The end of ‘Hybrid Mismatches’ for UK corporation tax
The UK has introduced ‘hybrid mismatch’ anti-avoidance rules from 1 January 2017 in response to Action 2 of the OECD Base Erosion and Profit Shifting (BEPS) project. The rules are broader in application than previous ‘tax arbitrage’ provisions and many multinational groups will be affected.
These rules generally only apply where the parties to the 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. Therefore all entities that are subject to UK corporation tax, including UK Permanent Establishments (PEs) will need to be aware of the changes.
The rules look to counteract situations where either a taxpayer obtains a tax deduction for a payment without there being a corresponding taxable income for the recipient (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 (double-deduction mismatch).
There are a number of situations where a hybrid mismatch can arise. These include:
Hybrid instruments: mismatches between the tax treatment of payments and receipts on a financial instrument (treated as debt in one country and equity in the other);
Hybrid transfer arrangements: mismatches from the differing ways that parties to an arrangement treat things such as stock loans and repos for tax purposes;
Hybrid entities: mismatches between the tax treatment of the hybrid nature of entities (treated as a taxable person in one country, but as tax-transparent in the other);
Companies with PEs in another country: mismatches between the tax treatment of expenses and income between the head office country and the PE country;
Dual resident companies: mismatches, specifically double deductions for the same expense if a company is resident in two countries or has a PE in another country.
The counteraction will either impose additional taxable income when a UK company receives a payment that would otherwise give rise to a mismatch; or the company will be denied or limited on the UK tax deduction that is available for payments it has made that give rise to a mismatch. Therefore it is the UK company that suffers the counteraction in both circumstances.
Going forward a review of the payments and receipts made by multinationals operating in the UK will need to be completed, in order to consider whether the counteraction will apply. Especially where the structure has been designed to obtain beneficial tax outcomes.
While the UK is one of the first to respond to BEPS Action 2, it is expected that other countries will implement similar rules shortly, making hybrid mismatch arrangements and structures no longer beneficial for tax purposes