Hybrid mismatch arrangements: the UK s take on Action 2

Transcription

1 mismatch s: the UK s take on Action 2 The draft legislation on hybrid mismatch s, which will apply from 1 January 2017, is closely based on the recommendations in the Action 2 report. The absence of a purpose test or a UK tax benefit test means that many commercially motivated s are potentially within scope. The reach of the draft legislation also extends beyond intra-group transactions, both by reason of the fact that some provisions apply a 25% test in assessing whether the parties are related, and in any event third party s can still be caught if they are found to be structured s. The OECD published its final BEPS reports on 5 October 2015, and the report on Action 2 set out the OECD s proposals in relation to hybrid mismatch s (the Action 2 Report ) (see Tom Scott s Tax Journal article of 31 October 2015). The UK published draft legislation to be introduced in a new Part 6A TIOPA 2010 (replacing the existing anti-arbitrage rules) in December 2015, along with the summary of responses to the UK consultation document (the Summary of Responses ). Perhaps unsurprisingly, in light of the length of the Action 2 Report, the draft legislation is not for the faint-hearted. Here I will set out an overview of the provisions and look at headline issues for UK companies considering their potential exposure. Those seeking good news will be relieved that the government is still considering how the hybrid rules should apply to regulatory capital. Instruments that are regulatory capital securities for the purposes of the Taxation of Regulatory Capital Securities Regulations, SI 2013/3209, are excluded from the definition of financial s (albeit that this only removes such securities from the scope of Chapter 3, not the entirety of Part 6A). Description of proposals The provisions target: i. payments under a hybrid mismatch that are deductible under the rules of the payer jurisdiction and are not included in the ordinary income of the payee or a related party investor (deduction/ non-inclusion, or D/NI, ) eg funding s that are taxed/ relieved as debt in the borrower jurisdiction, but as equity for the lender/investor; and payments under hybrid mismatch s that give rise to more than one deduction for the same single payment (double deduction, or DD, ) eg s where an entity has been checked as a branch for US tax purposes, such that a deduction would otherwise be expected to arise in both the local jurisdiction of the entity and in the US. The primary response and the secondary response seek to ensure that the mismatch is eliminated, even where not all the jurisdictions involved in the s have adopted rules based on the Action 2 Report ( foreign equivalent provisions ). Again, the basic approach of the draft legislation does not deviate from that recommended by the OECD: a. the primary response is to deny the deduction in the payer s jurisdiction (where there is a D/NI mismatch) and to deny a deduction in the investor s parent jurisdiction (where there is a DD); and b. the secondary response, which applies where there are no foreign equivalent provisions in the other jurisdiction, or where the primary rule does not apply in such instances, the payment should be included as ordinary income in the payee s jurisdiction.

2 The approach taken by the proposed Part 6A is to deal separately with different categories of D/NI and DD cases. The table below sets out an overview of the conditions required by each chapter before any counteraction can apply. Overview of draft legislation Required conditions Individual condition(s) Payment/ quasi-payment is made Payer or payee within charge to CT Reasonable to suppose that there would be a hybrid D/ NI mismatch or DD Relevance of connection / structured from financial s transfer D/NI payer D/NI payee D/NI entity DD cases Dual resident company DD cases Ch 3 Ch 4 Ch 5 Ch 6 Ch 7 Ch 8 Ch 9 Financial 4 under financial transfer (HTA), exception for financial traders 4 under or in connection with HTA or underlying Payer is a Payee is a 4 under or in connection with an Payer within charge to CT, or hybrid payee is a LLP Reasonable to suppose that, but for these provisions and any foreign equivalent provisions, there would be a D/NI mismatch in relation to the payment or quasi-payment Payer and payee are related; or Financial, or any connected with it (in the case of Ch 3) or the HTA (in the case of Ch 4) is a structured ; or Payer is also a payee (in the case of a quasi-payment) Payer and payee are in same control group; or Arrangement is a structured ; or Payer is also a payee (in the case of a quasi-payment) entity Dual resident company Imported Imported mismatch which is part of a series of s X X 4 under or in connection with an Investor or is within charge to CT There is an amount that, but for these provisions and any foreign equivalent provisions, it is reasonable to suppose that, could be deducted from (i) the ordinary income of the and an investor in that hybrid (in the case of Ch7); or (ii) the company s ordinary income for CT purposes and for non-uk tax purposes (in the case of Ch 8) entity and any investor are related; or Arrangement to which or investor is party is a structured X X Payer (P) is within charge to CT Under another in the series there is a payment or quasi-payment in relation to which it is reasonable to suppose there is or will be a hybrid mismatch. Reasonable to suppose that: neither these provisions nor any foreign equivalent provisions apply to any person in respect of the mismatch payment; but one of these or any foreign equivalent provisions would apply to P if P were payer, payee or an investor in the hybrid entity in relation to the mismatch payment P is in same control group as payer or payee under the mismatch payment; or imported mismatch, or the overarching, is a structured mismatch s: the UK s take on Action 2 2

