The UK hybrid mismatch rules have been in place since 1 January 2017. They aim to neutralise the effect of tax mismatch arrangements most commonly seen in cross-border scenarios which otherwise give rise to either a deduction with no corresponding taxable income, or deductions being claimed for the same expense by more than one person.
The rules are widely recognised as highly complex and have posed significant challenges since the outset in their interpretation and practical application.
Given the time that has passed since the introduction of these rules, businesses are now beginning to receive compliance check letters from HMRC that seek to review their application of the hybrid mismatch rules. The letters appear initially to focus more on the worldwide group structure and cross-border activities of the taxpayer than on the application of the hybrid mismatch rules, but this approach may provide HMRC with information to verify the legal form and tax residence of other entities in the group to help it to better target any detailed enquiries from a hybrid mismatch perspective.
Details of the tax treatment in the hands of the overseas group payee of specified cross border transactions (eg interest payments, management charges etc) is also likely to be requested. This will typically require the taxpayer to verify the local tax treatment of the income in the hands of the recipient group entity, which HMRC is likely to validate against information received from other tax authorities under international tax information exchange arrangements.
HMRC may also include widely drawn questions asking the taxpayer to comment on their self-assessment of the hybrid mismatch provisions. This approach places the onus on the taxpayer to comment on the application of the hybrid mismatch rules and it will be essential to ensure that responses are aligned with the analysis provided to the transaction-specific questions discussed above.
Updated guidance December 2019
HMRC’s published guidance has recently been extended to include commentary on the various legislative updates since the rules were first introduced in January 2017. This welcome update also clarifies HMRC’s view on several points of interpretation, although uncertainty persists in other aspects.
One example of greater clarity is in the definition of ‘investor’ for the purposes of determining the tax treatment of certain income which may allow a deduction for otherwise non-deductible hybrid entity double deduction amounts in some circumstances. The new guidance states that the term ‘the’ investor ‘should not be interpreted more widely to include ‘any’ investor’. Whilst the basis for this restricted interpretation is not immediately clear , it could be an unhelpful development for those taxpayers relying on a broader reading of the legislation.
The way forward
Whilst HMRC’s updated guidance, alongside the view it takes of particular transactions in any compliance checks and other correspondence may assist taxpayers with the future interpretation and application of these rules, this does not completely address historical uncertainties. It will therefore be important for HMRC to apply a consistent and measured practical approach to bring about greater certainty for taxpayers.
In this regard, we believe it may be helpful for HMRC to consolidate its approach to the hybrid mismatch rules by using a specialist enquiry team. We also wonder whether HMRC might ultimately even consider bringing the hybrid mismatch rules within some form of extended scope facility, akin to the Profit Diversion Compliance Facility launched in 2019, so that taxpayers can bring their affairs up to date and move forward with greater confidence and certainty.
In view of the issues involved, we would strongly recommend that taxpayers that receive correspondence from HMRC relating to the hybrid mismatch provisions consult with specialist professional advisers before responding.
For more information please get in touch with Suze McDonald.