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Hybrids rules and BEPS disclosures for 2021 tax returns: understanding your obligations

Tax Alert - February 2022

By Annamaria Mclean & Jeremy Beckham
 

Most taxpayers with cross-border operations will by now have some familiarity with the hybrid and branch mismatch rules and understand the sorts of arrangements the rules are targeting. Although the rules were enacted in 2018, the last 12 months has seen a number of important developments that will first impact 2021 tax returns and related BEPS disclosures due to be filed on or before 31 March 2022. Taxpayers should be mindful of these latest developments and consider any impact on the tax positions they take.

Additional BEPS disclosure requirements for hybrid mismatch arrangements

The first key development is that Inland Revenue has amended its BEPS disclosure guidance material in a small but significant way for when a BEPS disclosure is required. The guidance now requires New Zealand taxpayers that are subject to the hybrid rules but ultimately have no denial of deductions to still file a BEPS disclosure. Broadly, the BEPS disclosure requires a calculation of the hybrid mismatch amounts and offsets for surplus assessable income as calculated under the rules.

This small change to the guidance has significantly widened the circumstances where a BEPS disclosure must be made. Moreover, because the hybrid and branch mismatch rules were enacted in 2018, taxpayers will need to work backwards through earlier income years to determine their opening balances of hybrid mismatch amounts and surplus assessable income for the BEPS disclosure for the 2021 income year.

Among the taxpayers most impacted by the change are entities doing business in New Zealand via a branch or an Unlimited Liability Company that is treated as transparent for US tax purposes. Such taxpayers that are inbound distributors or service providers for offshore related parties often assume only limited risk and expect to be in a consistent tax paying position under their transfer pricing policies and as a result are unlikely to ever have amounts denied under the hybrid rules. It seems a fair question to ask what disclosure really achieves in these circumstances and we have raised our concerns with Officials at Inland Revenue.

Separately, we have also run into some odd outcomes with the rules not working as intended with New Zealand transparent entities of US multinational groups, to the effect that taxpayers in a taxpaying position may nevertheless have amounts denied under the hybrid rules. This is largely due to the overly prescriptive nature of the rules and it serves to highlight that the positions need to be carefully worked through.

New Zealand taxpayers with outbound branch operations or investments in overseas partnerships will also need to consider whether they are impacted by the new guidance material. In many situations a hybrid mismatch situation is not created if there is no ability to offset the expenditure or loss of the foreign branch or partnership against income of another person or entity (hence a BEPS disclosure is not required). However, there are situations where a BEPS disclosure may still be required so an analysis of the precise facts is important. We have been working closely with New Zealand corporates on these issues and documenting the conclusions reached to support the positions and in case of inquiry by Inland Revenue.

Operational Statement (OS 21/02) on imported mismatch rule now finalised

A second key development is Inland Revenue’s now finalised Operational Statement OS 21/02 Administration of the imported mismatch rule – section FH 11. OS 21/02 applies from the 2021 income year onwards.

By way of background, the imported mismatch rule is easily the most complex of all of the hybrid rules. It also applies more widely in the 2021 income year to include unstructured arrangements for income years beginning on or after 1 January 2020 (previously only applying to structured arrangements). In broad terms, the imported mismatch rule operates as a backstop, targeted at arrangements involving offshore hybrid mismatches that are imported into the New Zealand tax base via a series of payments that can be traced back to a payment from New Zealand. The rule is extraordinarily wide and can apply to any related party payment made from New Zealand that indirectly funds a hybrid mismatch in a foreign country.

OS 21/02 prescribes the approach Inland Revenue expects taxpayers to take to ensure they are complying with the imported mismatch rule in relation to payments to control group members. To comply with their self-assessment obligations, Inland Revenue expects that New Zealand taxpayers will:

  1. Identify payments made to non-resident control group members that are tax deductible before applying the imported mismatch rule;
  2. Determine whether any such payments are to a person that is in a jurisdiction that has not implemented hybrid mismatch rules equivalent to New Zealand’s; and
  3. Before claiming a deduction ensure that the group head office tax function has undertaken appropriate work to identify any hybrid mismatches within the group and determine the extent to which these are funded by otherwise deductible payments from New Zealand payers.

For multinational groups that are not headquartered in New Zealand, it is envisaged that the work may be undertaken by persons outside New Zealand. Where this is the case, the Commissioner expects that the taxpayer will obtain from the group’s head office tax function a written statement regarding that work. For groups headquartered in New Zealand, the expectation is that the work will generally be undertaken by group employees in New Zealand (or at their direction) and that written evidence is kept.

We have been working closely with both New Zealand head quartered and foreign multinationals to ensure any analysis undertaken of the imported mismatch rule is appropriate and has due regard to the New Zealand context. One thing we have come to appreciate is that the local domestic rules for taxing hybrid and branch mismatch arrangements vary widely between jurisdictions, even if they are all modelled on a common set of OECD recommendations (this includes differences in the Australian and New Zealand hybrid rules). If work has been undertaken offshore, then we strongly suggest taxpayers to work with their New Zealand tax advisors to review the work undertaken to ensure that the same outcomes arise under the New Zealand legislation.

It is worth emphasising Inland Revenue’s position that no deduction should be claimed unless it is clear that the imported mismatch rule does not apply on the basis of reasonable enquiry/analysis. OS 21/02 provides that Inland Revenue may make use of specific administrative powers to demand information to satisfy itself that the imported mismatch rule has been appropriately considered and has been complied with (with consequences for not complying with the information demand).

Amendments proposed to imported mismatch rule in new tax bill

A final key development (and a significantly complicating factor in terms of complying with OS 21/02) relates to the amendments proposed to the hybrid imported mismatch rule by the Taxation (Annual Rates for 2021-22, GST, and Remedial Matters) Bill currently working its way through Parliament. These amendments are remedial in nature, intended to ensure the imported mismatch rule works as intended and, for the most part, are beneficial for taxpayers. That said, the changes proposed to the legislative wording are not simply minor and when added together arguably amount to a wholesale rewrite of the imported mismatch provision. Most of the proposed amendments are also retrospective in effect and will apply from 1 July 2018.

The Taxation (Annual Rates for 2021-22, GST, and Remedial Matters) Bill is expected to be enacted by 31 March 2022. Given the retrospective nature of the proposed amendments, due care needs to be taken on the application of the rules for tax returns due by 31 March 2022, noting that we are in the position of having proposed legislation that is not yet enacted within months of the tax return filing date. We would hope that Inland Revenue will be pragmatic and accepting of voluntary disclosures that are made regarding the application of the imported mismatch rule for tax returns filed prior to the amendments being enacted.

If you have any queries or would like to discuss this further, please contact your usual Deloitte advisor.

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