Impetus for change
Form of relief
Potential additional amendments
UK hybrid and other mismatches rules broadly apply in cross-border transactions. However, the regime can also apply to purely UK domestic transactions, a point that is made repeatedly throughout Her Majesty's Revenue and Customs (HMRC) guidance. The rules, which have been in force since 1 January 2017, apply to corporates rather than individuals.
The rules follow the Organisation for Economic Cooperation and Development's (OECD's) recommendations and are aimed at counteracting tax mismatches where:
- the same payment is deductible in one country, but not considered taxable income in the country it is received (deduction/non-inclusion mismatch); and
- a deduction is allowed in more than one country for the same payment (double deduction mismatch).
In essence, for the rules to apply, hybridity will be a structural mismatch either in the way that a payment is treated, or in the different ways that countries might treat an entity. Where the rules apply, they can deny a UK tax deduction for the affected payments, which could have a significant effect on large corporates.
Previously, these mechanical rules were strongly criticised for their complexity and their disproportionate outcome, particularly as regards US check-the-box tax planning. Looking at things spherically, the rules can operate in circumstances where there is no real double deduction or deduction/non-inclusion mischief. Indeed, the UK government acknowledged that the 2017 US tax reform has created an incentive for US groups to disregard foreign subsidiaries for tax purposes, thereby creating additional hybrid entities.
On this basis, Finance Act 2021 introduced some significant amendments, some of which have retrospective impact. The changes are designed to ensure that the rules operate proportionately and as intended. Prior to the amendments, many stakeholders argued that the rules could lead to economic double taxation because of their narrow focus and the fact that, in some cases, it would be practically impossible to determine their extent. In many respects, therefore, the amendments reflect a softening of HMRC's original strict interpretation of the rules.
In particular, the most significant changes relate to:
- the definition of a hybrid entity, which is now refocused so that the United Kingdom's view of the entity is only relevant where it is established in the United Kingdom, or the United Kingdom is an investor in the entity (rather than in any territory). The principal effect of this change is to ensure that there are no conflicting views as to the transparent or opaque status of a US entity in the United Kingdom, which would trigger application of the rules; and
- the incidence of dual inclusion income, which broadly comprises income that is brought within the charge to tax in more than one tax jurisdiction. This aspect of the rules can be key to mitigate the extent to which additional UK tax charges arise. This amendment extends the definition of dual inclusion income to enable amounts that are taxable in the hands of the UK hybrid entity but not deductible for any non-UK tax purposes. The definition has been widened so that it can now capture income that is not strictly subject to tax in two jurisdictions. Rather, income is included that is taxed in the hands of the UK payee, but for which there is no deduction afforded to the payer (or anyone else) in any jurisdiction.
Potential additional amendments
At the Autumn Budget last October, a further amendment was announced that is expected to be included in the Finance Bill 2022. The change is focused on hybrid payee mismatches and, specifically, it aims to treat certain non-UK tax transparent entities (such as a US limited liability company) as partnerships. Where such entities are treated as partnerships, their members will be treated as partners for tax purposes. Consequently, the changes will allow certain payments made to such transparent entities to qualify for an existing exclusion under the rules.
Given the objective of seeking to minimise artificial tax arrangements, the hybrid and other mismatches rules play a significant role in combatting tax avoidance and, undoubtedly, they are here to stay. Although the most recent changes are positive and have been well-received, they do not offer a universal solution. There is certainly scope for further changes to achieve an outcome where the rules are more streamlined. Further developments are anticipated.
For further information on this topic please contact Sofia Stavridi at Pinsent Masons by telephone (+44 20 7418 8250) or email (s[email protected]). The Pinsent Masons website can be accessed at www.pinsentmasons.com.