3 The headline issues for groups assessing the potential application of the new rules are: Part 6A will apply to s from 1 January 2017; absence of a tax purpose or UK tax benefit will not of itself preclude application of the rules; the provisions can apply to third party transactions; and when assessing risks, groups will need to look beyond the UK loans themselves. Commencement The key date is 1 January 2017: i. provisions relating to counteraction of D/NI and imported apply to payments made on or after 1 January 2017; and provisions relating to counteraction of DD cases apply to payment periods beginning on or after 1 January 2017 periods which straddle 1 January 2017 are to be split into two separate taxable periods, with amounts being apportioned between these periods. Notwithstanding representations to the contrary, there are no grandfathering rules or transitional provisions. The Summary of Responses notes that the government s decision to implement the Action 2 recommendations was announced in the Autumn Statement The government s position is that UK companies will have had over two years to assess the impact of these rules and move towards simpler, non-hybrid, s. It is difficult to accept that groups can realistically be said to have had two years in which to restructure their s to avoid the application of the draft legislation, given that the Action 2 Report (or at least the final version thereof) was only published in October 2015 until that time groups could only make an educated guess as to the s which might potentially be caught. Nevertheless, the government s position on the start date is unequivocal, and any UK companies which have not already commenced this exercise must now analyse whether there are any s which they should seek to restructure during the course of this year. Significance of connection between parties The Summary of Responses states that aside from structured s, transactions between unrelated parties will be outside the scope of new rules. However, scrutiny of both the relationship definitions and the approach to structured s indicates that little comfort should be taken from such statement. Definitions of relevant relationship between parties The provisions relating to hybrid payer/payee D/ NI and imported (Chapters 5, 6 and 9) can apply if the parties are in the same control group. This will be the case if: i. they are consolidated for accounting purposes; or the participation condition is met one party directly or indirectly participates in the management, control or capital of the other, or the same person directly or indirectly participates in the management, control or capital of both parties; or i the 50% investment condition is met this may be share capital, voting power, entitlement to proceeds of the disposal of share capital, entitlement to income distributions or entitlement to assets available for distribution on a winding-up, and can be satisfied if either one party has such investment in the other, or if a third person has such an investment in both parties. When the considering the potential application of the hybrid mismatch rules, HTA D/NI mismatch s: the UK s take on Action 2 3

