On 22 August 2016 the OECD released a discussion draft on branch mismatch structures under Action 2 of the OECD report on base erosion and profit shifting (BEPS). Comments are invited from interested parties by 19 September 2016.
The discussion draft applies the principles outlined in the report on Action 2 to the basic types of branch mismatch arrangement and outlines preliminary recommendations for domestic tax rules to neutralize the mismatch in tax outcomes.
Branch mismatches arise when the ordinary tax accounting rules for allocating income and expenditure between branch and head office result in a situation where the net income of the taxpayer falls out of the charge to taxation in both the branch and the head office jurisdiction.
Branch Payee Structures
The discussion draft looks at two branch payee structures. In these structures the branch is the recipient of the payment but the income received is not subject to tax.
In the case of disregarded branch structures the payee has an insufficient presence in the branch jurisdiction to be taxable on the payment. In the case of diverted branch payments the branch jurisdiction exempts or excludes the payment from taxation on the grounds that the payment was made to the head office.
The paper notes that the simplest way to prevent a deduction non-inclusion (D/NI) outcome for the branch payee structure is for the residence jurisdiction to restrict the scope of the branch exemption so it does not cover payments that have not been brought into account for tax purposes by the branch. The residence jurisdiction could consider making improvements in the operation of the branch exemption so that payments disregarded, excluded or exempt in the branch jurisdiction are treated as received directly by the head office (and are therefore outside the exemption).
Given the similarity between reverse hybrid and branch payee structures the draft recommends that the jurisdiction of the payer should adopt a branch payee mismatch rule, in line with Chapter 4 of the BEPS Action 4 report. This would deny a deduction for a diverted branch payment of a disregarded branch if the branch structure gives rise to a mismatch in tax outcomes.
The branch payee mismatch rule should only apply to payments made under a structured arrangement or between members of the same group. The rule would only apply where there is a mismatch under the ordinary rules for allocating branch income.
Deemed branch payments
It is possible to generate an internal mismatch between the branch and the head office by exploiting rules that permit the taxpayer to recognize a deemed payment between the branch and head office and where there is no corresponding adjustment to the net income in the payee jurisdiction to recognize the effect of this deemed payment.
Given the similarity between disregarded hybrid and deemed branch payments the draft recommends that countries introduce rules neutralizing the effect of the arrangements consistent with Chapter 3 of the BEPS report on hybrid mismatches. The deemed branch payment rule would apply to a notional or deemed payment between the branch and the head office that was deductible under the laws of one jurisdiction (the payer jurisdiction) but not included in ordinary income under the laws of the other jurisdiction; and where the resulting deduction was eligible to be offset against non-dual inclusion income.
Double deduction (DD) branch payments
A double deduction outcome arises where the same item of expenditure is treated as deductible under the laws of more than one jurisdiction. These mismatches give rise to tax policy concerns where the laws of both jurisdictions permit the deduction to be offset against income that is not taxable under the laws of the other jurisdiction (i.e. against non-dual inclusive income).
The BEPS report on hybrid mismatches considered that the recommendations of chapter 6 could apply to DD outcomes using branch structures. The current consultation paper considers the application of that recommendation to branch structures.
Imported branch mismatches
This situation arises when a person with a deduction under a branch mismatch arrangement offsets that deduction against a taxpayer payment received from a third party. An imported mismatch rule is needed to deny the deduction for any payment that is directly or indirectly set off against any type of branch mismatch payment.