On 22 December 2015 the UK published some examples as part of the guidance on the hybrid mismatch rules. The examples are intended to illustrate the operation of the rules in practice. The hybrid mismatch rules will implement in UK legislation the outcomes of the OECD project on base erosion and profit shifting (BEPS) in respect of hybrid arrangements that give rise to a tax mismatch. The legislation is to be introduced in Finance Bill 2016 and will insert a new Part 6A into TIOPA 2010.

Hybrid mismatch arrangements may arise from the use of hybrid financial instruments or hybrid entities. A hybrid financial instrument would allow the payer to deduct interest but allow the receipt to be treated as an exempt dividend. A hybrid structure could be a partnership that is treated as transparent in one jurisdiction but as opaque by another jurisdiction.

The hybrid mismatch rules target outcomes involving hybrid financial instruments, hybrid transfers, hybrid entity payers or hybrid entity payees. They target double deduction outcomes involving hybrid entity payers or dual resident companies.

The tax mismatch could be a double deduction for the same expense or a deduction for an expense without a corresponding taxable receipt. The effect of the legislation is to change the tax treatment of either the payment or the receipt to counteract the UK tax advantage.

In the case of double deductions the primary response of the legislation is to deny a tax deduction for the parent company, but if this is not possible because the parent company’s tax law does not have relevant provisions then a tax deduction would be denied to the hybrid entity.

In a case where there is a deduction for an expense without inclusion of taxable income the primary response is to deny a deduction to the payer. If this does not occur the secondary response involves ensuring that the corresponding receipt is charged to tax.

The hybrid mismatch rules also aim to discourage arrangements that try to evade the rules by transferring a mismatch into a third jurisdiction, a so-called imported mismatch.

Examples

The examples in the guidance include a number of examples where hybrid and other mismatches arise from financial instruments. The examples are based on the examples produced by the OECD in the BEPS project reports.

They include examples of dealing with interest payments under a debt/equity hybrid; interest payments to a person in a no-tax jurisdiction or a territorial tax regime; debt issued in proportion to shares recharacterized as equity; deemed interest or the accrual of a deemed discount on an interest free loan; difference in valuation of discount on the issue of an optional convertible note; payment made for an agreement to modify the terms of a debt instrument; and release from a debt obligation.

Further examples relate to non-inclusion of income where certain payments are made involving hybrid entities; double deductions involving a hybrid entity or a dual resident company; and imported mismatches where a third jurisdiction is used in an attempt to evade the mismatch rules.