"My group has a low risk approach to tax planning. We do not engage in aggressive tax planning, none of our transactions are designed to exploit tax arbitrage and we have not implemented offshore financing structures. We do not need to worry about the UK's new anti-hybrid rules, right?"
Hybrid mismatches, according to the OECD report, are designed to exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions to achieve double non-taxation. The rules may be complicated, but when it comes to a hybrid mismatch, surely you'll know it when you see it?
Let's start with two situations that are relatively straightforward to spot:
- A UK company pays a coupon on a debt instrument which its parent (in a different jurisdiction) regards as (tax-exempt) equity. That sounds like a mismatch arising on a hybrid financial instrument: see Chapter 3 of the new rules (which are in Part 6A TIOPA 2010).
- A Luxembourg company issues CPECs (Luxembourg debt instruments) to its US parent (which treats CPECs as equity). The Luxembourg company on-lends the proceeds to an affiliate in the UK. If the UK company obtains a deduction for interest payments, that sounds like it has imported a foreign mismatch: see Chapter 11.
So far so good - and this makes sense once you've digested the OECD report.
But there are a number of situations where the UK anti-hybrid rules can apply without there being any obvious mischief - and in some cases where the OECD did not see the need for action. Takes these four examples:
- All payments by overseas PEs (to third parties, not just intra-group) need to be examined to test whether there is a deduction in the overseas territory as well as in the UK. If there is, the UK deduction is allowed only to the extent that there is "dual inclusion income" (i.e. where the same income is taxable in both territories). This is one example of the application of Chapter 10.
- The PE rule works in reverse, too, so UK PEs of overseas companies need to check whether all of their deductions are matched by dual inclusion income.
- Groups that contain UK transparent entities (e.g. an English limited partnership) may find they run into trouble with the counterfactual exercise required by s.259GB(3) TIOPA 2010, which can deem a mismatch arising for non-hybrid reasons (e.g. where a partner is tax-exempt) to be attributable to the hybrid nature of the partnership.
- US headed groups may spot that some widely used structures (such as payments from a checked open UK subsidiary to a US parent) are squarely within the sights of the anti-hybrids project, but may not appreciate that all "checked" entities in the group are likely to be "hybrid entities", such that each of Chapters 5, 7, 9 and 11 TIOPA 2010 need to be considered before you can be sure that UK deductions remain allowable.
In each case, the compliance exercise which is required to establish whether the anti-hybrid rules affect the UK tax position is a considerable undertaking.
And for many people working in tax, the precise details of the new rules (which have been in force since 1 January 2017) are likely to be unfamiliar. The legislation takes up 40 pages of the latest yellow tax handbook and uses unfamiliar terminology (such as "quasi-payments" and "impermissible deduction/non-inclusion mismatches"). In addition, HMRC has published draft guidance on the legislation (404 pages), which assumes familiarity with the OECD report (458 pages).
As with some other aspects of the BEPS project, the UK has rushed to introduce rules ahead of other OECD members and has - in its enthusiasm for the BEPS project as a whole - added considerable additional complexity to the UK corporate tax code. New Part 6A TIOPA 2010, which exceeds in a number of important respects the recommendations of the OECD report in relation to hybrids, is something which all groups need to be familiar with.