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.
EU Anti Tax Avoidance Directives
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.
Hybride Financial instruments
Particular attention is paid to hybrid financial instruments that may lead to the following taxation mismatches:
Example for hybriden Financial instrument:
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:
- Profit participation loans
- Non-interest-bearing loans
- (Retroactive) purchase price adjustments related to share deals
- Hybrid loan agreements collateralized by repos
- Share lending and bond lending structures
The Anti-Tax Avoidance Measures address as well all structures based on hybrid corporate forms that lead to unjustified tax advantages, in particular:
- Entities that are taxed as corporations in their country of residence while under the law of the investors’ country of residence they qualify as partnerships and as such are not taxed on the level of the entity but on the investor’s level (“hybrid entity”).
- Entities that in their country of residence are not taxed directly but on shareholder level whereas in the investors’ country of residence qualifies them as corporations (“reverse hybrid entity”).
- Dual resident entities.
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.
What measures are taken by the EU to neutralize the effects of hybrid mismatch arrangements?
EU Anti – Tax Avoidance – Directive (ATAD) Nr. 1
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):
- The regulations of the Directive regarding the hybrid mismatch arrangements are to be implemented by all EU Member States by December 31, 2018.
- The Directive applies to all tax subjects that are subject to corporate income tax in one or more Member States as well as to EU permanent establishments of non-EU parent companies.
- Pursuant to Art 9 of the Directive a payment is only deductible in the Member State, in which it originates, in case hybrid mismatch arrangements would provide for double a non-taxation.
- In case of hybrid mismatch arrangements, in which one Member States treats a payment as a tax-deductible expense while under the jurisdiction of the payment’s recipient the payment is qualified as tax-free dividend, the Member State in which the payment originates has to deny the tax-deductibility of the expense.
- In 2011 Austria introduced an Anti-Tax Avoidance Regulation within the framework of the international participation exemption, which stipulates that the dividend income is not subject to tax relief if the payment qualifies as tax-deductible under the other jurisdiction. This regulation will need to be amended in the course of the implementation of the new EU Directive.
EU Anti – Tax – Avoidance – Directive (ATAD) Nr. 2
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:
- The Directive is to be implemented by the Member States by December 31, 2019 with exception of the regulations regarding reverse hybrid entities, which are to be implemented by December 31, 2021.
- The proposed approach also extends the scope of application to entities that are treated as transparent entities by a Member State. Moreover, the proposal includes a new, more comprehensive definition of the term “hybrid entity” as well as examples concerning the Action 2 of the OECD’s Action Plan.
- Furthermore, the proposal extends the scope of application to reverse hybrid entities and to occurring mismatches in case of a dual tax residence of entities.
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.