4 and DD cases (Chapters 3, 4 and 7), the tests are even broader. The conditions there look at whether the parties are related. Two persons are related if either they are in the same control group or the 25% investment condition is met. The 25% investment condition can be satisfied by the same range of matters as for the 50% investment condition. If there is a relevant relationship between the parties, it is irrelevant whether or not there is a structured. Structured s If the parties to an are not related or members of the same control group (according to whichever condition is required), then the provisions can still apply if the is a structured. An is a structured if it is reasonable to suppose that: i. the is designed to secure the relevant mismatch this may be the case despite also being designed to secure any commercial or other objective; or the terms of the share the economic benefit of the mismatch between the parties to the or otherwise reflect the fact that the mismatch is expected to arise. Tax directors may (rightly) be wondering what ought to reasonably be supposed of any particular third party. The first limb, in using the phrase designed to secure, might suggest a need for an to have an aim or purpose of securing the relevant mismatch. However, the use of this terminology in the DOTAS rules has indicated that this is a fairly soft test, and could even be satisfied merely where a party knows what the consequences of the would be. The statement in the Summary of Responses, commenting on the concern that mezzanine finance may have a hybrid element as a consequence of commercial funding terms (rather than any tax planning), that the tax effects of such s will be neutralised by Part 6A is not reassuring in this regard. The second alternative limb looks at whether there is any attempt to share the economic benefit of the mismatch. Concerns have been raised as to whether standard tax provisions found in nearly all loan documents (eg tax redemption events) could result in them being identified as structured s. The Summary of Responses notes that the key issue is whether such provisions consider specific tax advantages, and the sharing of such advantages between the parties. Absence of a purpose or tax benefit test The draft legislation does not contain any purpose or UK tax benefit tests. For those who argue that such filters would appropriately confine the provisions to non-commercial transactions, or those where the non-tax benefit (or non-uk tax benefit) outweighs the UK tax benefit, the government s response is clear: no, this would be outside the scope of the OECD recommendations. The Summary of Responses even contains the somewhat optimistic statement that: The mechanical rules should be sufficiently clear and well-targeted to ensure that the policy objectives of the anti-hybrids initiative are met. Permitted reasons for D/NI One piece of good news is that certain D/NI will be disregarded for the purposes of Part 6A if they would have arisen in any event for a permitted reason. The broadest of these reasons are that a person is not liable, under the law of any territory, to tax on any income or profits received, or a person is subject to tax that is not charged on income or profits arising from a source outside the territory. Somewhat counter-intuitively, therefore, groups may find it easier to navigate their way out of Part 6A where amounts are borrowed from a tax haven. Imported For UK companies which consider that they have nothing to fear, as their UK tax deductions are reflected in the ordinary income of the recipient, and not also claimed as deductions in another mismatch s: the UK s take on Action 2 4

5 jurisdiction, it is the imported mismatch rules which are likely to present the greatest challenge. The UK has chosen to pay heed to the OECD s desire that, somehow, all should be counteracted, even if the jurisdictions most obviously relevant have not introduced any anti-hybrid rules. As noted in the table on page 2, the imported mismatch rules can apply where a UK borrower makes a payment under a (vanilla) loan, and under another in the series there is a relevant mismatch (which is not counteracted by foreign equivalent provisions) which would have been counteracted had a UK person been party to the relevant mismatch. In a scenario where most jurisdictions with sophisticated tax systems had already introduced anti-hybrid rules ahead of the UK, the burden imposed by the imported mismatch rules would be far less. You would expect that most would already have been picked up in either the payer or payee jurisdiction using the primary or secondary response. However, given that the UK is keen to be leading the way on hybrids, the likelihood of there being relevant which have not been counteracted elsewhere is far greater. Tax directors are expected to follow funding s and to work out that a mismatch arises in s between third countries. A laudable aim perhaps, but a significant burden. Conclusions The Government s position is that the draft legislation aims both to give effect to the design principles and specific recommendations set out in the Action 2 Report. They have succeeded in this respect, with many of the responses to the UK consultation which sought to encourage the Government to modify its adoption of the recommendations being rejected for the very reason that this would not be in line with the OECD recommendations. Perhaps such alignment is only possible given that the Action 2 Report was so very specific; but the hybrids experience may offer a preview of how further consultation exercises arising out of the BEPS recommendations may fare. This article was first published in the 29 January 2016 edition of the Tax Journal. Jeanette Zaman T +44 (0) E jeanette.zaman@slaughterandmay.com Slaughter and May 2016 This material is for general information only and is not intended to provide legal advice. For further information, please speak to your usual Slaughter and May contact. February 2016 OSM _v01