The European Union enhances the measures against international profit shifting. This article outlines the actions of the EU aiming to neutralize the effects of hybrid mismatch arrangements.
The Anti-Tax Avoidance Directives against hybrid mismatch arrangements have a material impact on M&A, financing and permanent establishments’ structures.
The first directive implementing the OECD’s BEPS Action Plan, was already enacted by the EU last year. On February 21, 2017 the EU’s directive was enhanced with regard to regulations concerning hybrid mismatch arrangements.
One of the OECD’s action plans against international structures facilitating base erosion and profit shifting (BEPS) focuses on the effects of hybrid mismatch arrangements.
The aforementioned action plan is the most complex of all BEPS action plans and aims against tax advantages such as for instance the double non-taxation of gains or double deductibility of expenditures by using hybrid mismatch arrangements.
Particular attention is paid to hybrid financial instruments that may lead to the following taxation mismatches:
B Co issues a hybrid financial instrument (e.g. hybrid bond) to A Co. The specific design of the loan provides for Country B treating it as debt, hence Country B grants a deduction for interest payments made under the instrument. Under the tax regime of Country A the payments under the instrument are treated as equity refund, hence qualify as non-taxable.
The following financial instruments may be affected by the regulations, provided that the payments under these instruments are subject to different tax treatment under the regime of two or more jurisdictions:
The Anti-Tax Avoidance Measures address as well all structures based on hybrid corporate forms that lead to unjustified tax advantages, in particular:
Permanent establishments can be affected if the installment of permanent establishments in two or more jurisdictions enable the generation of tax advantages in form of a double non-taxation of gains or the double deductibility of expenditures, especially in connection with hybrid financial instruments.
Example: The country of residence of the parent company assumes that a permanent establishment is maintained in other jurisdiction and, thus, grants a tax relief regarding the profit generated in the other jurisdiction. According to the jurisdiction of the country the permanent establishment resides in and pursues operational activity, no permanent establishment is maintained.
A double non-taxation can also be effected between the parent company and the permanent establishment if the jurisdiction of the permanent establishment allows the tax deductibility of payments to the parent company while under to the law of the parent company’s jurisdiction such payments are qualified as non-taxable income.
The European Commission has partially adopted the Action Plan of the OECD on the European level. In 2016 several points of BEPS Action 2 were implemented in the so-called Anti-Tax Avoidance Directive (ATAD):
In February 2017 the EU Economic and Financial Affairs Council (ECOFIN) agreed to enhance and strengthen the existing Directive by adapting further measures of the OECD’s BEPS Action 2:
Fiscal authorities will focus on M&A transactions, international financing structures and permanent establishment structures even more than before. Such transactions and structures will be examined with respect to the Anti-Tax-Avoidance regulations provided by the EU Directives as well as BEPS Action 2. As many questions concerning the concrete implementation are still open, the further development remains to be seen.
The tax issues occurring in connection with hybrid arrangements are particularly complex and extensive. Therefore, we recommend to thoroughly plan and analyse international M&A transactions, permanent establishment and financial structures very early in the development stage in order to check, whether and, if so, to which extent the new regulations may apply.
If you have questions about the EU Anti Tax Avoidance Directive and the hybrid mismatch arrangements contact TPA expert für international taxation and Transfer Pricing, Iris Burgstaller.