On 27 July 2017 the OECD released its final report extending its recommendations on addressing Hybrid mismatches to include Branch mismatch arrangements.
On 5 October 2015 the OECD published its final report on Action 2 (Neutralising the Effects of Hybrid Mismatch Arrangements). Subsequently, the UK Government introduced the ‘Hybrid and Other Mismatches’ rules (Part 6A TIOPA 2010) which took effect from 1 January 2017. Broadly speaking the UK Hybrid Mismatch rules implemented the OECD’s recommendations. However, in a number of key areas the Hybrid Mismatch rules extended beyond the OECD recommendations to address branch mismatches. The OECD has now published its final report, replacing a discussion draft published 22 August 2016, setting out its recommendations on how jurisdictions should approach Branch Mismatch arrangements. This article sets out the key points from the report and how these align with the UK’s Hybrid Mismatch rules.
The OECD report sets out five recommendations targeted at branch mismatches arising because of:
Where the parent jurisdiction allocates profits to a branch but there is insufficient presence in the branch jurisdiction for treaty or domestic law purposes to recognise a taxable presence; or
Where there are differences between the jurisdictions in the rules, or their application, of how profits should be attributed to the branch.
Relief is given for dual inclusion income where it would be under the UK rules.
This applies where relief is given for a deduction, but the corresponding receipt is not brought into charge. This could be by reason of a branch mismatch arising as outlined in Recommendation 2 or 3 below, or simply because the parent has allocated taxing rights of a receipt to the branch jurisdiction but the branch jurisdiction does not tax that income. The OECD highlights that this is ‘not’ restricted to branch mismatches and can extend to any situation where the branch does not subject the receipt to tax. This is to apply where the policy decision for exempting the branch was to relieve economic double taxation.
The OECD recommends that the primary counteraction should be imposed by the resident jurisdiction, by either:
The UK rules do not operate to bring an amount into tax for branch mismatch situations.
Where income is attributed by the parent jurisdiction to the branch (branch payee), and Recommendation 1 has not been applied, the rules broadly follow the approach adopted in the UK by denying a deduction to the payer. The mismatch must arise by reason of the payee operating through a branch. The report identifies the counterfactual test as asking what the tax treatment of the payment would have been if it had been made directly to the parent jurisdiction. Where the entity is tax exempt in the parent jurisdiction, no mismatch is treated as arising.
This recommendation targets inter-company dealings causing deduction/non-inclusion mismatches where a deduction is deemed to arise in the branch jurisdiction but is not recognised by the parent jurisdiction. An example could be a deemed interest deduction where the branch attributes debt funding from the parent jurisdiction.
The counteraction broadly mirrors the UK rules by denying the branch a deduction. However, the determination of the amount to counteract is more considered:
Unilateral deductions, such as relief for contributed equity, are outside scope.
Recommendation 4 addresses instances of double deductions for the same amount of expenditure. Differences in valuation remain outside scope. This corresponds to the UK rules:
The OECD has supported an ‘alternative approach’ to that adopted by the UK, and in the 2015 OECD report. The UK denies a deduction where it is not offset against income recognised in both the branch and parent jurisdiction.
The alternative is a ‘wait-and-see’ approach, allowing relief to be claimed initially, which can be retained until the other deduction is relieved against non-dual inclusion income. Relief could be clawed back by requiring a taxable receipt to be brought into charge. This more closely mirrors the US’s dual consolidated loss rules.
Recommendation 5 extends the Imported Mismatch rule to branch mismatches, requiring a deduction be denied where it is set-off directly or indirectly against expenditure giving rise to a branch mismatch. Set-off extends to group-relief surrenders. This is equivalent to the UK’s stated approach.
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