EU Developments: Tackling Tax Avoidance
EU ECOFIN Council approves amendments to the Anti-Tax Avoidance Directive
28 February 2017
Following on from our earlier alerts on this topic, the EU ECOFIN Council have recently confirmed they have reached agreement on the widely-anticipated amendments to the Anti-Tax Avoidance Directive (ATAD), which was finalised last July. The amendments to the ATAD (ATAD 2) are primarily concerned with an expansion of the scope of anti-abuse rules pertaining to hybrid mismatches. A hybrid mismatch can arise where there are mismatches in the legal characterisation of a transaction, financial instrument or entity between countries, and such mismatches result in a double deduction or a deduction without inclusion of income in another jurisdiction.
Expansion of existing rules: The original ATAD addressed hybrid arrangements, but was limited to hybrid financial instruments and hybrid entity mismatches between Member States.
The objective of ATAD 2 is to target all hybrid mismatches where at least one of the parties involved is a taxpayer that is subject to corporate income tax in an EU Member State (including permanent establishments of entities resident in “third countries”).
By broadening the definition of hybrid mismatches, ATAD 2 creates a comprehensive anti-hybrid abuse framework aimed at preventing arrangements that involve Member States and third countries. Included within the expanded definition are:
- Hybrid transfers: Hybrid transfers can occur where the laws of two jurisdictions differ on whether the transferor or the transferee of a financial instrument has obtained the ownership of the payments on the underlying asset. This may lead to a deduction of an expense in a jurisdiction without the inclusion of income elsewhere, or the generation of a surplus tax credit.
- Permanent establishment mismatches: Permanent establishment mismatches occur where the differences in the rules between the permanent establishment jurisdiction and residence jurisdiction for allocating income and expenditure, between different parts of the same entity, give rise to a mismatch in tax outcomes.
It includes those cases where a mismatch outcome arises due to the fact that a permanent establishment is disregarded under the laws of the branch jurisdiction. This may result in a double deduction of an expense in one or more jurisdictions or deduction without the inclusion of income elsewhere.
In certain circumstances the hybrid mismatch rule should not apply, however, where the mismatch would have arisen in any event due to the tax exempt status of payee under the laws of any payee jurisdiction.
- Imported mismatches: Imported mismatches shift the effect of a hybrid mismatch between parties in third countries into the jurisdiction of a Member State through the use of a non-hybrid instrument thereby undermining the effectiveness of the rules that neutralise hybrid mismatches. A deductible payment in a Member State can be used to fund expenditure involving a hybrid mismatch. This may involve the import of a double deduction of an expense in one or more jurisdictions or the import of a deduction without inclusion of the income elsewhere.
- Dual resident mismatches: Dual resident mismatches can arise where a taxpayer is resident for tax purposes in two jurisdictions. This may result in a double deduction outcome if a payment made by a dual resident taxpayer is deducted under the laws of both jurisdictions where the taxpayer is resident.
The rules should only apply in the case of a mismatch between a taxpayer and an “associated enterprise” or in the case of “structured arrangements” between the parties involved.
Member states may potentially exclude from provisions of ATAD 2 certain financial instruments issued for the sole purpose of satisfying loss absorbing capacity requirements applicable to the banking sector, or financial instruments with conversion, bail-in or write down features, where the appropriate conditions are met.
View the agreed text of ATAD 2.
Timetable and entry into effect
The new rules will come into force on 1 January 2020, with a longer phase-in period of 1 January 2022 for reverse hybrid mismatches. A reverse hybrid entity is one which is treated as transparent in the jurisdiction in which it was originally formed or created and as non-transparent by another jurisdiction.