The Economic and Financial Affairs Council of the EU (ECOFIN) published on 21 February 2017 the latest proposal to amend EU Directive 2016/1164. This sets out their approach to hybrid mismatches as proposed under the Anti-Tax Avoidance Directive (ATAD) and extends it to non-EU countries (ATAD 2). This brief article highlights some changes of scope within that amendment, which is of interest when contrasted with the UK Hybrid rules.
The deadline for EU member states to apply the provisions in the ATAD have been pushed back a year until 1 January 2020 (with the exception of the rules in relation to reverse hybrids which do not need to be provided for until 1 January 2022). KPMG’s EU Tax Centre has published a Euro Tax Flash that provides background, a link to the actual amendment proposal and next steps.
The Directive follows more closely the OECD recommendations in targeting mismatches arising on payments made ‘under’ a financial instrument, and does not follow the UK’s extension to payments made ‘in connection with’ a financial instrument, such as debt releases.
The UK’s rules treat finance income as not included to the extent its effective tax rate is reduced in the payee territory by connected relief. The Directive restricts its application to mismatches caused by a ‘conflict in the characterisation of financial instruments’, specifically permitting unilateral relief, thereby excluding situations whereby a finance receipt is recognised but then otherwise relieved.
In relation to companies with a permanent establishment (PE) the UK’s rules require a wide application, targeting mismatches that ‘arise by reason of’ the company having a PE. The Directive is more explicit, targeting mismatches only where they arise from a conflict in “allocating income and expenditure between different parts of the same entity”. Where a Double Taxation Treaty allocates income to a PE in a jurisdiction that chooses not to tax it, it would be outside scope.
Present throughout the UK’s Hybrid rules is the targeting of transactions with hybrid characteristics regardless of whether the mismatch would have arisen anyway, such as if the payee were tax exempt. The Directive applies a more causative approach, stating that “payment should not give rise to a hybrid mismatch that would have arisen in any event due to the tax exempt status of payee”, sanctioning situations whereby “the instrument is held subject to the terms of a special regime”.
Both the UK and the EU Directive allow mismatches to arise where they are offset by ‘dual inclusion income’ however the UK restricts recognition to income arising within the targeted company, which had been mirrored in the Directive. The amendment follows more closely the OECD recommendation and recognises “any item of income that is included under the laws of both jurisdictions where the mismatch outcome has arisen”. Therefore, income against which the deduction is surrendered should be recognised.
The UK rules allow timing mismatches between deduction and receipt where the delay is ‘just and reasonable’, with little clarification. The amendment clarifies the EU position by stating that time delays will be permitted if “the terms of payment are those that would be expected to be agreed between independent enterprises”.
The Directive makes some allowance for hybrid regulatory capital, investment funds and an exclusion for financial traders. The amendment also allows for a hybrid payee to be treated as opaque by the state of establishment.
In a post-Brexit world it is welcome to note that the Directive recognises counteractions in non-EU member states.
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