Hybrid instruments are used in the tax structuring of, in particular, intra-group financing transactions with the intention to generate a double dip in the jurisdiction of the corporation providing the financing and the jurisdiction of the financed corporation. A provision under Austrian tax law was introduced to prevent such structures. However, under certain circumstances, this provision may also trigger an Austrian tax liability in situations that do not involve a hybrid instrument.
Double dip under hybrid instruments
Instruments that are treated as equity in one jurisdiction and debt in another jurisdiction (hybrid instruments) may be used for tax arbitrage in cross-border financing transactions. For example, an instrument may be treated as debt financing in the non-Austrian jurisdiction where the financed corporation is resident, but as equity from the perspective of the Austrian corporation acting as the financing corporation. The intended qualification for tax purposes of the payments under such hybrid instrument would be that of tax deductible debt financing interest at the non-Austrian corporation, making the payment and tax exempt dividend income at the Austrian corporation receiving the payment. As a result, the instrument would lead to a profit reduction in the former jurisdiction and tax-exempt income in the latter (double dip). Instruments that may be structured as hybrid instruments include participation rights, certain priority shares and profit participating loans.
Carve-out from the scope of the Austrian participation exemption
The Austrian legislator has decided that such double dip structures should be prevented. For that purpose, a specific provision that limits the scope of application of the Austrian general and international participation exemption was introduced. Accordingly, the exemption from Austrian corporate income tax for non-Austrian dividends received by an Austrian corporation under the international participation exemption and, with respect to certain portfolio participations, under the general participation exemption shall not apply if such payments are deductible at the level of the non-Austrian corporation making the payment.
As a result, the qualification of a hybrid instrument under the applicable non-Austrian law prevails over the qualification of the instrument for Austrian tax purposes. In other words, the Austrian tax treatment of a certain payment depends on the applicable non-Austrian tax law.
In some cases, only a portion of the payment may be deductible at the non-Austrian corporation. Such partial deductibility may be due to, for example, debt/equity ratios or interest barrier rules under the applicable non- Austrian law. The new provision takes such situations into account by denying the Austrian participation exemption to the extent the payments are deductible at the non-Austrian corporation. Therefore, in scenarios where not the entire payment is deductible at the non-Austrian corporation, the Austrian participation exemption (provided all requirements are met) should remain available for the portion of the payment that is not deductible.
The Austrian participation exemption may also be available to non-Austrian residents holding shares in a non- Austrian corporation in an Austrian permanent establishment. In this respect, the carve-out from the participation exemption is also relevant for non-Austrian residents.
The new provision applies to financial years starting after 31 December 2010. Consequently, payments under instruments acquired before that date are also covered (ie, the provision, economically, has a retroactive effect).
Austrian tax liability possibly also triggered in other cases
Although double dip structures with hybrid instruments were the declared target, the wording of the new provision does not refer to hybrid instruments. Rather, it is sufficient for the denial of the participation exemption that the payment is deductible at the non-Austrian corporation making the payment. The following example shows that the provision may also apply in cases that do not involve hybrid instruments.
An Austrian corporation with a permanent establishment in Finland acquired a shareholding in a Finnish corporation and attributed the shareholding to the Finnish permanent establishment. Under the Double Taxation treaty between Austria and Finland, the right to tax the dividends paid under the shareholding in the Finnish corporation was attributed to Finland (with double taxation to be avoided under the credit method). However, pursuant to the rules of the Finnish group contribution regime, the Finnish dividends were deductible at the Finnish corporation paying the dividend (and subject to tax at the recipient of the dividend) in Finland. As a consequence, the provision that should prevent double dips under hybrid instruments triggered a tax liability for the Finnish dividends in Austria with the Finnish tax being credited against the Austrian tax liability. The Austrian Federal Ministry of Finance admitted that the new provision did not target this scenario but still considered its application justified to avoid a potential distortion of tax credits.
Stricter consequences than in cases of misuse
Both the Austrian general participation and the international participation exemption are subject to specific antiabuse provisions. Basically, misuse would be assumed if the dividends are subject to low or no taxation at the non-Austrian corporation and, in case of the international participation, the non-Austrian corporation has a predominantly passive business purpose. If misuse is constituted, a switch-over from the exemption method to the credit method applies.
In contrast, if a payment is deductible at the non-Austrian corporation making the payment and, therefore, carvedout from the scope of the participation exemption, there is no switch-over to the credit method; a tax relief is entirely denied under Austrian domestic tax law. Considering that the deduction of a payment equally effectively results in no (or low) taxation, Austrian domestic tax law provides for different consequences depending on how low (or no) taxation is achieved under the applicable non- Austrian tax law. Commentators have questioned whether such different treatment of comparable fact patterns is justified.
The Austrian legislator has introduced a provision to prevent double dip structures under hybrid instruments by effectively following the qualification of the hybrid instrument under the applicable non-Austrian tax law.