INTERNATIONAL ASPECTS OF HYBRID MISMATCHES Prof dr Bart
INTERNATIONAL ASPECTS OF HYBRID MISMATCHES Prof. dr. Bart Peeters Bart. peeters@ugent. be
PRESENTATION 1. Introductive comments 2. Two general questions 3. 8 possible mismatches in entity qualifications 4. Importing mismatches from third countries 5. Conclusion 3
1 FUNDAMENTALS OF HYBRID MISMATCHES => Conflict between different simultaneously applicable legislations -domestic income tax legislation (common) -tax treaties (less common => solving with interpretation ? ) => How to resolve conflict ? -giving priority to one interpretation/legislation over others => ‘priority approach’ -conceptually ‘neutralizing the mismatch effect’ => ‘conceptual approach’ => Illustration with example of ‘classification of entities’ 4
1 GENERAL CONTEXT OF CLASSIFICATION Entity Taxable income General purpose Entrepreneurial risk Tax payer Financial support Tax payer
1 CLASSIFICATION OF AN ENTITY Entity Taxable income General purpose Entrepreneurial risk Tax payer Classification: -Fiscally transparent: 1 flow of income -Fiscally non-transparent: 2 separate taxable flows of income
1 3 CLASSIFICATIONS TO BE FULFILLED Entity Taxable income State S: source of the income General purpose Entrepreneurial risk State P: state of the location of the entity State R: residence state of the partner
1 CLASSIFICATION FROM THE POINT OF VIEW OF S S Taxable income P R Entity State S: -Taxing the entity or its partners ? -Which treaty limitations have to be respected ? (analysis for ‘inbound operations’ ? )
1 CLASSIFICATION FROM THE POINT OF VIEW OF P S Taxable income P R Entity State P: -Taxing the entity and distribution to the partners or immediately the partners (entity as PE? ) ? -Unilateral remedies foreign income ? -Which conventions should be applied ?
1 CLASSIFICATION FROM THE POINT OF VIEW OF R S Taxable income P R Entity State R: -When can the partners be taxed and how to qualify their income? -Unilateral remedies foreign income ? -Which conventions should be applied ? (analysis for ‘outbound operations’ ? )
2 2 GENERAL QUESTIONS 1. How to determine which treaty should be applied ? -If state S attributes to partners, does convention S-P applies ? -If state S attributes to entity, can convention S-R apply ? -If state P taxes distribution to partners, does convention P-R apply ? -… 11
2 2 GENERAL QUESTIONS 2. How to solve conflict between residence states P and R ? P: NT R: T Entity HYBRID ENTITY : Taxable income P: T REVERSE HYBRID ENTITY : R: NT Entity Taxable income 12
2 FUNDAMENTALS OF HYBRID MISMATCHES Focus in the partnership report (1999): unbalanced tax burden S => Priority approach: attribution of income (and treaty entitlement) is determined by the state of residence (P or R) An implicit treaty principle binding the source state to the attribution rules of the residence state(s) to determine treaty applications P/R => Conceptual approach: residence state of the partner (R) avoids the mismatch Reducing (excessive) double taxation / avoiding non-taxation needs a particular interpretation of its relief obligation in the treaty in the residence state of the partner (R) 13
2 FUNDAMENTALS OF HYBRID MISMATCHES Focus in BEPS action 2: “Neutralise the effect of a hybrid mismatch by ensuring that a payment is subject to tax at least once” S => (Limited) priority approach: attribution of income (and treaty entitlement) is determined by the state of residence (P or R) as explicitly added in art. 1, 2 OECD Model Convention P/R => Conceptual approach: avoiding ‘tax avoidance’ by way of linking rules (D/NI, DD, NI/NI) Mismatch is considered to be planned and should be avoided in domestic legislation being influenced by foreign legislation 14
2 INITIATIVES IN ATAD 1 AND 2 => BEPS Action 2 OECD: -P/R conflict to be dealt with in domestic legislation => ATAD 1: general principles (DD and D/NI) in art. 9 to be implemented by the end of 2018 => ATAD 2: “it is clear that this cannot sufficiently be achieved by Member States acting individually, in a non-concerted mode” Proposal of commission October 2016: not realised ! ECOFIN council 21/02/2017 detailed rules to be implemented 31/12/2019 15
