A bill has been introduced into Parliament (expected to be passed during the August Parliamentary sitting) to enact the Government’s announced hybrid mismatch rules. The rules will apply for income years starting on or after 1 January 2019, and apply regardless of whether an entity is a Significant Global Entity (SGE).
Broadly, hybrid mismatches are differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions, or where an entity claims a deduction in two or more jurisdictions. If a mismatch arises, it is neutralised by disallowing a deduction or including an amount in assessable income.
The bill also contains an integrity rule (not included in the original exposure draft), which purports to target arrangements that are designed to circumvent the hybrid mismatch rules. For example, interposing conduit type entities that pay effectively no tax to invest in Australia to replicate the deduction/non-inclusion outcome, as an alternative to investing into Australia via hybrid instruments or entities which would now be caught by the proposed core hybrid provisions.
The integrity rule is designed to capture interest and derivative payments made by an entity (the paying entity) to a foreign entity (the interposed foreign entity) under a scheme where, broadly:
- the paying entity, interposed entity and ultimate parent entity are within the same ‘control group’ (broadly, the entities are consolidated for accounting purposes or one of the entities (or a third entity) holds an interest of 50% or more in each of the entities);
- the payment is deductible in Australia and taxed at a rate of 10% or less overseas (or not taxed at all); and
- there is a principal purpose associated with the scheme of obtaining the Australian deduction and low rate of tax overseas (or no tax overseas).
The integrity rule would not apply if, broadly:
- the payment is picked-up under a country’s controlled foreign company-type rules; or
- assuming that the payment had been made directly to the ultimate parent entity, the parent would have paid the same rate of foreign tax (i.e. so there is no foreign tax benefit from ‘inserting’ the interposed foreign entity).
Inbound real estate investments
The integrity rule is by no means targeted specifically at inbound real estate investments. Nevertheless, there are a few things to bear in mind with existing and new investment structures. For instance, the rule could potentially be relevant to interest bearing loans that are used by a non-resident to fund its Australian real property investments where:
- an interest payment deductible in Australia is made by an entity to a foreign entity (that is not the ultimate parent or controlling entity of the group) where the entities are within the same control group. Importantly, the integrity rule can apply whether or not the entity making the deductible interest payment is an Australian or foreign entity – for instance, the integrity rule could be relevant for a foreign entity holding Australian property which is claiming interest deductions against income from the property taxable in Australia; and
- the interest is subject to foreign income tax at a rate of 10% or less or not subject to foreign tax at all.
However, the integrity rule should not apply to deny interest deductions if it is reasonable to conclude that:
- assuming that the interest payment had been made directly to the ultimate parent entity, the ultimate parent entity would have paid no more foreign tax than the interposed entity – for instance, the ultimate parent entity was an exempt entity such as a foreign pension fund or sovereign wealth fund; or
- there was not the requisite principal purpose of obtaining the Australian deduction and the low rate of foreign tax, which may take into account factors such as the way in which the interposed entity is funded and whether it is an entity of substance with other activities.
At this stage, it is important to review existing and new loan (and derivative) arrangements to determine not only whether the primary anti-hybrid rules could be triggered, but whether the integrity rule could be relevant. Importantly, unlike Part IVA, the integrity rule is self-executing – it does not require that the Commissioner makes a determination that it applies.
Part IVA should be considered where a restructuring is undertaken to avoid the potential application of the integrity rule. We note that the ATO recently issued a draft Practical Compliance Guideline (PCG 2018/D4) which sets out the ATO’s compliance approach with respect to Part IVA and restructures of hybrid mismatch arrangements.