The government will publish a consultation on the UK's "hybrids" anti-avoidance regime. We understand that the consultation will look again at the issues which have caused real difficulties for investment funds.

The OECD's Profit Shifting and Base Erosion Project (BEPS) recommended in its 2015 final reports that countries take steps to neutralise the effects of hybrids mismatch arrangements. The UK wholeheartedly embraced the proposals and was an early adopter, introducing its domestic regime in 2017 and even "gold plating" certain provisions such that they go further than the BEPS proposals. By contrast, under the equivalent EU rules member states only had to introduce hybrid rules in two main phases, one from January 2019 and the other from January 2020, and the EU mandated rules are narrower than the UK regime.

In the Budget the government has announced that it will publish a consultation on the hybrid rules that seeks to ensure that they "work proportionately and as intended". This is a rather vague statement and so, prior to its publication, we cannot be sure what the consultation will contain. However, it appears that an area of focus will be dealing with situations where the rules are giving rise to real difficulties for taxpayers where it is hard to see any good policy reason for them doing so, in particular, in the context of the asset management sector. In this regard, a separate consultation that HMRC published today on the tax treatment of asset holding companies in alternative fund structures (click here for more on this) sheds light on a couple of areas the government has in mind.

The first of these is the wide definition in the regime of when parties are considered to "act together" in relation to another person. This definition is important because it increases the situations in which the rules will apply. The reason for this is that when parties act together in relation to another person, broadly, the aggregate rights and interests those parties have in the other person are attributed to each other, so that their holdings in that other person are more likely to satisfy the regime's size thresholds.

The second of these areas is the application of the rules relating to "deduction/non-inclusion" outcomes (essentially, situations where a party gets a tax deduction for a payment but the recipient is not taxed on receipt) where the recipient of the payment is a hybrid entity and the ultimate owner is exempt from tax. At the moment this is leading to a denial of a tax deduction in benign situations and causing real problems in common structures involving, for example, pension funds.

We understand from HMRC that the consultation will also seek views on the provisions relating to hybrid entity double deduction mismatches (essentially, situations where a hybrid entity and an investor each get a tax deduction for the same payment). In particular, a technical flaw with the rules has led to UK taxpayers not being able to claim tax deductions in some common benign situations, typically involving supplies between a UK service provider which has been subject to a "check the box" election for US tax purposes and a related overseas customer.

On the basis that the consultation will focus on reducing the situations where the regime is either unclear or too wide, rather than increase its scope, it is a promising first step, and if it ultimately results in a more proportionate hybrids regime, this would only increase the UK's competitiveness as an asset management hub and would, accordingly, be very welcome.