Hybrid and other mismatch rules – example of payments | KPMG | UK

Hybrid and other mismatch rules – example of payments to hybrid entities

Hybrid and other mismatch rules – example of payments

Article seven in our series on the new hybrid rules looks at examples of payments to hybrid entities located in ‘tax havens’.

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Our series of articles looking at the practical implications of the anti-hybrid and other mismatch rules applying, broadly, to deductions on or after 1 January 2017, continues this week with a look at payments to hybrid entities. If a UK company has borrowed from an overseas group company which is a hybrid entity, perhaps because it is disregarded for US tax purposes, the interest expense in the UK can be disallowed where the interest income is not subject to tax, e.g. the lender is based in a tax haven. Similar rules apply where the UK company is paying for goods or services provided by overseas group companies.  

The example below illustrates how the rules can apply where payments are made to hybrid entities located in tax haven jurisdictions; we have used the Cayman Islands as an example.

Background

  • A UK subsidiary (UK Co) has borrowed on interest bearing terms from a Cayman incorporated and tax resident company (Cayman Co).  Both UK Co and Cayman Co are held underneath the US and are treated as disregarded for US tax purposes.
  • There is a mismatch because the interest expense is deductible in the UK as recognised in the accounts but the corresponding income is exempt from tax under the laws of the Cayman Islands.
  • This mismatch arises by virtue of Cayman Co being a tax exempt entity, rather than it being a hybrid payee.

Does this matter?

Although the new hybrid mismatch rules are primarily focused on counteracting mismatches which arise by virtue of hybridity, the scope of the rules have been extended in certain areas.

In particular, one of the charging chapters (Chapter 7 Hybrid Payee Deduction/Non-Inclusion Mismatches) applies where the recipient is a hybrid (disregarded for US tax purposes) in a ‘no-tax’ territory or a territory which applies a 0% tax rate and, broadly, the interest income is not subject to a Controlled Foreign Company (CFC) charge in the UK or elsewhere. In these circumstances, UK Co will be required to self-assess a disallowance of the interest expense on its borrowing from Cayman Co. HMRC have confirmed to us that the treatment in the situation here (combination of no tax in a recipient which is disregarded for US tax purposes) intentionally goes further than the OECD BEPS Action 2 recommendations.  

Please note, that where groups are looking to restructure their UK financing arrangements, it will be necessary to carefully consider the potential application of a main purpose type anti-avoidance rule. This was introduced to counteract arrangements where the main purpose or one of the main purposes of the arrangements is to enable a person to obtain a relevant tax advantage. However, arrangements should not be caught where the obtaining of the relevant tax advantage can reasonably be regarded as consistent with the principles and policy objectives on which the new rules are based. 

Businesses should therefore act now to ensure that they fully understand the tax treatment of their global transactions, and to establish what the impact of the new rules on them may be. If you have any questions, then please get in touch with your usual KPMG contact or one of the named contacts below.

This article is the seventh in a series on the application of the UK’s new hybrid and other mismatch rules. The previous articles in this series cover: 

 

For further information please contact : 

John Addison

Greg Smythe

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