Hybrid mismatches with third countries targeted by EC Directive proposal

Article

Hybrid mismatches with third countries targeted by EC Directive proposal

The European Commission issued a proposal for an amendment to the Anti Tax Avoidance Directive. It is targeting hybrid mismatches with third countries. The effective date is currently proposed at 1 January 2019 at the latest.

26 October 2016

EU Anti Tax Avoidance Directive

On 20 June 2016, agreement was reached in the Economic and Financial Affairs Council (“ECOFIN Council”) on the EU Anti Tax Avoidance Directive (“ATAD”). The ATAD sets a minimum standard for (EU) Member States and includes rules that target hybrid mismatches between Member States. Currently, hybrid mismatches with third (i.e. non-EU) countries are out of scope of the ATAD. Simultaneously, however, the ECOFIN Council requested the European Commission (“EC”) to put forward, by October 2016, a proposal on hybrid mismatches involving third countries. Such proposal was to provide for rules consistent with and no less effective than the rules recommended by the OECD BEPS report on Action 2 (i.e. hybrid mismatches), with a view to reaching an agreement by the end of 2016.

On 25 October 2016 the EC issued their proposal for an amendment to the ATAD (“the Proposal”). The key aspects thereof are outlined below.


The proposed amendments

The Proposal broadens the definition of hybrid mismatches in such a way that it would cover the following mismatches: i) hybrid entity mismatches, ii) hybrid financial instrument mismatches, iii) hybrid transfers, iv) hybrid permanent establishment mismatches, v) imported mismatches and vi) dual resident mismatches. The first two mismatches are already included in the ATAD. The last four mismatches, however, are newly added. Except for imported mismatches and dual resident mismatches, as a minimum standard all of the mismatches regard both situations involving Member States only as well as those involving a Member State and a third country. Imported mismatches require a payment by a taxpayer from a Member State to a third country and the involvement of at least another third country. Dual resident mismatches require that the taxpayer is a resident for tax purposes in both a Member State and a third country.

The situations reflected above could have double deductions (“DD”), deductions without inclusion (“D/NI”), non-taxation without inclusion (“NT/NI”) or double tax relief at source (“DTR”) as an outcome. The Proposal therefore sets forth the measures to be taken by Member States should any of the above mismatches and outcomes occur even if it involves third countries. These measures are, depending on the situation, the denial of a deduction, inclusion of income or a limitation of tax relief at source and may be summarized as follows in a simplified manner:

 

Outcome type

Solution (EU only)

Solution (3rd country situations)

DD (hybrid entity and financial instrument)

Deduction only in source Member State (“MS”)

MS to deny deduction unless already denied by 3rd country

D/NI (hybrid entity and financial instrument)

MS of payer to deny deduction

i) MS to deny deduction if MS is source state of payment; or
ii) MS to include payment in tax base if 3rd country is source state unless 3rd country already denied deduction

NT/NI (permanent establishment)

MS of taxpayer’s residency to include income attributed to PE in tax base

MS to include income attributed to 3rd country PE in tax base

DD (imported mismatch)

N/A

MS to deny deduction unless already denied by one of the third countries

D/NI (imported mismatch)

N/A

MS to deny deduction unless already denied by one of the third countries

DTR (hybrid transfer)

MS to limit benefit of relief in proportion to net taxable income

MS to limit benefit of relief in proportion to net taxable income

DD (dual resident)

N/A

MS to deny deduction unless already denied by 3rd country

 

Effective date

The effective date is proposed to be no later than 1 January 2019.


Other remarks

The Proposal can be considered another step in the international combat against base erosion and profit shifting. As it is still a proposal, question is whether amendments will still be made and whether (eventually) agreement will be reached. In its present form, the Proposal could have a significant impact on businesses. Also taking into account that the OECD BEPS report on Action 2 is not a minimum standard, an item that could for instance be subject of further discussion is the proposed effective date, transitional periods and/or the need for grandfathering rules.


Source(s): https://ec.europa.eu/taxation_customs/sites/taxation/files/com_2016_687_en.pdf and http://europa.eu/rapid/press-release_IP-16-3471_en.htm?locale=en

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