On December 9, 2015 the UK HM Revenue & Customs (HMRC) published a policy paper titled: “Corporation Tax: anti-hybrid rules”. Next to publishing the policy paper the UK Government also announces that on December 22, 2015 a series of examples illustrating the application of the hybrid mismatch rules will be published.

The policy paper gives the following general description of the measure:

“The measure implements the agreed Organisation for Economic Co-operation and Development (OECD) rules for addressing hybrid arrangements that give rise to hybrid mismatch outcomes and generate a tax mismatch. Mismatches can involve either double deductions for the same expense, or deductions for an expense without any corresponding receipt being taxable.

The measure neutralises the tax mismatch created by the hybrid arrangement by changing the tax treatment of either the payment or the receipt, depending on the circumstances. The rules are designed to work whether both the countries affected by a cross-border hybrid arrangement have introduced the OECD rules, or just one. This measure deals with mismatches in two ways, described as a ‘primary response’ and a ‘secondary response’.

In the case of double deductions, the primary response is to deny a deduction to the parent company. If this does not occur (because the tax law in the country in which the parent company is resident does not provide for this), the secondary response is to deny the deduction to the hybrid entity.

In the case of deduction/non-inclusion, the primary response is to deny a deduction to the payer. If this does not occur, the secondary response is to bring the receipt into charge for the recipient.

Hybrid mismatch outcomes can arise from both hybrid financial instruments and hybrid entities.

An example of a hybrid financial instrument would be one which allowed the payer to deduct an amount as interest, but allowed the receipt to be treated as an exempt dividend in the hands of the payee.

An example of a hybrid structure would be a partnership which is treated as transparent by one jurisdiction, but treated as opaque by another jurisdiction. The effect would be that one jurisdiction would apply its tax rules to the partnership, whilst the other would look through the partnership and apply its tax rules to the partners.

This measure targets hybrid mismatches in the following circumstances.

Deduction/non-inclusion outcomes involving:

·        Hybrid Financial Instruments

·        Hybrid Transfers

·        Hybrid Entity Payers

·        Hybrid Entity Payees

Double deduction outcomes involving:

·        Hybrid Entity Payers

·        Dual Resident Companies

The measure also includes rules to deter arrangements which attempt to circumvent the main hybrid mismatch rules by transferring a mismatch into a third jurisdiction - such arrangements are known as ‘imported’ mismatches. These additional rules deal with Double deduction or deduction/no inclusion imported mismatch outcomes involving: 

·        Hybrid Financial Instruments

·        Hybrid Entity Payees

·        Hybrid Entity Payers”

Furthermore the policy paper describes the policy objective as follows: 

“The measure will neutralise the tax effect of hybrid mismatch arrangements in accordance with the recommendations of Action 2 of the G20/OECD Base Erosion and Profit Shifting (BEPS) project.

This measure seeks to tackle aggressive tax planning where, within a multinational group, either one party gets a tax deduction for a payment while the other party does not have a taxable receipt, or there is more than one tax deduction for the same expense.

The aim is to eliminate the unfair tax advantages which arise from the use of hybrid entities and instruments, and thereby encourage businesses to adopt less complicated cross-border investment structures.”

Click here to be forwarded to the webpage on GOV.UK where one can find links to the policy paper as well as to the Draft legislation and Draft explanatory notes.

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