2 INITIATIVES IN ATAD 1 AND 2 Reaction only in case of ‘associated enterprises’ (50 % participation) (but comment (13) is not entirely clear who needs to be associated) => reactions against tax avoidance based on the use of hybrid mechanisms (entities or financial instruments) => Cf. definitions in art. 2, § 4; § 9, 10 and 11 No concept of solving ‘mismatches’, but avoiding ‘abuse of mismatches’ to avoid taxation 16
3 8 MISMATCHES IN ENTITY QUALIFICATION Hybrid entity: receiving income paying expenses internal income flow to the entity internal income flow to the “shareholder”/partner/… Reverse hybrid entity: receiving income paying expenses internal income flow to the entity internal income flow to the “shareholder”/partner/… 17
3 Hybrid entity: receiving income S P: NT R: T Entity Taxable income If state P: NT and state R: T Hybrid entity => state P taxes income at the level of the entity => (Partnership report: state R has to avoid double taxation through the correct application of the treaty P-R, because state P taxes the income in accordance with the terms of the convention P-R (as interpreted by state P)) BEPS and ATAD: ‘dual inclusion income’ ? ? ? Case not dealt with
3 Hybrid entity: paying expenses S Receiver of interest P: NT R: T Entity Intrest payment If state P: NT and state R: T Hybrid entity => states P and R deduct the interest payment from the taxable income => it is a DD in case the deduction is not against dual inclusion income negative result (primary attribution to di-income) from the payment, but if income is linked with entity in P, but not with partner in R or with partner in R, but not with entity in P
3 Hybrid entity: paying expenses S Receiver of interest P: NT R: T Entity Intrest payment Art. 9, § 1 Directive: (a) Refuse ‘excess’ deduction in Member State that is the investor jurisdiction (b) Refuse ‘excess’ deduction in EU-Member State of the payer jurisdiction, where the deduction is not denied in the investor jurisdiction
3 Hybrid entity: internal income flow to the entity S P: NT R: T Entity If state P: NT and state R: T Hybrid entity => state P taxes income at the level of the entity => state R does not recognize the payment BEPS and ATAD: inclusion without deduction ? ? ? Case not dealt with BUT supposing partners and entity are linked: situation can be avoided
3 Hybrid entity: internal income flow to the shareholder/partner S P: NT R: T Entity If state P: NT and state R: T Hybrid entity => state P deducts payment at the level of the entity => state R does not recognize the payment D/NI in case the deduction is not against dual inclusion income linked with entity in P, but not with partner in R Directive: “hybrid mismatch results in a deduction without inclusion“ is tax transparent according to P (and not according to R) -group tax regime (S and P) according to P - … other possibilities ? Additional linked income in P -entity in S
3 Hybrid entity: internal income flow to the shareholder/partner S P: NT R: T Entity Art. 9, § 2 Directive: (a) Deny ‘excess’ deduction (b) Include in income of EU-Member State, that is the payee jurisdiction
3 Reverse hybrid entity: receiving income S Payer of interest P: T R: NT Entity Taxable income If state P: T and state R: NT Reverse Hybrid entity => state P taxes income at level of the partners (unless entity is PE in state P) => state R taxes income at level of entity no taxation: Deduction and no inclusion ? (Partnership-report: R no longer has to exempt income, based on treaty ? ? ? ) BEPS and ATAD: Art. 9, § 2 Directive, depending on source of payment
3 Reverse hybrid entity: receiving income S Payer of interest P: T R: NT Entity Taxable income Art. 9, § 2 Directive: (a) Deny deduction (b) Include in income of EU-Member State that is the payee jurisdiction (What is the “payee jurisdiction” ? ? ? P or R)
3 Reverse hybrid entity: paying expenses S Receiver of interest P: T R: NT Entity Intrest payment If state P: T and state R: NT Reverse hybrid entity => neither state P, neither R deduct the interest payment from the taxable income (unless entity is a PE of the partners in state P) => it is an inclusion / no deduction not dealt with
