(ii) ATAD 2
(iv) Concluding remarks
Last week, Ecofin reached political agreement on an amendment to the EU Anti Tax Avoidance Directive ("ATAD"; see our Tax Alert of 23 June 2016 for further background) to provide for minimum standards for hybrid mismatches ("ATAD 2"). ATAD 2 extends the territorial scope of the EU hybrid mismatch rules to hybrid mismatches with third countries. In addition, it provides for a broader scope of hybrid mismatches, as the rules will also apply to inter alia permanent establishment ("PE") mismatches, imported mismatches, reverse hybrid mismatches and dual resident mismatches.
Ecofin will formally adopt ATAD 2 once the European Parliament has given its opinion. ATAD 2 will have to be implemented by the EU Member States into domestic law no later than 31 December 2019 (thus becoming effective as from 1 January 2020). As an exception, implementation of the provision on reverse hybrid mismatches can be postponed to 31 December 2021 (thus becoming effective as from 1 January 2022). However, it seems that the general hybrid mismatch provisions will already affect certain reverse hybrid structures as from 1 January 2020.
Below, we will discuss ATAD 2, whereby we will focus on the proposed amendments that are expected to have a material impact on Dutch (intermediary holding) structures, namely the hybrid entity mismatch rules and the reverse hybrid mismatch rules.
The ATAD currently already includes rules that target hybrid mismatches between EU Member States (i.e., EU situations). ATAD 2 amends the ATAD by extending the scope of the EU hybrid mismatch rules to both a wider variety of mismatches and to mismatches between EU Member States and third countries. These amendments tie in with OECD BEPS Action 2 (neutralizing the effects of hybrid mismatches). According to the Preamble to ATAD 2, the EU Member States should use the BEPS Action 2 Final Report as a source of illustration and interpretation to the extent the rules are consistent with the provisions of ATAD 2 and Union Law. Subject to certain exceptions (see below), ATAD 2 should become effective as from 1 January 2020, a year later than the ATAD (that will become effective as from 1 January 2019). However, given that the ATAD 2 hybrid mismatch rules will in principle become effective as from 1 January 2020, it has been agreed that the ATAD hybrid mismatch rules will also become effective as from 1 January 2020.
The hybrid mismatches covered by ATAD 2 are largely based on the European Commission Proposal dated 25 October 2016 (see our Tax Alert of 7 November 2016).
Hybrid mismatches are the result of two (or more) jurisdictions qualifying an entity, a financial instrument or a PE differently for tax purposes. Hybrid mismatch may also arise in case of dual tax residency of an entity. These mismatches can e.g. lead to situations in which the same payment is deductible in more than one jurisdiction or to a situation where a payment is deducted from the tax base in one jurisdiction without a corresponding inclusion of that payment in the tax base of a taxpayer in another jurisdiction. As to the broadening of the scope of the EU mismatch rules, ATAD 2 addresses the following hybrid mismatch arrangements:
- Hybrid entity mismatch (already covered by ATAD)
- Hybrid financial instrument mismatch (already covered by ATAD)
- Hybrid transfer mismatch
- Hybrid PE mismatch
- Imported hybrid mismatch
- Reverse hybrid mismatch
- Dual resident mismatch
ATAD 2 only applies in cases of a hybrid mismatch between "associated enterprises", between head offices and their PEs, between two or more PEs of the same entity or mismatches under a structured arrangement. The term "associated" is defined and generally covers direct and indirect interests of 25% or more. However, for certain types of mismatches the percentage is increased to 50%. In determining whether these thresholds are met, the direct and indirect interests of persons who are acting together have to be aggregated. Furthermore, an associated enterprise also means (i) an entity that is part of the same consolidated group for financial accounting purposes as the taxpayer, (ii) an entity in which the taxpayer has a significant influence in the management or (iii) an entity that has a significant influence in the management of the taxpayer. ATAD 2 only neutralizes hybrid mismatches resulting in mismatch outcomes (i.e., double deductions, deduction without inclusion, non-taxation without inclusion and double tax credit). To neutralize these mismatches, EU Member states are either required to deny the deduction of payments, expenses or losses, to include payments as taxable income or to deny relief from double taxation. According to ATAD 2, any adjustments that are required to be made thereunder should in principle not affect the allocation of taxing rights between jurisdictions set under a double taxation treaty (e.g., a taxpayer resident in an EU Member State cannot be required to include certain income under ATAD 2 if this EU Member State is required to exempt such income under a double taxation treaty with a third country).
