In January 2017 the UK introduced “hybrid mismatch” anti-avoidance rules in response to Action Point 2 of the OECD’s BEPS project. While many accountants may ignore this complex legislation, believing it to not be relevant to them or their clients, the rules may be further reaching than originally thought.
The new legislation, contained in Part 6A TIOPA 2010, is broader in application than the tax arbitrage provisions (which are anticipated to be repealed), and it extends to cover mismatches arising from permanent establishments and dual residents. Additionally, and unlike the tax arbitrage rules, there is no “purpose” based exclusion to provide relief if a taxpayer’s arrangements do not have a main purpose of achieving a UK tax advantage.
The hybrid mismatch rules generally apply where parties to an arrangement are related. However, where it is reasonable to suppose that a “structured arrangement” is designed to secure a mismatch, these arrangements will also be caught, even if the parties are not related.
The rules seek to counteract situations where either a taxpayer obtains a tax deduction for a payment without there being corresponding taxable income for the recipient (a deduction / non-inclusion mismatch), or where a tax deduction is available on the same payment to two taxpayers, or to the same taxpayer for two different taxes (a double-deduction mismatch). The legislation also includes rules to deter arrangements which attempt to circumvent the main hybrid mismatch rules by routing a mismatch outcome to a third jurisdiction (imported mismatches).
Dependant on the applicable conditions, a mismatch is counteracted by disallowing the deduction claimed or taxing an amount of income which represents the mismatch amount.
Broadly, a hybrid mismatch could arise in circumstances which involve the presence of one of the following:
Hybrid instruments
Mismatches may occur due to the terms or features of a financial instrument resulting in a different tax treatment between two territories. For example, if the instrument is treated as debt in one country and equity in another, a tax deduction may be available for interest paid on the debt whereas the corresponding income is treated as an exempt dividend in the hands of the payee.
Hybrid transfer arrangements
Mismatches from the differing ways that parties treat arrangements such as stock loans and repos for tax purposes.
Hybrid entities
Mismatches may be attributable to the hybrid nature of entities. A UK LLP, for example, may be treated as transparent in the UK but treated as opaque in another jurisdiction. The effect is that the UK will tax the members of the partnership, whilst the other jurisdiction taxes the partnership itself. It is possible, therefore, that each jurisdiction could view a receipt as taxable in the other jurisdiction, with the consequence that the receipt would be untaxed in both territories.
Companies with permanent establishments in another country
A permanent establishment can create a mismatch in a couple of ways. Firstly, if payments are made to a company with a PE and the payments are not fully taxed in either the head office or the PE, or secondly, because the PE territory allows tax deductions for actual or notional payments to the head office territory and they are not taxed there.
Dual resident companies
If a company is resident in two countries or has a PE outside its territory of residence, a mismatch, specifically a double deduction for the same expense, may occur.
An “imported mismatch” may be harder to spot because the rules restrict deductions in the UK, even where there is no direct hybrid arrangement in the UK. Consequently, even if a UK corporate taxpayer makes a payment that does not in itself give rise to a mismatch, it will be necessary to look at the wider arrangements to which the UK company is a party, in order to ascertain whether a mismatch occurs.
Multinationals operating in the UK cannot afford to ignore these rules and should review their current arrangements. If there are arrangements which may be caught under the hybrid mismatch rules, it will be necessary to consider whether it is appropriate to restructure in order to eliminate the hybrid elements. Looking ahead, it seems unlikely that hybrid mismatches will figure significantly in the tax planning strategies of many multinational groups.
The UK is one of the first countries to respond to BEPS Action Point 2, presumably hoping to maximise the tax collected in the UK before other countries adopt similar rules in an attempt to protect their own tax base. This is undoubtedly a positive response to the BEPS process but the financial impact will depend on the ability of multinationals to achieve tax efficient outcomes using non hybrid arrangements.
Alison Conley is a corporate and international partner at MHA MacIntyre Hudson