The report under Action 2, titled Neutralising the Effects of Hybrid Mismatch Arrangements (the Hybrid Mismatch Report or Report) consists of two parts providing recommendations with respect to domestic law provisions and treaty provisions.
Overview
The first part of the Hybrid Mismatch Report makes recommendations for domestic rules to address mismatches generally consisting of multiple deductions for a single expense, deductions in one country without corresponding income inclusion in
another country or the generation of multiple foreign tax credits for one amount of foreign tax paid.
The Report recommends the enactment of linking rules that seek to relate the tax treatment of a payment with respect to a specific hybrid entity or arrangement in one jurisdiction to the tax treatment of such payment granted in the counterparty jurisdiction.
Further, it suggests a “rule order” under which primary and defensive rules would operate to address the unwanted double non-taxation (i.e., double deduction or direct or indirect deduction and non-inclusion) outcomes and avoid double taxation. Lastly, reflecting the comments received from the business community and stakeholders, the Hybrid Mismatch Report limits the scope of the recommended rules by using the “bottom up approach.” More specifically, the recommended rules would apply to hybrid arrangements involving related parties (the threshold for which has been increased to 25%) and members of the same controlled group and to certain “structured” arrangements.
The second part of the Hybrid Mismatch Report describes changes to the OECD Model Tax Convention to ensure that hybrid instruments and entities do not unduly benefit from treaty provisions and to coordinate between the domestic law recommendations and tax treaty provisions.
In particular, the report includes (i) a discussion of the proposed new Article 4(3) of the Model Tax Convention as put forward in the report on treaty abuse under Action 6 in the context of dual resident entities; (ii) a new provision in Article 1 and changes to the associated Commentary to address fiscally transparent entities; and (iii) various proposed changes to address treaty issues that may arise from the recommended domestic law changes.
Implications
The recommendations included in Hybrid Mismatch Report reflect the extensive input the OECD received from the business community and stakeholders.
The Report limits the scope of the application of the hybrid rules to structured arrangements and related party transactions. The threshold for related party also was increased from 10% to 25%.
The Report indicates that the OECD is continuing its work on Action 2 to address certain substantive and implementation issues. In this regard, the OECD intends to develop guidance on how the rules would operate in practice, including practical examples. The Report also notes that there are specific areas where the recommended domestic law rules may need further refinement.
The two areas specified are the treatment of certain capital market transactions such as onmarket stock-lending and repos and the rules on imported hybrid mismatches (i.e., deduction/non-inclusion outcome extended to a third jurisdiction by using intercompany loans).
In addition, the OECD will further explore concerns raised by countries and business with respect to the application of the rules to intragroup hybrid regulatory capital. The OECD also will address the potential treatment of inclusions under CFC rules as included in income for purposes of the Report. Until work on the hybrid regulatory capital and CFC inclusion issues is completed and consensus reached, countries are free in their policy choices in these areas.
It is important for interested stakeholders to continue to engage with the OECD and country policy makers as work on these technical issues and on the development of more detailed implementation rules continues into 2015.
It is anticipated that this work will be finalized in September of 2015.
