in a group may automatically be regarded as receiving an arm’s-length remuneration where its profit would be equivalent to 2% of the assets financed, irrespective of loans granted in similar circumstances between independent enterprises.

Bilateral or multilateral safe harbor rules should be excluded from the scope of the E1 hallmark. Thus, the application of a fixed 5% mark-up on any low value-adding intragroup services which is not justified by a benchmark study in accordance with paragraph 7.61 of the 2017 OECD Transfer Pricing Guidelines, should not be considered as being within the scope of unilateral safe harbor provisions.

Hallmark E2

This hallmark applies to any arrangement involving the transfer of hard-to-value intangibles (HTVIs) between associated enterprises.

Under paragraph 6.189 of the 2017 OECD Transfer Pricing Guidelines, HTVIs are intangibles or rights in intangibles meeting two conditions at the time of their transfer: (i) no reliable comparables exist; and (ii) at the time the transaction was entered into, the projections of future cash flows or income expected to be derived from the transferred intangible, or the assumptions used in valuing the intangible, are highly uncertain, making it difficult to predict the level of ultimate success of the intangible at the time of the transfer.

On the basis of the above, HTVIs may have the following features:

  • they may only be partially developed at the time of transfer;
  • they are not expected to be exploited commercially for several years or are exploited in a manner that is novel;
  • they are being transferred for a lump sum payment; or
  • they are used in connection with or developed under a cost-sharing agreement or a similar arrangement.

To the extent that the valuation of an intangible asset is inherently uncertain, this provision could apply to a wide range of transactions.

In France, it has been made clear in the French tax administration guidelines that the transfer of patents and other intangibles related to a pharmaceutical formula at an early stage of development could be subject to DAC6 provisions if: (i) no reliable comparable exists; and (ii) at this stage of partial development of the pharmaceutical formula, the formula is not expected to be commercially exploited for several years.

The nature of the transferred intangible, and whether it qualifies as an HTVI, should be considered at the time the obligation to report arises.

Hallmark E3

This hallmark refers to intragroup cross-border transfer of functions and/or risks and/or assets resulting in a significant decrease in EBIT. It applies to any arrangement involving an intragroup cross-border transfer of functions and/or risks and/or assets, if the projected annual EBIT of the transferor or transferors, during the three-year period after the transfer, is less than 50% of the projected annual EBIT of such transferor or transferors if the transfer had not been made.

Intragroup Cross-Border Transfer of Functions and/or Risks and/or Assets

Even though DAC6 does not define a “group,” the European Commission Services summary record of September 24, 2018 clarified that any “intragroup” relationship refers to a relationship between “associated enterprises.”

All types of cross-border business restructurings should be covered, as they may potentially impact the allocation of the functions, risks and assets between the associated enterprises of a group, thus resulting in a major change in the transferor’s (or transferors’) EBIT.

In this respect, Chapter IX of the 2017 OECD Transfer Pricing Guidelines, and more precisely paragraph 9.1, defines a business restructuring as “the cross-border reorganisation of the commercial or financial relations between associated enterprises, including the termination or substantial renegotiation of existing arrangements.”

Practically, restructurings likely to fall within this hallmark as they may result into a drop of profitability notably include conversions of full-fledged distributors into limited-risk distributors, conversions of full-fledged manufacturers into contract or toll manufacturers, transfers of intangibles to a central entity, or the rationalization of manufacturing operations or research and development activities.

It should be noted that this hallmark shall apply even if the transferee is established in a “high-tax” state.

Projections of Future Earnings

This hallmark requires comparison of the projection of future earnings further to the transfer with the projected EBIT where the transfer would not have been made.

The French tax administration guidelines provide for an example of the conversion of a French exclusive distributor buyer-reseller (subsidiary of a foreign group) into a sales agent whose activity is limited to product promotion and market research. Before conversion, the French company was remunerated by a gross margin (resale price method minus 20%). Further to the conversion, it is remunerated by a commission calculated in such a way as to enable it to receive a 2% margin on its costs. The transfer of its functions, risks and assets to its parent company has led to reducing its turnover from 100 million euros to 6 million euros per year, and its operating profit from 2 million euros to 0.7 million euros per year.

The French entity’s profit before interest and taxes is thus more than 50% lower than it would have been without such transfer: so the arrangement is within the scope of DAC6 reporting.

Hallmarks Indirectly Addressing Standard Transfer Pricing Arrangements

Hallmark E may not be the only hallmark that is applicable to standard transfer pricing arrangements. Such arrangements may “fall” into other categories of hallmarks, although the direct purpose of such hallmarks may not be to address transfer pricing arrangements. These hallmarks are hallmark A3 on arrangements based on standardized documentation/structure, and hallmark C1 on deductible cross-border payments between associated enterprises.

Hallmark A3

Hallmark A3 applies to any arrangement that has substantially standardized documentation and/or structure and is available to more than one relevant taxpayer without a need to be substantially customized for implementation.

The notion of “standardised documentation and/or a structure” is inspired by the concept of “mass-marketed schemes” used by the OECD to define “standardised tax product” in Action 12 of the OECD/G-20 BEPS project. It is also close to the concept of “marketable arrangement” dealt with by DAC6, i.e. a cross-border arrangement that is designed, marketed, ready for implementation or made available for implementation without a need to be substantially customized.

The key characteristics of such arrangements are their ease of replication and/or implementation which do not require significant additional professional advice or services.

One characteristic of this hallmark is that it shall only be reportable provided that the main tax benefit test is met.

