ATO clarifies ‘extremely complicated’ hybrid mismatch rules
The ATO’s approach to interpreting hybrid mismatch rules will affect more arrangements and taxpayers than previously expected, expert says.
The ATO has clarified hybrid mismatch rules will apply to entities with “hypothetical” incomes and entities beyond the immediate recipient of a deduction.
While the draft determination goes some way to clarifying the “very complicated” hybrid mismatch rules, Denis Larkin, international tax partner at KPMG Australia said the interpretation is broader than he and others had anticipated.
Further, the expansive approach will make compliance “much more complicated” for certain taxpayers.
Developed by the OECD, hybrid mismatch rules are integrity rules designed to prevent multinationals from avoiding taxes or obtaining double benefits.
For example, a “deduction-deduction” outcome occurs where a dealing is treated as a deduction in two different countries. The same can happen where one country treats a dealing as a deduction, and another treats it as a non-inclusion of income. Both can give rise to unfair tax benefits.
While many countries have adopted the OECD rules, including New Zealand and most EU countries, they are not as widespread as other OECD arrangements.
“Trying to capture that in legislation is very hard,” said Larkin. “I have some sympathy for the government in trying to do that, but…it does make the rules extremely complicated.”
While many countries have adopted the OECD rules, including New Zealand and most EU countries, they are not as widespread as other OECD arrangements.
The determination clarified two points of uncertainty. Firstly, the ATO made it clear that a ‘liable entity’ under the rules can include a party whose income or profits are entirely hypothetical within the tax base of the country.
Secondly, the interpretation overturns the general presumption that for tax purposes, the direct recipient or the immediate taxpayer is the relevant party for a deduction or inclusion.
Instead, the ATO has clarified that a “non-including country” for the purposes of defining a “hybrid payer can be a jurisdiction other than the country in which the recipient of a payment resides.
The expanded approach is significant and will have considerable impact on “quite a few players, and especially US multinational groups,” said Larkin.
US tax rules employ “check-the-box” elections which mean that entities are treated differently for US purposes and other purposes. The US has yet to introduce the full suite of OECD mismatch rules. In other words, there is a degree of hybridity built into those rules.
This makes US multinationals particularly susceptible to changes regarding hybrid mismatch rules, said Larkin.
“Probably a lot of taxpayers who are subsidiaries or members of a US multinational group would find this broader than what they would have expected,” he said.
“It will make the compliance process much more complicated and probably more uncertain in some regards for US multinationals.”
