BEPS - Action 2

Neutralising the Effects of

Hybrid Mismatch Arrangements – Liu Qihao

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 BEPS - Action 2
Neutralising the Effects
of Hybrid Mismatch Arrangements
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Tools : entity hybrids or transactional hybrids (complexe financial instrument)
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Complex financial instruments possess more than one financial component,
such as a combination of debt or equity attributes (e.g. can be converted )
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e.g : Interest and dividend using hybrid transfert instrument like convertible
financial instrument
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Effects :
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Multiple deduction in different countries related to the same cost
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Deduction without taxation in others jurisdictions
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Different tax credit for the same paid tax in others jurisdictions

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 BEPS - Action 2
Neutralising the Effects
of Hybrid Mismatch Arrangements
Broad Context

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Hybrid mismatch arrangements
Two deductions and/or not inclusion
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Hybrid mismatch arrangements are used in aggressive tax planning to exploit
differences in the tax treatment of an entity or instrument under the laws of two or more
tax jurisdictions to achieve double non-taxation, including long-term taxation deferral.

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Agressive Tax Planning that involves taking advantage of the intricacies of a tax system
or inconsistencies between two or more tax systems in order to exploit theses mismatch
to benefit unduly of tax systems of differents jurisdictions. Among the consequences of
this practice are double deductions (for example, the same loss is deducted in both the
State of source and the State of residence) and double non-taxation (for example,
income that is not taxed in the State of source are exempt in the State of residence)

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 BEPS - Action 2
Neutralising the Effects
of Hybrid Mismatch Arrangements
Broad Context
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OECD report on increase inequality and banking sector and structured finance in banking ;
https://www.oecd.org/economy/How-to-restore-a-healthy-financial-sector-that-supports-long-
lasting-inclusive-growth.pdf

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The NGO world that works on tax matters advocate for tax justice. Indeed, the shortfall is
estimated at 100 billion dollars per year (estimate of the UN report eg. 2015), the
associative world considers that this money does not return to the public purse and have
therefore required a reduction in the quality and quantity of public service, both in the
countries of the North and South.
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For example, according to an Oxfam report, one third of the annual amount of tax evasion
would save 8 million mothers and infants in developing countries (public investment in
health care infrastructure ). While in developed countries the shortfall of the State forces to
reduce the quality and the quantity of public service leading to a budgetary restriction badly
experienced by the citizens (e.g. : hospital hold up video from Oxfam «  : “Silence ! On
braque un hôpital” , since Covid theses practices has been seen as even worse than before)

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 BEPS - Action 2
Neutralising the Effects
of Hybrid Mismatch Arrangements

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BEPS reactions
- Change of domestic law
- Automatic rules to neutralize the tax mismatch without
any effect on commercial side or regulatory side
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neutralise the hybrid mismatch by either denying a
deduction, or including in taxable income, certain
payments or amounts.

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 OECD view point on hybrid mismatch
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Domestic law provisions with refusal of exemption benefit for expense that
have been already subjected to a deductible expense regime
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Domestic law that prevent deduction for payement thant cannot be included
for the recipient
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Provision in domestic law that deny deduction for a cost that has already
been deducted in another jurisdiction
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Change the OECD model tax in order to make impossible the usage of
hybrid mismatch based on financial instrument or entity
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Guidance on coordination if more than one country seeks to apply theses
rules to transaction or structure , therefore increase of information
exchange

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 Concepts
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Hybrid entity: an entity that is treated as transparent in
one country, but opaque in another, and it either makes
deductible payments, or receives payments which were
deductible to another entity
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Hybrid transfer arrangement: a hybrid financial
arrangement that is treated as debt in one country, but
as equity by another, or a financial arrangement that
gives rise to a timing deferral

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 Concepts
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Mismatch occurs where there is a deduction in one state but no
income in another – referred in BEPS as D/NI and DD

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Deduction / non-inclusion (D/NI) effects: payment is deductible
in one jurisdiction, but not considered taxable income in the
country it is received

