HMRC have published a consultation document in relation to certain aspects of the hybrid and other mismatch rules.
The hybrid and other mismatch rules were introduced with effect from 1 January 2017 to implement OECD recommendations known as BEPS Action 2. Mismatches in the tax treatment within the scope of the rules are counteracted by disallowing tax deductions or requiring taxable income to be recognised. Although there was a consultation on the draft legislation prior to it being enacted, the practical implications were insufficiently understood by business, advisers and HMRC, so many problems were either not identified at that time or not resolved in the final legislation. It has now been accepted that the rules, as currently drafted, can apply more widely than the intended scope and it is to be welcomed that HMRC are undertaking this review. Similar rules are being introduced in EU member states with effect from 1 January 2020 (ATAD2), and this may have been a factor in prompting the review.
The consultation focuses on the following three areas:
Dual inclusion income
The hybrid rules can disallow expenses which are deductible in more than one jurisdiction, but, broadly, no counteraction is required to the extent that the expenses are deducted from certain categories of income, e.g. dual inclusion income which is recognised twice for tax purposes.
It is generally recognised that, despite a beneficial change to the legislation in Finance Act 2018, which took account of certain taxable income where there is no corresponding deduction (section 259ID income), the mechanical nature of the rules means that they can apply more widely than the intended target area, particularly in relation to commercial operating activities.
HMRC are receptive to making changes and are looking for evidence and explanations of structures which are disproportionately affected by the current UK rules, as well as related issues in the other relevant jurisdictions.
The hybrid rules are intended to counteract certain mismatches in the tax treatment, broadly, where parties to an arrangement are in the same group or otherwise have substantial commonality of ownership or control. This can include otherwise unconnected persons who are ‘acting together’ and HMRC are asking for evidence of when this applies disproportionately.
In addition, HMRC are aware that, in situations where the acting together rules apply, it is often very difficult for taxpayers to obtain information as to their counterparties’ structures which is necessary in order to assess the application of the hybrid rules.
If changes were to be made, HMRC will look to rely on the regime targeted anti-avoidance rule to counter arrangements entered into to circumvent the rules.
Exempt investors in hybrid entities
Under the rules as currently drafted, an expense in a UK company would not typically be disallowed if the income is received directly by an exempt investor (e.g. a pension fund) but could be disallowed if the exempt investor makes their investment via a hybrid entity. This can be the case where the intermediate entity is characterised as transparent in the UK and opaque in the jurisdiction of the exempt investor.
HMRC are sympathetic that this may not represent the preferred outcome and are consulting on options to improve the operation of the rules, e.g. a ‘white list’ of entities which would not give rise to a counteraction.
Scope to make representations
We understand that there is scope to comment on other issues but HMRC will prioritise which are taken forward.
We would encourage all taxpayers who are potentially affected by the hybrid rules to make representations because evidence from taxpayers is likely to be persuasive in determining whether HMRC propose amendments to the legislation.
The consultation will complete on 29 May 2020.
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