Consultation on hybrid and other mismatches

20 June 2020

The tax documents published following the Chancellor’s Budget on 11 March included a consultation on the hybrid and other mismatches rules. These rules aim to tackle tax avoidance arrangements which take advantage of the difference in tax treatment of those arrangements between two or more tax jurisdictions. These differences may otherwise allow, for example, a deduction to be claimed twice for the same expense or a deduction in one jurisdiction without a matching taxable receipt in another jurisdiction.  The consultation focuses on three specific areas of the current legislation.

Operation of the double deduction rules

The particular provisions under consultation are commonly in point where a UK hybrid entity is remunerated on a cost plus basis. In order for the cost plus income to qualify as dual inclusion income in the hands of the UK hybrid entity and thereby allow a tax deduction for the entity’s costs , the rules currently require that the payment to the hybrid entity is made as a direct consequence of a payment  made to the investor (often  the hybrid entity’s immediate parent) by a third party. Where this is not the case, deductions claimed by the UK company are at risk. We welcome the decision to consult on redrafting the relevant rules to provide low risk groups that operate in the UK on a cost plus basis greater certainty around the application of these complex rules.

Scope of the acting together rules

The hybrid and other mismatches rules require UK taxpayers to take steps to understand and then document how an item of income or expenditure is treated for local tax purposes in the hands of the overseas counterparty to support the UK tax treatment. Sometimes these requirements may apply even where there is no, or minimal, common ownership between the taxpayer and the counterparty.  An absence of evidence  may result in an increased UK tax liability. The consultation aims to establish whether there may be alternatives to provide greater certainty to UK taxpayers in such circumstances. Many taxpayers have encountered significant practical challenges when seeking to comply with the documentation requirements of the hybrid and other mismatches rules, and we would therefore encourage HMRC to consider broader options to address this issue  than the limited reforms the consultation document appears to envisage. 

Treatment of tax-exempt investors 

Where income arising from a payment made by a UK taxpayer is attributable to an investor that is tax exempt in its home jurisdiction, the hybrid mismatch rules sometimes  attribute the non-taxation of the receipt to the hybridity of the UK taxpayer or the instrument underlying the transaction  (ie the fact that the taxpayer or the instrument has a different taxable form in different jurisdictions) and, therefore, deny any UK tax deduction for the payment. The consultation recognises that this approach may not be appropriate where the investor is treated as exempt for public policy reasons (as a pension fund may be, for example). It therefore proposes possible mechanisms that can provide a limited carve-out for such investors.

We would encourage HMRC to introduce legislation that provides for a pragmatic solution consistent with the efficacy  and wider policy aims of the rules.

As a result of the coronavirus outbreak the closure date for this consultation has been extended by three months to 29 August 2020. Affected businesses should consider whether they wish to respond to the consultation.

For more information please get in touch with Suze McDonald.

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