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:
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:
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