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Hybrid Mismatches: further nails in the cross-border financing coffin

Hybrid Mismatches: nails in cross-border finance coffin

Alia Lum, Liam Delahunty, and Stefan Hempelmann discuss the revised draft legislation on implementing OECD Hybrid Mismatch Rules.


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Different curtain designs

On 7 March 2018, Treasury released Revised Exposure Draft (ED) legislation and an accompanying Explanatory Memorandum, addressing hybrid mismatch arrangements, for public consultation. This follows from Action 2 of the Organisation for Economic Co-operation and Development's (OECD) Base Erosion and Profit Shifting (BEPS) initiative.

Following on from the earlier Exposure Draft issued on 24 November 2017, the revised ED makes various refinements, and also includes two new key measures announced last November.

Finance integrity measure

The first is a targeted financing integrity measure, which can apply to deny a deduction for interest or derivative payments on financing arrangements that fall outside the hybrid mismatch rules but achieve similar outcomes. This includes cases where the lender or counterparty is a related party that is resident in a jurisdiction with a corporate tax rate of 10 percent rate or less (such as the Cayman Islands), or with a territorial regime system of tax (such as Hong Kong or Singapore). There is no grandfathering for existing structures.

There are exceptions to the application of the integrity rule, such as where a direct payment to the ultimate parent would not have produced a higher tax outcome or where is it is reasonable to conclude the scheme was not “designed to produce” the Australian and foreign tax outcomes. Relevant factors include whether the foreign entity undertakes a group financing function, is a regional holding company and/or has a substantial level of economic activity. It is concerning that the ‘designed to produce’ test adds yet another ambiguous anti-avoidance concept, which, whilst likely lower than ‘sole or dominant’, creates uncertainty as to whether it is a higher or lower bar than the ‘principal purpose test’.

Limited scope response

The second new measure is a limited scope response to the OECD’s Branch Mismatch Arrangements Report, which includes provisions to deny the application of Australia’s foreign branch exemption to branch income that is not subject to tax in the foreign jurisdiction, and deductions for deemed intra-branch payments from the Australian branch of a foreign bank where there is no corresponding income pick in the other jurisdiction. Other recommendations in the Report appear to have been excluded as they are not necessary in the Australian context.

There has been no further guidance with respect to the timing of the imported mismatch rule, which presents a significant compliance burden and can operate to deny deductions in Australia for any cross-border related party payment (including management fees) if there is a hybrid arrangement anywhere in the worldwide group, whether related to the Australian payment or not.

The consultation period finishes on 4 April 2018. Following that, we expect that the Bill will be finalised relatively quickly and will experience a relatively tranquil passage through the House and Senate. Lobbying will likely continue for the indirect imported mismatch rule to be deferred, but we anticipate that the broader substantive measures will most likely take effect from 1 January 2019. This does not leave much time to consider the application of these rules to existing and proposed arrangements, which in some cases may need to be unwound.

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