Taxpayers can sometimes claim a tax deduction for a payment that is either untaxed in the country of receipt of that payment, or for which a deduction has already been claimed in another jurisdiction. These so-called hybrid mismatch arrangements are in effect structured transactions, whose purpose is to lower the tax burden on cross-border investments by exploiting differences in the tax treatment of instruments or entities in different tax jurisdictions.
An OECD report called Hybrid Mismatch Arrangements published in 2012 concluded that although it can be difficult to identify which country has actually lost tax revenue under a hybrid mismatch arrangement, these arrangements pose a collective risk to the tax base of all countries by lowering the aggregate tax burden on taxpayers who use them. As well as raising BEPS concerns, the report concluded that the ability of cross-border investors to use sophisticated and often opaque hybrid structuring techniques to reduce their domestic tax liability can have a negative impact on both the efficiency and fairness of tax systems.
The 2012 report specifically recommended that countries consider introducing “matching” rules that align the tax treatment of instruments and entities in both jurisdictions in order to neutralise their hybrid effect. As part of the BEPS Action Plan, the OECD and G20 countries have taken this recommendation one step further by agreeing to formulate a set of recommendations, domestic rules and treaty provisions designed to eliminate hybrid mismatches. More progress is expected on this front in 2014. The OECD Committee on Fiscal Affairs (CFA) has formed a new working party to deal with aggressive tax planning and to help complete a report on eliminating hybrid mismatches in September 2014. The report will cover three main aspects: first, hybrid financing instruments, including sophisticated hybrid transfers; second, expenditures incurred by a hybrid entity that give rise to tax deductions under the laws of two or more jurisdictions (so-called double deduction structures); and third, hybrid structures that are designed to allow an investor to avoid tax on deductible payments made by a counterparty to the arrangement (so-called deduction/ no-inclusion structures).
The OECD-G20 work on hybrids is being undertaken in parallel with work being done by the European Union in relation to intra-EU hybrid mismatch arrangements. However, it has a broader scope and involves a wider range of countries than the EU work.
For John Peterson, who heads the aggressive tax planning unit at the OECD, the work on hybrids is an “interesting and challenging project with a very tight deadline.” Countries have set themselves the task of producing matching rules that are comprehensive, easy for tax authorities to administer, and clear and transparent in their operation, and which keep taxpayer compliance costs to a minimum. Their task is complicated by the need to ensure that the rules target the mismatch and do not disturb other commercial outcomes or result in unintended double taxation for taxpayers.
The first draft of the hybrid mismatch report is due to be released for public consultation at the end of the first quarter of 2014. “This is an ambitious target,” Mr Peterson admits, “but one that captures the importance that G20 and OECD member countries place on the need to urgently address gaps in the international tax architecture that are presently being exploited by these sorts of arrangements.”
© OECD Observer No 297, Q4 2013