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OECD releases two BEPS reports of recommendations to combat hybrid mismatch arrangements

Posted by William Byrnes on March 24, 2014


In July 2013, the OECD published its Action Plan on Base Erosion and Profit Shifting. The Action Plan identifies 15 actions to address BEPS in a comprehensive manner and sets deadlines to implement these actions.

The OECD states that a Hybrid Mismatch Arrangement “is a profit shifting arrangement that utilises a hybrid element in the tax treatment of an entity or instrument to produce a mismatch in tax outcomes in respect of a payment that is made under that arrangement.”  The hybrid mismatch arrangements targeted by the OECD rules are “those where the resulting mismatch results in a lower aggregate tax burden for the parties to the arrangement.”  (See Page 8 of OECD Discussion Draft Neutralise the effects of Hybrid Mismatch Arrangements – Recommendations for Domestic Laws).

Action 2 of the BEPS Action Plan calls for the development of model treaty provisions and recommendations for the design of domestic rules to neutralise the effect of hybrid mismatch arrangements:  

ACTION 2

Neutralise the effects of hybrid mismatch arrangements

Develop model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect (e.g. double non-taxation, double deduction, long-term deferral) of hybrid instruments and entities. This may include: (i) changes to the OECD Model Tax Convention to ensure that hybrid instruments and entities (as well as dual resident entities) are not used to obtain the benefits of treaties unduly; (ii) domestic law provisions that prevent exemption or non-recognition for payments that are deductible by the payor; (iii) domestic law provisions that deny a deduction for a payment that is not includible in income by the recipient (and is not subject to taxation under controlled foreign company (CFC) or similar rules); (iv) domestic law provisions that deny a deduction for a payment that is also deductible in another jurisdiction; and (v) where necessary, guidance on co-ordination or tie-breaker rules if more than one country seeks to apply such rules to a transaction or structure. Special attention should be given to the interaction between possible changes to domestic law and the provisions of the OECD Model Tax Convention. This work will be co-ordinated with the work on interest expense deduction limitations, the work on CFC rules, and the work on treaty shopping.

In connection with this work the Committee on Fiscal Affairs (CFA) has now released two consultation documents on Action Item 2 as a single proposal for public consultation.  

The first discussion draft (Neutralise the effects of Hybrid Mismatch Arrangements – Recommendations for Domestic Laws) sets out recommendations for domestic rules to neutralise the effect of hybrid mismatch arrangements and the second discussion draft (Neutralise the effects of Hybrid Mismatch Arrangements – Treaty Aspects of the Work on Action 2 of the BEPS Action Plan) discusses the impact of the OECD Model Convention on those rules and sets out recommendations for further changes to the Convention to clarify the treatment of hybrid entities.  

The OECD recommendations of the first discussion draft Neutralise the effects of Hybrid Mismatch Arrangements – Recommendations for Domestic Laws target three categories of hybrid mismatch arrangement:

(a) Hybrid financial instruments (including transfers); where a deductible payment made under a financial instrument is not treated as taxable income under the laws of the payee’s jurisdiction;

(b) Hybrid entity payments, where differences in the characterisation of the hybrid payer result in a deductible payment being disregarded or triggering a second deduction in the other jurisdiction;

(c) Reverse hybrid and imported mismatches, which cover payments made to an intermediary payee that are not taxable on receipt. There are two kinds of arrangement targeted by these rules:

(i) arrangements where differences in the characterisation of the intermediary result in the payment being disregarded in both the intermediary jurisdiction and the investor’s jurisdiction (reverse hybrids);
(ii) arrangements where the intermediary is party to a separate hybrid mismatch arrangement and the payment is set-off against a deduction arising under that arrangement (imported mismatches).

The second discussion draft Neutralise the effects of Hybrid Mismatch Arrangements – Treaty Aspects of the Work on Action 2 of the BEPS Action Plan focuses on ensuring that (1) dual resident entities and (2) transparent entities are not used to obtain the benefits of treaties unduly.

The OECD stated that the recommendations set out in these discussion drafts do not represent the consensus views of the CFA or its subsidiary bodies but rather are intended to provide stakeholders with substantive proposals for analysis and comment.  The CFA requested that such comments on these documents should be submitted electronically (in word format) before 5.00 pm on May 2, 2014 and should be addressed as follows:

Hybrid Mismatch Arrangements: Please send comments addressed to Achim Pross, Head, International Co-operation and Tax Administration Division, OECD/CTPA to aggressivetaxplanning@oecd.org.

OECD Model Convention: Please send comment addressed to Marlies de Ruiter, Head, Tax Treaties, Transfer Pricing and Financial Transactions Division, OECD/CTPA to taxtreaties@oecd.org.

Public Consultation:

The OECD invited Persons and organisations who intend to submit comments on these two Consultation Documents to indicate by May 2 whether they wish to speak in support of their comments at a public consultation meeting on Action 2 (Neutralise the effects of hybrid mismatch arrangements), which is scheduled to be held in Paris at the OECD Conference Centre on 15 May 2014.  Persons wishing to attend this public consultation meeting should fill out their request for registration on line by May 2, 2014.  This meeting will also be broadcast live on the internet and can be accessed on line.

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