New rules to prevent hybrid mis-matches

05 October 2015

Andrew Seidler

The OECD has confirmed its view on how hybrid arrangements should be tackled, proposing that countries amend their domestic legislation, and giving a defensive rule where the other country has not incorporated such measures. These measures put detail on previous recommendations, and cover off some aspects (for example regulatory capital) which were identified as requiring further work.

Hybrid mis-matches generally involve an inconsistent treatment of a transaction (ie the paying country gives a tax deduction for interest, whilst the receiving country sees the payment as a non-taxable dividend) or entities (ie one country recognises the entity locally and gives tax relief for costs arising on a charge from the parent, but the parent jurisdiction disregards the foreign entity and so those costs have the effect of cancelling the income in the parent). The report only addresses cases where there is a hybrid. So a mismatch whereby a tax deductible payment is made to an entity that is exempt from tax in its own jurisdiction isn’t covered. It also confirms that legal and regulatory aspects of structures considered aren’t within the scope of the report – only tax aspects.

The recommended primary rule is that countries deny tax relief for a payment to the extent it is not included in the taxable income of the recipient in the counterparty jurisdiction, or that the cost is also deductible in the counterparty jurisdiction. If the primary rule isn’t applied, then the counterparty jurisdiction can apply a defensive rule either denying the duplicate deduction, or bringing in income to the extent of the tax-deductible payment. Further rules are targeted at arrangements aimed at procuring the same outcome but with third countries.

The report also proposes changes to the Model treaty aimed at ensuring double tax treaties don’t prevent the application of changes required to counter hybrid mis-matches, along with a mechanism for dispute resolution.

These recommendations will impact upon UK companies. For a decade, the UK has had anti-arbitrage legislation where there was a purpose of obtaining a UK tax advantage from the mis-match. However many arbitrage arrangements would not have been within the rules – for example where the advantage accrued overseas and the UK deduction would have been available regardless of the hybrid structure. By contrast, the proposed primary rule will, for example, require UK subsidiaries to disallow tax relief on interest payments if there’s arbitrage within the overseas parent.

If you would like to discuss any of the issues raised, please contact Andrew Seidler or your usual RSM contact.

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