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OECD Hybrid Mismatch Report - As implemented in the United Kingdom

  • United Kingdom
  • Tax planning and consultancy

05-10-2017

What are they?

Tax rules implemented in the UK and other countries following the OECD BEPS project to tackle unintended tax advantages arising from the mismatching tax treatment of payments and corresponding receipts involving hybrid entities – generally across borders. The rules also tackle double deductions in respect of a single expense.

Why do they matter?

If your company incurs costs for which it could normally claim a deduction in its calculation of profit for corporate income tax then, if the recipient is not fully taxed on the corresponding receipt, or if someone else is also able to claim a deduction for the same cost, then your deduction may not be allowed in the UK or other implementing country.

What is a hybrid entity?

Essentially it is an entity that is or may be treated for tax purposes differently in one jurisdiction to another. The concept includes permanent establishments (branches) which have special rules and entities which use US ‘check the box’ rules.

Example 1

A US parent company provides finance to its UK subsidiary out of a Swiss finance branch of a Belgian group company. The UK subsidiary pays interest at an arms-length rate to the Swiss finance branch. This interest is a cost to the UK company and would normally be deductible for UK tax purposes.

A Swiss finance branch is subject to Swiss federal corporate income tax. However Swiss federal tax law allows a finance branch to receive a notional interest deduction based on a small minimum profit margin. This has the effect of reducing the taxable income of the branch for Swiss tax purposes. The Belgian company is not taxable in its home country on the profits of the Swiss branch. So the interest received by the branch is only taxed to the extent of the small notional profit margin.

The effect of UK hybrid mismatch legislation is that the UK company will not be able to deduct the interest costs in its calculation of taxable profit.

Example 2

A UK branch of a company in country A pays for a commercial service at an ‘arms-length rate’ to a company located in country B. The UK branch and the country A parent both claim a deduction in their respective countries for the expense. If the deduction in the parent is not disallowed (primary response) then the UK rules will disallow the deduction in the branch (secondary response).

International context

The OECD hybrid mismatch recommendations are intended to prevent both a deduction where there is no taxation of the corresponding receipt and also a double deduction (in two entities or two countries) of the same cost. They are targeted at arrangements involving hybrid entities intended to achieve a tax mismatch or arising due to the involvement of a hybrid entity. If domestic rules are implemented according to OECD recommendations then they should achieve their intended result to prevent a mismatch even if only one relevant country in a series of transactions has implemented them (see Example 2).

The OECD recommendations are complex in order to address a variety of situations and to provide several opportunities to prevent a tax advantage. They may not be implemented in the same way in all countries.

If a company or group of companies appears to be getting a tax deduction for a payment where the corresponding receipt is not taxed in any country, or to be getting a double deduction for the same cost. then it is possible that hybrid mismatch rules will apply. Advice should then be sought to analyse the position.

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