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Deduction / deduction (D/D) effects : a deduction is allowed in
more than one country for the same payment

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 BEPS and Hybrid Transfers
Hybrid transfers are treated as a type of hybrid financial instrument
because they are, in substance, financial instruments rather than
asset transfers and they give rise to a difference in tax treatment that
allows them to be used as part of a structured arrangement to
engineer a cross-border mismatch. As with other types of financial
instrument, the hybrid transfer rules do not take into account whether
the funds obtained under the transfer have been invested in assets
that generate a taxable or exempt return. The adjustment that the
transferor is required to make in respect of payment under a repo or
stock loan will therefore not be affected by whether the transferor is
taxable on the financing or equity return on the transferred asset.

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 BEPS - Action 2
Neutralising the Effects
of Hybrid Mismatch Arrangements
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BEPS exemple
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Australia and France same groupe Parent A
& B company
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Complex financial instrument - deductible
expense as interest under french law and
exempt from taxation in Australia as a
dividend
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Effect : no taxation in both countries
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From double taxation to double non-taxation
(deduction, non inclusion : DNI)
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BEPS in Australia for hybrid mismatch

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BEPS recommandation on hybrid financial
instrument

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Hybrid mismatch: Differences in the
tax treatment of the instrument mean
that payments under the instrument
have a different character
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Type : D/NI
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Domestic law : No dividend
exemption for deductible payments
Proportionate limitation of
withholding tax credits

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BEPS recommandation on hybrid financial
instrument

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Primary Response : Payer jurisdiction denies deduction
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Defensive rule : Payee jurisdiction includes payment as income
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Time Scope : timing consideration if differents delay of
recognition, taxpayer can include in taxe base within reasonable
timing from point of view of tax authority
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What usage about timing  delay ? financial reflexion about
interest rate and financial investment in point of view of ROI
during the reasonable timing
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Personnae scope : payement made to a related person or where
the payement is made under a structured arrangement and the
taxpayer is party to that structure : see exemple from BEPS
youtube France – Australia
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Derivative contract – Debt – Equity and if payement made in
subsitution for theses assets and difference between substitution
and theses financiall instruments

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BEPS recommandation on hybrid financial
instrument

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Restriction of foreign tax credit
under hybrid mismatch : if tax relief
for dividend from one jurisdiction
using hybrid then restriction to the
advantage in another for taxpayer
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Deny the dividends exemption for
deductible payement

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 Transactional Hybrid Mismatch
convertible financial instrument =
Deductible interest debt + Exempt dividend
equity

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BEPS recommandation on hybrid financial
instrument

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Tax treatment recommandation :
alignement with general treatment
of theses kinds of financial
instrument
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Limite the ability of taxpayer to claim
relief from jurisdiction when financial
instrument with hybrid transfer is
involved ( recommandation 2 .2)

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 Concepts
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Hybrid entity: an entity that is treated as transparent in
one country, but opaque in another, and it either makes
deductible payments, or receives payments which were
deductible to another entity
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Hybrid transaction arrangement: a hybrid financial
arrangement that is treated as debt in one country, but
as equity by another, or a financial arrangement that
gives rise to a timing deferral

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 Entity Hybrid

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Entity hybrid :
- Straight hybrid : transparent between Parent A Co & B Co
and separate between differents jurisdictions
- Reverse hybrid : transparent between jurisdictions and
separate between Parent Co A & B Co

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 BEPS - Action 2
Neutralising the Effects
of Hybrid Mismatch Arrangements
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Entity hybrid
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Two kinds depends on
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Opaque and transparency
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Straight or Reverse
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Same groupe and presumption of purpose of
using mismatch
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Difference with hybrid transfer mismatch
arrangments (e.g. Bank Structured Finance )
diff - transaction and company entity
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Lightbubble where its transparent then the
reverse is opaque