In this respect, numerous countries, including France, have excluded from the scope of the hallmark standardized tax products where their tax outcome is consistent with the purpose of the legislation, such as standard banking contracts, licensing, or incorporation of companies. The French tax administration has specified in its guidelines that certain banking and financial products shall not be reportable provided that the tax benefit received is provided for by French law and that the use of these products is consistent with the purpose of the legislation.

Transfer pricing arrangements are however not covered by these guidelines from the French tax administration, which could lead certain standardized intragroup agreements (e.g., services or licensing agreements) to fall into the scope of the hallmark, to the extent that the main tax benefit test would be met.

Hallmark C1

This hallmark applies to any arrangement that involves deductible cross-border payments made between two or more associated enterprises. Given that transfer pricing is intrinsically related to cross-border arrangements between associated enterprises, a transfer pricing arrangement may fall into the provisions of hallmark C1. This hallmark should therefore be scrutinized in case of a transfer pricing arrangement.

Furthermore, the different sub-categories of Hallmark C1 may not apply uniformly, due to the application of the main tax benefit test in some sub-categories and not in others, as presented in the table above.

Hallmark C1a applies if the beneficiary of the payment is not resident for tax purposes in any jurisdiction.

This situation is likely to arise in cases where none of the jurisdictions concerned considers that the income is attributable to one of its residents. The residence is assessed in accordance with the definitions provided for by applicable double tax treaty.

Hallmark C1b applies if the jurisdiction in which the beneficiary resides:

  • does not impose any corporate income tax (CIT) or imposes CIT at the rate of zero or almost zero; or
  • is on a list of non-cooperative jurisdictions.

CIT at the almost zero rate varies from one country to another, despite a European Commission recommendation of 1%. In France, a CIT rate at almost zero is a CIT rate below 2%.

With respect to non-cooperative jurisdictions, DAC6 refers to a list of third-country jurisdictions which have been assessed by member states collectively or within the framework of the OECD as being non-cooperative. In France, the lists of non-cooperative jurisdictions referred to by the French tax administration guidelines are the EU list and the OECD list (for jurisdictions assessed as non-compliant or partially compliant by the OECD within the framework of the Global Forum on Tax Transparency).

Hallmark C1c applies to payments which are fully exempt in the jurisdiction of residence of the recipient.

The question arose as to whether the exemption is related to the status of the recipient of the income (e.g. pension fund) or to the nature of the income. Various positions have been adopted by different jurisdictions. In France, for example, the exemption includes payment that would not give rise to taxation because of an allowance, compensation, deduction of losses or other deductible costs, deduction/credit of taxes paid abroad or fictitious tax credits. The French tax administration guidelines have clarified that the exemption at stake may have been granted in the context of a cross-border ruling within the meaning of Directive 2015/2376 of 8 December 2015 (“DAC3”) , which may concern transfer pricing issues.

Hallmark C1d applies where the payment benefits from a preferential tax regime.

The concept of “preferential tax regime” is not defined by DAC6. The exact scope of this provision thus depends on the position adopted by each of the jurisdictions concerned.

While some jurisdictions have decided to limit the scope to harmful preferential regimes, the French approach is much wider as it refers to Action 5 of the OECD/G-20 BEPS project preferential regimes, without any limitation to “harmful” regimes. This position is surprising considering that French tax law already provides for a definition of a “preferential tax regime” and that the French tax administration guidelines have expressly specified that this definition shall not be retained in the context of DAC6.

The “preference” is assessed by comparison with the general principle of taxation of the jurisdiction concerned. The nature of the preference may vary. It will cover reductions in tax rates or tax bases, preferential payment conditions or tax refunds. Preferential regime may also be applicable as a result of a cross-border ruling within the meaning of DAC3, which may concern transfer pricing issues.

Hallmarks Addressing Transfer Pricing Incidentally

Hallmarks addressing transfer pricing incidentally could be defined as hallmarks that are not particularly or directly relevant when addressing transfer pricing aspects of an arrangement, but that should be kept in mind when working on transfer pricing.

For example, transfer pricing questions may arise in the context of transactions involving asset valuation or loss-making companies. In this regard, hallmarks B which encompasses specific hallmarks linked to the main benefit test, and the rest of the categories of hallmark C (C2, C3 and C4) which encompass specific hallmarks related to cross-border transactions, should be kept in mind from a DAC6 perspective when addressing transfer pricing.


Since transfer pricing is the subject of a specific hallmark, DAC6 confirms—after the work performed by the OECD/G-20 in the context of the BEPS project—that transfer pricing is viewed by governments as a potential tool for tax avoidance. As detailed above, when analyzing a specific transaction, transfer pricing practitioners should have in mind not only the hallmarks specific to transfer pricing (belonging to category E) but also nearly all of the other categories of hallmarks, to check whether such transaction should be disclosed under DAC6.

DAC6 and transfer pricing provisions are two complementary sets of rules. The various transfer pricing reporting obligations shall therefore not preclude any DAC6 reporting. In addition, transactions documented under transfer pricing provisions as complying with the arm’s-length principle may nevertheless be reportable under DAC6 provisions. Thus, even routine transactions shall not prevent the need to verify whether the transactions fall within the scope of DAC6.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Xavier Daluzeau is a Partner, Celine Pasquier is a Senior Associate and Delphine Groux is a Tax Specialist with CMS Francis Lefebvre Avocats.

The authors may be contacted at: [email protected]; [email protected]; [email protected]