Hybrid financial instrument mismatches & Hybrid transfer mismatches
Hybrid financial instrument mismatches concern situations where the tax treatment of a financial instrument differs between two jurisdictions. Mismatches that have already been targeted under the EU Parent-Subsidiary Directive (that have been implemented in the tax laws of the Netherlands effective as from 1 January 2016; see our Tax Alert of 21 January 2016 for further background) are not covered by ATAD 2. The term 'financial instrument' also includes a hybrid transfer. A hybrid transfer means any arrangement to transfer a financial instrument where the underlying return on the transferred financial instrument is treated for tax purposes as derived simultaneously by more than one of the parties to that arrangement (e.g. structuring loans as a share sales and repos). In the case of a financial instrument mismatch, the primary rule is that the deduction should be denied in the state of which the payer is a resident. If the deduction is not denied by the third country payer jurisdiction, as a secondary rule, the payment should be included in the income in the EU Member State that is the payee jurisdiction. To the extent that a hybrid transfer is designed to produce a relief for tax withheld at source on a payment derived from a transferred financial instrument to more than one of the parties involved, the EU Member State of the taxpayer shall limit the benefit of such relief in proportion to the net taxable income regarding such payment.
As an exception, in specific situations payments made by financial traders do not give rise to hybrid mismatches provided that certain requirements are met. As such, the anti-hybrid mismatch rules regarding double deduction shall not be applicable where a payment is made by a financial trader under an on-market hybrid transfer provided that the payer jurisdiction requires the financial transfer to include as income all amounts received in relation to the transferred financial instruments.
In addition, ATAD 2 includes an exemption with respect to the banking sector. In order to avoid unintended outcomes in the interaction between the hybrid financial instrument rule and the loss-absorbing capacity requirements on banks, EU Member States may temporarily exclude from the scope of the hybrid mismatch rules to be implemented under ATAD 2 certain financial instruments that have been issued with the sole purpose of meeting the issuer's loss-absorbing capacity requirement. The provision may be applied by EU Member States until 31 December 2022 and shall be evaluated by the European Commission by 1 January 2022.
Hybrid PE mismatches
ATAD 2 addresses several PE mismatches. Hybrid PE mismatches concern situations where the business activities in a jurisdiction are treated as being carried on through a PE by the head office jurisdiction whereby such jurisdiction exempts the income derived from the PE while those activities are not treated as being carried on through a PE in the PE jurisdiction, resulting in an exemption with no inclusion of the relevant items of taxable income. ATAD 2 addresses a number of PE mismatches and corresponding remedies to neutralize the relevant mismatch. Where a hybrid mismatch e.g. involves disregarded PE income which is not subject to tax in the EU Member State in which the taxpayer is resident, that EU Member State shall require the taxpayer to include the income that would otherwise be attributed to the disregarded PE (unless the EU Member State is required to exempt the income under a double taxation treaty).
Imported hybrid mismatches
Imported hybrid mismatches concern situations where the effect of a hybrid mismatch between parties in third countries is shifted into the jurisdiction of an EU Member State through the use of a non-hybrid instrument thereby undermining the effectiveness of the rules that neutralize hybrid mismatches. This includes a deductible payment in an EU Member State under a non-hybrid instrument that is used to fund deductible payments involving a hybrid mismatch (i.e., double deduction or deduction without inclusion). To neutralize these imported mismatches, ATAD 2 includes a provision disallowing the deduction of a payment under a non-hybrid instrument if the corresponding income from that payment is set-off, directly or indirectly, against a deduction that arises under a hybrid mismatch arrangement giving rise to a double deduction or a deduction without inclusion between third countries. This rule should not apply to the extent that one of the third country jurisdictions involved in the transaction has made a hybrid mismatch adjustment in respect of the imported hybrid mismatch. This provision may catch structures with an interest deduction in an EU Member State where the loan on which the interest is paid is related to (C)PECs issued by a Luxembourg entity up the corporate chain.
