Australia released draft legislation to counteract "hybrid mismatches".
Under Australia's proposed rules, certain entities with transactions that have resulted in a mismatch will be denied a deduction on otherwise deductible payments, or will be taxed on receipts that are usually non-taxable.
The draft legislation, released on November 24, 2017, follows Australia's budget 2016 commitment to neutralize mismatches caused by hybrid financial instruments and hybrid entities that create either deductions for the same amount in two jurisdictions (double deductions) or situations where payments are deductible in one jurisdiction, but not assessable in another (deduction/ non-inclusion).
These rules could also apply to indirect or "imported" hybrid mismatches that are not directly realized by an Australian entity.
The draft legislation is open for consultation until December 22, 2017.
In its 2016 federal budget, Australia committed to adopt the key recommendations set out in Action 2 of the OECD Base Erosion and Profit Sharing (BEPS) project - "Neutralizing the Effects of Hybrid Mismatches"). This measure is aimed at multinational corporations that exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions and targets instances where tax is either deferred or not paid at all.
In its 2017 federal budget, Australia further proposed to apply the OECD hybrid mismatch rules to a bank's regulatory capital.
The proposed rules target hybrid financial instruments, which are recognized as debt in one jurisdiction and equity in another, and hybrid entities, which are treated as taxable in one jurisdiction but tax transparent in another. These structures can give rise to double deduction or deduction/ non- inclusion outcomes, or a "hybrid mismatch". Where there is a hybrid mismatch, depending on the treatment in the other jurisdiction, the proposed rules will either deny a deduction of an otherwise deductible payment or tax a receipt which would otherwise not be taxable. Affected transactions may include financing payments, royalties, rents and service payments.
The draft legislation also includes changes for hybrid regulatory capital for banks, largely consistent with the Australian government's previous announcements, with some mechanical changes.
Extension of rules to indirect or "imported" mismatches
Significantly, the rules have been extended to also target indirect or imported hybrid mismatches in certain cases. For example, if an Australian company issues a non-hybrid debt to a foreign affiliate, and the foreign affiliate is taxable on the interest income, but is financed through a hybrid mismatch arrangement with another entity, the new rules could still apply to deny the interest deduction to the Australian company even though it may not have any knowledge of the upstream financing arrangements of its immediate lender.
The impact of the Australian rules could fluctuate over time and as more countries introduce their own hybrid mismatch rules.
Other announced changes, not included in the draft legislation
Australia says it will develop new integrity rules to deal with multinational groups that structure out of the hybrid mismatch rules to achieve double non-taxation outcomes-for example, by investing through certain zero-tax countries. Australia also announced that it will adopt the OECD's previously announced recommendations for branch mismatch arrangements. These new rules are intended to commence at the same time as Australia's other hybrid mismatch rules.
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