Last week we wrote about the current ATO focus on offshore branches. In that piece, we noted how both the “law” and the “LORE” in this area are extremely complicated (involving principles of branch attribution, transfer pricing, thin capitalisation and other areas) and have developed over many years.
The complexity in this area is likely to increase significantly as a result of the current OECD proposal to apply the BEPS Hybrid Mismatch principles to branches. As readers will be aware, in November 2015 the OECD released the BEPS Action 2 Final Report on “Neutralising the Effects of Hybrid Mismatch Arrangements”. That report focussed on various cross-border mismatch arrangements such as Country A says debt/Country B says equity, Country A says sale/Country B says financing (i.e. SLAs and repos) and Country A says company/Country B says transparent entity. The Australian Government has indicated that it will introduce rules in Australia to counter such hybrid mismatch arrangements.
Earlier this week, the OECD released a further discussion paper entitled “BEPS Action 2 – Branch Mismatch Structures”. This paper takes the Hybrid Mismatch arrangements work one step further by proposing to apply similar principles to offshore branches. By way of example, the proposal is that action is required if a company in Country C makes a payment (deductible in Country C) to a branch in Country B where that payment is not taxable in either Country B or Country A (head office being located in Country A). Consistent with the basic principles of the Hybrids work, the solution would be to deny the deduction in Country C or, if that does not occur, include the payment in assessable income in Country B or Country A. Related work on similar issues also features in the final report on BEPS Action 6 (treaty abuse).
This type of example is relatively easy to understand. Things get a lot more complicated when similar principles are applied to inter-branch “transactions” between the branch and head office (i.e. “transactions” that do not legally occur, at least so far as Australian law views the matter, but are, in other jurisdictions, recognised for tax purposes – whether respected as transactions, or functioning as a proxy for attributing income and expenses between branches and head office).
In order to even consider how such rules would operate it would be necessary to have a clear understanding of precisely how each relevant jurisdiction treats such inter-branch “transactions”. This is far from clear in Australia let alone other jurisdictions. Although the paper does have some helpful comments, in that it recognises that these Hybrid-type principles should not apply when the inter-branch “transaction” is operating as an allocation of third party expenses, the very fact that it may have application to such inter-branch “transactions” at all is extremely worrying for taxpayers with offshore branches.
The paper does not stop there – even further layers of complexity are then added. The possibility of adopting the so-called “imported mismatch rule” to branch transactions is perhaps the closest thing that tax advisers will ever get to understanding quantum physics – yes, it really is potentially that complicated and, as a matter of fact, almost impossible to actually administer. (Fortunately, the Board of Taxation has already recommended that Australia can wait to see if this notion is really necessary for us.)
It will be interesting to see how this plays out. If recent history is a reliable indicator it is likely that the OECD’s final report will look very similar to the discussion draft. It is then likely that the Government will ask the Board of Taxation to consider this further report and to make recommendations. Call us idealistic, but it would be good to have some clear “law” on precisely how basic inter-branch “transactions” are treated in Australia prior to any legislation being implemented to counter cross-border mismatches that result from such “transactions”.