Dual resident mismatches
To the extent that a deduction for payment, expenses or losses of a taxpayer which is resident for tax purposes in two (or more) jurisdictions is deductible from the taxable base in both jurisdictions, the EU Member State of the taxpayer shall deny the deduction to the extent that the other jurisdiction allows the duplicate deduction to be set-off against non-dual inclusion income (i.e., any item of income that is not included under the laws of both jurisdictions where the hybrid mismatch outcome has arisen). If both jurisdictions are EU Member States, the EU Member State where the taxpayer is not deemed to be a resident according to the double taxation treaty between the two EU Member States concerned shall deny the deduction.
Hybrid entity mismatches
A hybrid entity is any entity or arrangement that is regarded as a taxable entity under the laws of one jurisdiction and whose income or expenditure is treated as income or expenditure of one or more other persons under the laws of another jurisdiction. ATAD 2 covers a number of hybrid entity mismatches that result either in a deduction without inclusion or in a double deduction.
A hybrid entity mismatch may concern a payment made to a hybrid entity which gives rise to a deduction without inclusion (i.e., if the entity is considered as non-transparent by the jurisdiction in which the persons with a controlling interest in the entity are resident, but is considered transparent in its residence state). As a primary rule, the deduction shall be denied in the state of which the payer is a resident. If the deduction is not denied by the payer jurisdiction (i.e., a non-EU Member State), as a secondary rule, the payment should in principle be included in the income in the EU Member State that is the payee jurisdiction. However, an EU Member State may exclude this secondary rule (i.e., mandatory income inclusion). We note that this type of hybrid mismatch may also qualify as a reverse hybrid mismatch in case the hybrid entity is incorporated or established in an EU Member State, in which case the specific reverse hybrid mismatch provision should be applied first (see further below).
A hybrid entity mismatch may also concern a payment made by a hybrid entity which results in a deduction without inclusion (i.e., if the hybrid entity is considered as non-transparent in its residence state and makes a payment to a person that has a controlling interest in the entity and this person is resident in a state that treats the entity as transparent and therefore disregards the payment made by the hybrid entity). As a primary rule, the deductibility of the payment should be denied at the level of the hybrid entity. If the deduction is not denied in the payer jurisdiction (i.e., a non-EU Member State), as a secondary rule, the payment should be included in the income in the EU Member State that is the payee jurisdiction. We note that for this type of hybrid entity mismatches an EU Member State cannot exclude the secondary rule.
Finally, a hybrid entity mismatch may concern a payment by a hybrid entity resulting in a double deduction (i.e., if the hybrid (intermediary) entity is considered as non-transparent in its residence state and considered transparent in the state of the person that controls the hybrid entity, payments made by the hybrid entity are deductible in both the state of which the entity and the state of which the investor is a resident). As a primary rule, the state of which the investor is a resident, should deny the deduction if and to the extent the payment is deductible against income that is not dual-inclusion income (i.e., any item of income that is not included under the laws of both jurisdictions where the hybrid mismatch outcome has arisen). If the deduction is not denied in the investor jurisdiction, as a secondary rule, the deduction should be denied in the EU Member State that is the payer jurisdiction.
Reverse hybrid mismatches
Although not included in the European Commission Proposal, dated 25 October 2016, ATAD 2 also includes specific rules aimed at reverse hybrid mismatches. This concerns situations where an entity is incorporated or established in an EU Member State which qualifies the entity as transparent, whereas the jurisdiction of one or more associated non-resident entities that hold (in aggregate) a direct or indirect interest in 50% or more of the voting rights, capital interests or rights to a share of profit in the hybrid entity, qualifies the entity as non-transparent.
