It is something of an indictment of new tax legislation if tax practitioners find themselves reaching wildly different conclusions about its effect.
That seems to be the case for the new hybrid rules, where I have reached the opposite conclusion to James Ross as to the effect of the assumptions in TIOPA 2010 s 259EB(3)(b) (‘Hybrids: making sense of the draft guidance’, Tax Journal, 20 January 2017). Mr Ross believes the assumptions are there to benefit taxpayers. I disagree.
To rewind: a key condition for a payment by a hybrid entity to fall within the hybrid payer rules in TIOPA 2010 Part 6A Chapter 5 is that it is reasonable to suppose that there is a ‘hybrid payer deduction/non-inclusion mismatch’ in relation to the payment. That term is defined in s 259EB(1) to mean, very broadly, that the payer is obtaining a deduction which exceeds the ordinary income arising to the payee, and that this excess arises by reason of (my emphasis) the payer being a hybrid entity. Therefore there must be a causal link between the excess and the hybridity of the payer.
Take a simple example of a US parent company receiving an interest payment from a disregarded UK subsidiary. The US will not tax the parent company on the interest because the US taxman thinks the subsidiary, and therefore the loan, don’t exist. Thus there is an excess of deductions against ordinary income, and it arises by reason of the subsidiary’s hybridity. Hence one would expect there to be a hybrid payer deduction/non-inclusion mismatch.
What if, however, the idiosyncrasies of US tax mean that, if the subsidiary was not disregarded, the parent would be exempt from US Federal corporate income tax on the interest? We can argue that the excess is now not arising ‘by reason of’ the hybridity: there would always be an excess regardless of whether the subsidiary was a hybrid entity. The hybrid rules therefore don’t apply.
HMRC apparently doesn’t want taxpayers to be able to run this kind of defence.
Sub-sections 259EB(3)(b) and (4) therefore re-run the test of causality, but this time making certain ‘relevant assumptions’ about the status of the payee. So, in the example above, one must assume that the payee is not exempt from US tax, and then ask whether the excess of deductions over ordinary income arises by reason of the payer being a hybrid entity. That neatly disposes of the subsidiary’s causality argument, and the hybrid rules will apply.
The assumptions in sub-s 259EB(4) are, therefore, always unhelpful for taxpayers – as are the equivalent assumptions in ss 259CB (financial instrument mismatches) and 259DC (hybrid transfer arrangements). In a best case, taxpayers have to go through the challenging exercise of determining a payees’ local tax treatment on a counter-factual basis. In a worst case, the assumptions mean the hybrid rules apply even when hybridity is of no technical relevance to the tax result.
The result is counter-intuitive, and inconsistent with both the original OECD hybrids proposal and the original UK draft legislation (which contained a helpful concept of ‘permitted reasons’ which assisted taxpayers in cases where an excess would have arisen regardless of hybridity).
We can only speculate as to why the final legislation takes this approach. Perhaps HMRC came to view hybridity as sufficiently sinful that it must be punished, even where the hybridity is irrelevant to the tax result in question?
It is something of an indictment of new tax legislation if tax practitioners find themselves reaching wildly different conclusions about its effect.
That seems to be the case for the new hybrid rules, where I have reached the opposite conclusion to James Ross as to the effect of the assumptions in TIOPA 2010 s 259EB(3)(b) (‘Hybrids: making sense of the draft guidance’, Tax Journal, 20 January 2017). Mr Ross believes the assumptions are there to benefit taxpayers. I disagree.
To rewind: a key condition for a payment by a hybrid entity to fall within the hybrid payer rules in TIOPA 2010 Part 6A Chapter 5 is that it is reasonable to suppose that there is a ‘hybrid payer deduction/non-inclusion mismatch’ in relation to the payment. That term is defined in s 259EB(1) to mean, very broadly, that the payer is obtaining a deduction which exceeds the ordinary income arising to the payee, and that this excess arises by reason of (my emphasis) the payer being a hybrid entity. Therefore there must be a causal link between the excess and the hybridity of the payer.
Take a simple example of a US parent company receiving an interest payment from a disregarded UK subsidiary. The US will not tax the parent company on the interest because the US taxman thinks the subsidiary, and therefore the loan, don’t exist. Thus there is an excess of deductions against ordinary income, and it arises by reason of the subsidiary’s hybridity. Hence one would expect there to be a hybrid payer deduction/non-inclusion mismatch.
What if, however, the idiosyncrasies of US tax mean that, if the subsidiary was not disregarded, the parent would be exempt from US Federal corporate income tax on the interest? We can argue that the excess is now not arising ‘by reason of’ the hybridity: there would always be an excess regardless of whether the subsidiary was a hybrid entity. The hybrid rules therefore don’t apply.
HMRC apparently doesn’t want taxpayers to be able to run this kind of defence.
Sub-sections 259EB(3)(b) and (4) therefore re-run the test of causality, but this time making certain ‘relevant assumptions’ about the status of the payee. So, in the example above, one must assume that the payee is not exempt from US tax, and then ask whether the excess of deductions over ordinary income arises by reason of the payer being a hybrid entity. That neatly disposes of the subsidiary’s causality argument, and the hybrid rules will apply.
The assumptions in sub-s 259EB(4) are, therefore, always unhelpful for taxpayers – as are the equivalent assumptions in ss 259CB (financial instrument mismatches) and 259DC (hybrid transfer arrangements). In a best case, taxpayers have to go through the challenging exercise of determining a payees’ local tax treatment on a counter-factual basis. In a worst case, the assumptions mean the hybrid rules apply even when hybridity is of no technical relevance to the tax result.
The result is counter-intuitive, and inconsistent with both the original OECD hybrids proposal and the original UK draft legislation (which contained a helpful concept of ‘permitted reasons’ which assisted taxpayers in cases where an excess would have arisen regardless of hybridity).
We can only speculate as to why the final legislation takes this approach. Perhaps HMRC came to view hybridity as sufficiently sinful that it must be punished, even where the hybridity is irrelevant to the tax result in question?
