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Hybrid instruments

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On 5 October, HM Treasury announced that it intends to legislate to clamp down on the use of ‘hybrid mismatch’ arrangements that exploit differences between countries’ tax rules.

Although details of the proposed changes are limited, it seems that this consultation will focus on how the UK will implement the recommendations of the OECD’s BEPS report on hybrid mismatch arrangements.

So what is this likely to mean for issuers of hybrid debt instruments? The answer may depend on the type of issuer in question. HMRC seems to view ‘regulated’ issuers, such as banks and insurers, differently from other corporate issuers.

The UK’s existing (and helpful) rules for taxing bank regulatory capital were introduced at the start of 2014. Their broad thrust is to tax these instruments as ‘debt’ rather than ‘equity’, even though they may have various equity-like features (e.g. results dependent coupons, perpetual term and write down triggers). In FA 2014, HMRC gave itself powers to introduce a similar regime for insurers issuing regulatory capital in anticipation of the rules to be introduced by the EU ‘Solvency II’ regime (although these powers have not yet been exercised).

Are we about to see a volte-face in HMRC’s approach? The 5 October statement could be read as raising this unwelcome possibility, stating that the government will be ‘considering the case for special provisions for banks’ and insurers’ hybrid regulatory capital instruments’.

However, such a major change seems unlikely. The BEPS hybrid report expressly acknowledges that, in the absence of an agreed approach between participating states, each is free to continue to tax bank/insurer regulatory capital instruments as it sees fit (at least until a hoped for agreement is reached next September). Against this background, the policy reasons for having a special regime remain as valid today as they were last year, when the current bank rules were being introduced. We understand that HMRC has been among those arguing that banks and insurers should be treated differently to other insurers.

So the bank regulatory capital regime seems likely to stay largely intact, although the existing (rather broad and imprecise) targeted anti avoidance rule may well be broadened still further, to capture the concept of ‘structured arrangement’ which is used in the BEPS report. We hope that HMRC will also take this opportunity to begin the introduction of similar rules for insurers, using the power given by FA 2014.

The position for other types of hybrid issuer is less clear. We know that HMRC has had corporate perpetuals ‘in its sights’ for several years. It has indicated that equity-accounted, ‘perpetual’ debt instruments should be taxed as equity (see the recent condoc, Modernising the taxation of corporate debt and derivative contracts). Perhaps this is the moment that new rules in this area will be announced.