In these types of reverse hybrid mismatches, the hybrid entity shall be regarded as a resident of the EU Member State where it was formed and taxed on its income, but only if and to the extent that such income is not otherwise taxed under the laws of the EU Member State where it was formed or any other (EU or third country) jurisdiction.
This rule will affect Dutch disregarded CVs that are used as mere holding structure and so-called Dutch "CV-BV structures" (where the CV e.g. owns IP and licenses such IP back-to-back through the BV in consideration for payments of royalties), if the associated non-resident entities holding a qualifying interest in the CV are located in a jurisdiction that regard the CV as a taxpayer, such as the US. To the extent the aforementioned non-resident entities participating in the CV were to be located in the US and regard the CV as a taxpayer, the CV would in principle become liable to Dutch corporate income tax as a resident taxpayer on its income. To the extent the income of the CV is allocable to non-resident entities participating in the CV that are located in jurisdictions that also disregard the CV, such income may not become subject to Dutch corporate income tax, but only if this income is taxed in the jurisdiction of the non-resident entities that participate in the CV.
If the CV becomes liable to Dutch corporate income tax, the questions arise whether distributions by the BV to the CV (see below) or by the CV to its partners would in that case become subject to Dutch dividend withholding tax as well and whether double taxation treaties could mitigate the Dutch corporate income tax (and dividend withholding tax) imposed on the CV. As to distributions by the BV to the CV becoming subject to Dutch dividend withholding tax, we note that pursuant to a Decree of the Dutch State secretary of Finance US entities participating in a CV-BV structure are eligible for a reduction of the Dutch dividend withholding tax in respect of distributions made by the BV to the CV to 0%, notwithstanding that from a US tax perspective they are not considered to have received these distributions. Although this option does in principle not fall within the scope of ATAD 2 (it concerns Dutch treaty policy), it may also be affected as a result of the implementation of the reverse hybrid rules in the Netherlands.
As an exception to the implementation date of 31 December 2019, EU Member States have the option to postpone the implementation of the reverse hybrid mismatch provisions to 31 December 2021 (thus becoming effective as from 1 January 2022). It is not clear at this moment whether or not the Netherlands will postpone the reverse hybrid rules to 1 January 2022. Reverse hybrid mismatches may, however, also fall under other ATAD 2 provisions (which should already be effective as from 1 January 2020). Although the specific reverse hybrid mismatch takes precedence over other provisions of ATAD 2, it seems that the general hybrid mismatch rules apply to reverse hybrid mismatches in the transactional period during which the specific reverse hybrid mismatch rules have not yet been implemented (i.e., possibly as from 1 January 2020 until 31 December 2021; see above). Dutch CV-BV structures where the CV owns IP and licenses such IP back-to-back through the BV in consideration for payments of royalties are likely affected under these rules because under the general hybrid mismatch rules the payments of royalties by the BV to the CV (holding the IP) should no longer be deductible as from 1 January 2020.
Only if the Netherlands were to implement the reverse hybrid mismatch rules effective as from 1 January 2020 as well, solely the specific reverse hybrid mismatch rules should apply to the CV-BV structure, and the general hybrid mismatch rules should not. This should also be the case as from the moment that both provisions have been implemented in the Netherlands.
Finally, we note that collective investment vehicles are excluded from the scope of reverse hybrid mismatch provision.
As a result of the extension of the scope of the hybrid mismatch rules, virtually all structures in which hybrid mismatches arise may be caught by these rules. Although the impact will depend on the ultimate implementation in the Netherlands, we would recommend to review ATAD 2's impact on existing structures, and in particular on imported hybrid mismatches (e.g. (C)PECs issued by a Luxembourg entity), CV-BV structures and CV holding structures. In respect of the latter, it is noted that these structures may already be affected as from 1 January 2020, also because it cannot be excluded that the Netherlands already implements the reverse hybrid provision as from 1 January 2020 (instead of 1 January 2022).