Hybrids – unexpected consequences for US investors with UK ‘Check the Box’ entities

unexpected consequences for US investors with UK

This article notes some of the ways in which the new hybrid rules may cause unexpected disallowances for UK CTB entities.

1000

Also on KPMG.com

This article, the fourth in our series on the new hybrid rules, notes some of the ways in which these rules may cause unexpected material disallowances for UK groups which are wholly or partly owned from the US and include ‘Check the Box’ (CTB) entities.  We illustrate some of the problems these groups are experiencing in practice and which can result in significant UK disallowances even in cases where there is no UK tax advantage currently being obtained.

One of the areas targeted by the new legislation is the use of ‘hybrid’ entities, broadly those treated as taxable entities in one jurisdiction but as tax transparent in another.  This can cause particular issues for US groups, as these will often make CTB elections to treat group companies (including those resident outside the US) as transparent for US federal tax purposes.  Where these US elections are made in relation to UK companies, this will often cause the companies to be regarded as ‘hybrid entities’ for the purposes of the new UK anti-hybrid legislation.

Any group in which CTB elections have been made in relation to UK companies will therefore need to actively consider the impact of the hybrid rules, even if no hybrid tax benefit was intended or is being received. It should also be noted that the rules can apply to all types of deductions, not just finance costs.

The examples below illustrate cases where material UK disallowances may nonetheless arise.

Third party costs incurred by ‘checked’ entities

If third party costs are incurred by a ‘checked’ entity then these costs will not only result in a UK tax deduction, but may also result in a US tax deduction because the US regards the entity as tax transparent.  If tax relief is being given in more than one jurisdiction, then the anti-hybrid rules blocking ‘double deductions’ must be considered, as these can deny UK tax relief.

In general, UK relief would only continue to be available in this situation against income of the relevant entity which is taxable in both the UK and the US. Issues therefore arise if:

  • the income in the entity is exempt for UK tax purposes (e.g. it is a holding company just receiving dividends); 
  • its income is intra-group (as this may be disregarded for US tax purposes if received from another ‘checked’ entity – see figure 1 below); or 
  • the company is loss-making (as the loss will represent costs not being offset against double taxed income). 

Payments to the US by ‘checked’ entities

If costs payable to a US parent are incurred by a ‘checked’ entity then these costs will usually result in a UK tax deduction, but may not result in US taxable income because the US regards the UK entity as tax transparent.  If this happens, then the anti-hybrid rules must be considered as they may block the UK deduction as giving rise to a ‘deduction/non-inclusion mismatch’.

Again, relief would usually only continue to be available in this situation against income of the relevant entity which (in addition to other requirements) is taxable in both the UK and the US. As above, issues therefore arise if:

  • the income in the entity is exempt for UK tax purposes (see figure 2 below); 
  • its income is intra-group; or 
  • the company is loss-making.
In both of these ‘problem cases’ the effect of the anti-hybrid rules is often to simply treat some or all of the costs as non-deductible for UK tax purposes.
 
This article is the fourth in a series on the application of the UK’s new hybrid and other mismatch rules. The previous articles in this series covered an overview of the new rules, their application in the context of an election to disregard a UK subsidiary for US tax purposes, and how they can apply to deny a deduction for the purchase of goods.

 

For further information please contact :

Paul Freeman 

Tax Matters Digest

View KPMG's weekly newsletter covering the latest issues in taxation and government announcements relating to tax matters.

 
Read more

Connect with us

 

Request for proposal

 

Submit

KPMG’s new-look website

KPMG has launched a state of the art digital platform that enhances your experience and provides improved access to our content and our people, whatever device you are on.