On 28 July 2017 the OECD’s Committee on Fiscal Affairs (CFA) issued a document entitled Neutralising the Effects of Branch Mismatch Arrangements, Action 2. This document was issued as part of the implementation of the action plan on base erosion and profit shifting (BEPS) through the Inclusive Framework. It sets out rules to combat branch mismatch arrangements.

Previously a discussion draft on branch mismatch rules was issued on 22 August 2016 with recommendations to bring the treatment of branch mismatches into line with the hybrid mismatch rules. Following consideration of comments received on the document and legal changes made by various countries the OECD has now finalized the document.

Branch mismatches are the result of inconsistency between domestic tax rules to determine income and expenditure subject to taxation. Branch mismatch structures may help the taxpayer avoid tax by exploiting differences between jurisdictions in rules determining if the taxpayer is subject to tax in a particular jurisdiction and differences in rules for including income and expenditure in the computation of taxable profit. These differences in rules may allow a taxpayer to leave an item outside the charge to tax in both jurisdictions or claim a deduction for the same item in both jurisdictions (double deduction).

Branch mismatch rules are similar to hybrid mismatch rules in their structure and outcomes. Therefore countries adopting hybrid mismatch rules have generally also adopted an equivalent set of rules relating to branch mismatches. The branch mismatch rules proposed by the OECD therefore apply similar analysis and solutions to the branch mismatch rules set out in the recommendations on BEPS action 2.  By aligning the branch and hybrid mismatch rules jurisdictions can prevent taxpayers shifting from hybrid to branch mismatches to achieve similar tax advantages.

Types of mismatch arrangement

The OECD report sets out five types of branch mismatch arrangement:

• Disregarded branch structures – arising where the branch is not within the definition of a permanent establishment and does not have any other taxable presence in a jurisdiction;
• Diverted branch payments – arising where a jurisdiction recognizes the existence of the branch but the payment made to the branch is attributed to the head office in that jurisdiction, while the jurisdiction of the head office exempts the payment from tax because it was made to the branch;
• Deemed branch payments – arising where the branch is deemed to make a notional payment resulting in a mismatch in tax outcomes under the rules of the residence and branch jurisdictions;
• Double deduction branch payments – where the same item of expenditure creates a tax deduction under the laws of both jurisdictions; and
• Imported branch mismatches – arising where the payee offsets income from a deductible payment against a deduction arising under a branch mismatch arrangement.

Mismatches can also arise indirectly where a taxpayer invests through a tax transparent arrangement such as a partnership.

Recommendations

The document sets out recommendations relating to each type of branch mismatch, as follows:

• The scope and operation of the branch exemption can be adjusted so as to achieve a closer alignment with the policy of exempting income of a foreign branch under double tax relief rules;
• A branch payee mismatch rule would deny the payer a deduction for a diverted or disregarded branch payment to a related person or a payment under a structured arrangement to the extent that the payment is not included in income by the payee;
• A deduction would be denied for a deemed payment between a branch and head office (or two branches of the same person) to the extent that the payment results in a double non-income outcome and the resulting deduction is offset against non-dual inclusion income (dual inclusion income would be income taxable in both branch and head office jurisdictions);
• The double deduction rules are based on the rule set out in Chapter 6 of the report on BEPS action 2 but an adjustment would need to be made only when the payer jurisdiction allows the deduction to be set off against non-dual inclusion income; and
• An imported mismatch rule would deny a deduction for a payment made within the same control group or under a structured arrangement to the extent that the income from the payment is offset against expenditure giving rise to a branch mismatch.