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 BEPS - Action 2
Neutralising the Effects
of Hybrid Mismatch Arrangements
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Entity hybrid Straight
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Parent Co treat B Co as transparent
and country of establishment of B co
treat B co as opaque
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B Co send dividend to Parent Co as
branch (transparent) but country B see
it as opaque so give deduction
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Parent Co exempt of tax on dividend
(RDT)
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Or Deduction for B Co also using
Income Trust (Canada)
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Entity Hybrid Straight

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 BEPS - Action 2
Neutralising the Effects
of Hybrid Mismatch Arrangements
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Entity hybrid Reverse
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Parent Co treat B Co as opaque
and country of establishment
treat B co as transparent
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If Parent Co country : non-
taxable or tax credit
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B Co Transparent : non-taxable
as company tax entity

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Entity Hybrid Reverse

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 Concepts
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A hybrid entity mismatch can occur where a company is treated as tax
opaque ( actual tax paying entity) in one jurisdiction and tax transparent (
entity is not taxed and taxable items pass thru to owners who bear the tax
consequences ) in another
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e.g. disregarded entities for tax purposes ( the entity organized and valid
under “corporate” law in the state where it was formed, simply does not
exist for tax purposes in one state but does exist for tax purposes in the
other state.) e.g US check-the-box rules
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US Co (e.g. Apple Computer ) organized in the world, can elect if they will
be tax opaque, tax transparent, or even disregarded for US tax purposes
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Effect double non-taxation as entity DNI

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 Recommandations
straight hybrid DNI
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Primary Response - Payer jurisdiction denies deduction
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Defensive rule - Payee jurisdiction includes payment as
income
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Personnae scope - Related parties (incl. persons acting
in concert) & structured arrangements.

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 Recommandations
straight hybrid DD
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Primary Response - Investor jurisdiction denies
deduction
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Defensive rule – Subsidiary jurisdiction denies deduction
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Personnae scope - Primary rule no limitation. Defensive
rule limits to related parties (incl. persons acting in
concert) & structured arrangements..

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 Reverse hybrid
recommandation
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Primary Response - Investor required to include income

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Primary Response - Intermediate jurisdiction follows tax
treatment of controlling investor if no inclusion by that investor

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Defensive rule - Payer jurisdiction denies deduction
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Personnae scope - Members of controlled group (incl. persons
acting in concert) and anti-abuse

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 Dual residence
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Dual residence entities: Entities that are resident in two
different countries for tax purposes.
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Double deduction for the same expense

Jursidiction A
Jurisdiction B
Effective
Setup Company
Management
By Incoporated
Rule

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 Dual residence
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Double deduction for the same expense
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Each jurisdiction deny deduction
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Payment is offset against expenditure incurred under a
hybrid mismatch arrangement (recommandation add the
part that has been unduly deducted)

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 Imported mismatches
D/NI
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Any Payment is offset against expenditure incurred
under a hybrid mismatch arrangement
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Primary Response – general anti-hybrid rules
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Payer jurisdiction denies deduction

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Members of controlled group (incl. persons acting in
concert) and anti-abuse

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 Monitor BEPS action 2
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Australia
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The Australian hybrid mismatch rules (HMR) were
introduced in response to the OECD’s recommendations
on neutralising a mismatch in tax outcomes arising from
countries’ different tax treatment
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Effect for income years beginning on or after 1 January
2019.

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 Monitor BEPS action 2
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China hasnt integrated BEPS action 2
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China has relatively limited guidance on the tax classification and treatment of hybrid
financial instruments, i.e. those with features of both debt and equity. For example,
China did not adopt the BEPS Action 2 rules [2015] to deal with hybrid mismatch tax
planning.
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It was however considered that the existing rules did not adequately deal with cross-
border situations, in particular the tax arbitrage possible where a foreign enterprise
invests in an instrument issued by a Chinese company. Under the existing guidance
it was possible for an instrument’s terms to be tailored such that the Chinese
enterprise would have its payments treated as deductible interest but the foreign
enterprise could, under the tax law of its jurisdiction, treat the payment as an exempt
dividend.

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Thank you

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