On 22 August 2016 the OECD released a discussion draft on branch mismatch structures and their preliminary recommendations for domestic rules to counteract the mismatches. The discussion draft identifies four basic types of branch mismatch arrangements, and goes on to set out its preliminary recommendations for domestic rules that would neutralise the mismatches in tax outcomes arising from the use of these structures. Broadly speaking, the operation of these proposed branch mismatch rules follows the general approach set out in the Action 2 Final Report published in October 2015. The UK Government have already incorporated rules to counteract certain branch mismatch structures in the draft UK hybrid and other mismatches legislation in Finance Bill 2016. However, there are important differences between the draft UK rules and the OECD recommendations.
The discussion draft sets out four basic types of branch mismatch arrangements:
1) Deduction/non-inclusion (D/NI) outcomes with a permanent establishment (PE) payee (incorporating disregarded branch structures and diverted branch payments)
These arise where the head office treats a deductible payment as received by a foreign branch (and therefore excludes or exempts the payment from ordinary income) while the branch does not tax the payment because:
The primary response in this case would be for the payer jurisdiction to deny the deduction to the extent it gives rise to a mismatch in tax outcomes. The OECD also recommends limiting the scope of any foreign branch exemption regimes so that they do not cover payments that have not been brought into account for tax purposes by the branch. Such branch mismatches are considered under Chapter 8 (Multinational payee deduction non-inclusion/deduction mismatches) of draft UK hybrid rules, where the payer is within the charge to UK corporation tax.
2) D/NI outcomes in respect of deemed branch payments from a PE to its head office.
These can arise where the PE jurisdiction claims relief for a deemed payment to the head office against non-dual inclusion income, where there is no corresponding recognition of this deemed payment in the head office. The primary response is to deny the deduction for the deemed branch payment to the extent it exceeds dual inclusion income. The defensive response is to include such deemed payments in ordinary income of the head office to the extent necessary to eliminate the mismatch. Such branch mismatches are considered under Chapter 6 (Deduction/non-inclusion mismatches relating to transfers by PEs) of the draft UK hybrid rules.
3) Dual Deduction (DD) mismatches by PEs
These arise where the same item of expenditure gives rise to a deduction under the laws of both the head office jurisdiction and the PE jurisdiction and is offset against non-dual inclusion income. The primary response is for the head office jurisdiction to deny the deduction to the extent it is not offset against dual inclusion income. Such branch mismatches are considered under Chapter 10 (Dual territory double deduction cases) of the draft UK hybrid rules.
4) Imported mismatches involving PEs
These arise where the payee offsets the income from a deductible payment against a deduction arising under a branch mismatch arrangement. Such branch mismatches are considered under Chapter 11 (imported mismatches) of the draft UK hybrid and other mismatches rules.
In scenarios 1 and 4, the OECD recommendations will only apply where the parties to the arrangement are members of the same control group or, where the payment is made under a structured arrangement (i.e. one which is designed to secure the hybrid mismatch or where the mismatch is priced into the terms of the arrangement).
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