- Part I contains recommendations on domestic law rules to address hybrid mismatch arrangements.
- Part II contains recommended changes to the OECD Model Tax Convention.
- Payments that give rise to a deduction with no taxable inclusion arising from a hybrid financial instrument (including a hybrid transfer), a disregarded payment made by a hybrid entity or a payment made to a reverse hybrid
- Payments that give rise to a double deduction arising from a deductible payment made by a hybrid entity or a dual resident
- Payments that give rise to an indirect deduction with no inclusion arising from an imported mismatch
Part I: recommendations for domestic law
- Payments that give rise to a deduction/no inclusion outcome (D/NI outcome) (i.e., payments that are deductible under the rules of the payer jurisdiction and are not included in the ordinary income of the payee) — Recommendations 1-5 deal with such D/NI outcomes
- Payments that give rise to a double deduction outcome (DD outcome) (i.e., payments that give rise to two deductions in respect of the same payment) — Recommendations 6 and 7 deal with such DD outcomes
- Payments that give rise to an indirect D/NI outcome (i.e., payments that are deductible under the rules of the payer jurisdiction and that are set off by the payee against a deduction under a hybrid mismatch arrangement) — Recommendation 8 deals with such indirect D/NI outcomes
Recommendation 1 — hybrid financial instrument rule
- Arrangements that are treated as debt, equity or derivative contracts under local law (“financial instruments”)
- Arrangements involving the transfer of financial instruments where differences in the tax treatment of that arrangement result in the same financial instrument being treated as held by more than one taxpayer (“hybrid transfers”)
- Arrangements involving the transfer of financial instruments where a payment is made in substitution for the financing or equity return on the transferred asset and differences between the tax treatment of that payment and the underlying return on the instrument have the net effect of undermining the integrity of the hybrid financial instrument rule (“substitute payments”)
Recommendation 2 — specific recommendations for the tax treatment of financial instruments
Recommendation 3 — disregarded hybrid payments rule
Recommendation 4 — reverse hybrid rule
Recommendation 5 — specific recommendations for the tax treatment of reverse hybrids
Recommendation 6 — deductible hybrid payments rule
Recommendation 7 — dual-resident payer rule
Recommendation 8 — imported mismatch rule
- A payment under a financial instrument that results in a hybrid mismatch
- A disregarded payment made by a hybrid payer that results in a hybrid mismatch
- A payment made to a reverse hybrid that results in a hybrid mismatch
- A payment made by a hybrid payer or dual resident that triggers a duplicate deduction resulting in a hybrid mismatch
Recommendation 9 — design principles
- Operate to eliminate the mismatch without requiring the jurisdiction applying the rule to establish that it has “lost” tax revenue under the arrangement
- Be comprehensive
- Apply automatically
- Avoid double taxation through rule co-ordination
- Minimize the disruption to existing domestic law
- Be clear and transparent in its operation
- Provide the flexibility necessary for the rule to be incorporated into the laws of each jurisdiction
- Be workable for taxpayers and keep compliance costs to a minimum
- Be easy for tax authorities to administer
- Agree on guidance on how the rules ought to be applied
- Develop standards that will allow coordination of the implementation of the recommendations, including of timing in the application of rules, minimizing impact arising from a different implementation time
- Identify the need for transitional rules (in this regard the recommendation states that the need for transitional arrangements can be minimized by setting a sufficient notice period for taxpayers and that there will be no presumption as to the need for grandfathering rules)
- Undertake a review of the operation of the rules as necessary to determine whether they are operating as intended
- Enter into exchange of information, with early and spontaneous exchange of information recognized as key to an effective implementation of hybrid mismatch rules
- Endeavor to make relevant information on the tax treatment of entities and financial instruments available to taxpayers
- Consider — before applying a “fixed ratio rule” under Action 4 — the interaction with other BEPS actions, including providing that rules to address hybrid mismatch arrangements should be applied
Recommendation 10 — definition of structured arrangement
Recommendation 11 — definitions of related persons, control group and acting together
- They are consolidated for accounting purposes.
- The first person has an investment in a second person that grants the former effective control, or a third person has such an investment in the first two.
- The first person has a 50% or greater investment in the second person, or a third person has a 50% or greater investment in both.
- The two persons can be regarded as associated enterprises under Article 9 of the OECD Model Tax Convention.
Recommendation 12 — other definitions
Part II — recommendations on treaty issues
Chapter 13 — dual-resident entities
Chapter 14 — transparent entities
Chapter 15 — interaction between Part I and tax treaties
Following the discussion drafts released in March 2014,[i] extensive comments from stakeholders on those discussion drafts and the 2014 report, this Final Report is the conclusive output on Action 2.
The recommendations included in the Final Report incorporate some of the input the OECD received from stakeholders and reflects the consensus reached on those issues.
At this stage, implementation via changes in domestic law and practices and via treaty provisions is at the discretion of individual countries.
The Final Report is an expansive document with complex recommendations.
Considering this complexity and the difficulties countries may face in incorporating these recommendations into their domestic tax system, it remains to be seen to what extent countries will adopt these rules.
However, countries have already begun adopting anti-hybrid measures of various types in advance of the final output on Action 2 from the OECD.
What is the action trying to achieve?
Were any of the action recommendations unexpected?
Is there any interaction between this action and the others?
Have any countries made specific comments in relation to this action?
- A deduction of the same payment, expenses or losses occurs both in (i) the Member State in which the payment has its source, the expenses are incurred, or the losses are suffered, and (ii) in another Member State
- A deduction of a payment in the Member State in which the payment has its source without a corresponding inclusion of the same payment in the other Member State
What’s going to happen next, and how uniform might implementation be?
What are the potential impacts on business?
 See EY Global Tax Alert, OECD releases report under BEPS Action 2 on hybrid mismatch arrangements, dated 24 September 2014.
 BEPS Action 2: Neutralize the Effects of Hybrid Mismatch Arrangements (Recommendations for Domestic Laws) and BEPS Action 2: Neutralize the Effects of Hybrid Mismatch Arrangements (Treaty Issues), both dated 19 March 2014.
 See EY Global Tax Alert, EU formally adopts proposed linking rule for hybrid loans under Parent-Subsidiary Directive, dated 9 July 2014.
 See EY Global Tax Alert, UK issues consultation document on implementing OECD proposals on hybrid mismatches, dated 9 December 2014.
This article was first published in EY´s Tax Policy and controversy briefing 17
DID YOU LIKE THIS ARTICLE?
Subscribe to the Tax Insights newsletter for the latest thinking in tax.
EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.