3 Reverse hybrid entity: internal income flow to the entity S P: T R: NT Entity If state P: T and state R: NT Reverse hybrid entity => state P doesn’t tax income at the level of the entity => state R does recognize the deductible payment D/NI => art. 9, § 2 Directive
3 Reverse hybrid entity: internal income flow to the entity S P: T R: NT Entity Art. 9, § 2 Directive: (a) Deny deduction (b) Include in income in the EU-Member State of the payee jurisdiction, (BUT how to include in case of a lacking PE ? ? ? )
3 Reverse hybrid entity: internal income flow to the shareholder/partner S P: T R: NT Entity If state P: T and state R: NT Reverse hybrid entity => state P doesn’t deduct payment at the level of the entity => state R does recognize the payment as taxable income Inclusion, without deduction => not dealt with
3 GENERAL SUMMARY ‘External’ payment to entity ‘External’ payment from entity ‘Internal’ payment to entity ‘Internal’ payment from entity Hybrid entity Reverse hybrid entity Not foreseen D/NI (art. 9, § 2), but which payee jurisdiction ? ? Not foreseen DD (art. 9, § 1) Not foreseen D/NI (art. 9, § 2), but how in case of no tax payer? ? Not foreseen 30
4 IMPORTING MISMATCH (D/D) FROM THIRD COUNTRIES External D/D Conflict: Resident of member state provides the non-dual inclusion income against which the deduction is realised => (1) Primary rule: deny deduction in state of investor jurisdiction (2) Defensive rule: deny deduction in state of payer jurisdiction (3) Extra additional rule: deny deduction in Member State funding the non-dual inclusion income (art. 9, § 3 Dir. ) 31
4 Hybrid entity: paying expenses S Receiver of interest P: NT R: T Entity Intrest payment If state P: NT and state R: T Hybrid entity => states P and R deduct the interest payment from the taxable income => it is a DD in case the deduction is not against dual inclusion income negative result (primary attribution to di-income) from the payment, but some income is linked with entity in P, but not with partner in R or with partner in R, but not with entity in P
4 Hybrid entity: paying expenses S Receiver of interest Art. 9, 1, (b): Refuse ‘excess’ deduction (2) P: NT Entity 1 R: Art. 9, 1, (a): Refuse ‘excess’ T deduction (1) Intrest payment Entity 2 According to P income of 2 is attributed to Entity 1, but not according to R (Non dual inclusion income) EU financing entity Art. 9, 3: Refuse deduction of payment (option 3)
4 IMPORTING MISMATCH (D/NI) FROM THIRD COUNTRIES External D/NI Conflict: Resident of member state provides the income against which the deduction is realised => Primary rule: refuse ‘excess’ deduction Defensive rule: include in taxable income of receiver Extra additional rule: refusing deduction in Member State paying the non-dual inclusion income (art. 9, § 5 Dir. ) “unless one of the third countries involved has already denied the deduction of the non-included payment” 34
4 Hybrid entity: internal income flow to the shareholder/partner S P: NT R: T Entity 1. Refuse ‘excess’ deduction 2. Include in taxable income If state P: NT and state R: T Hybrid entity => state P deducts payment at the level of the entity => state R does not recognize the payment Causes a D/NI conflict if deduction is against non dual inclusion income
3 Hybrid entity: internal income flow to the shareholder/partner S Receiver of interest 1. Refuse ‘excess’ deduction P: NT R: T 2. Include in taxable income Entity 1 Entity 2 According to P income of 2 is attributed to Entity 1, but not according to R (Non dual inclusion income) EU financing entity 3. Refuse deduction of payment Art. 9, § 3 Dir
4 -Integration of a D/NI-conflict: refuse deduction in Member state “except to the extent that one of the jurisdictions involved has made an equivalent adjustment in respect of such hybrid mismatch” BUT: primary rule: refusing deduction in payer jurisdiction defensive rule: including income in tax base of payee jurisdiction extra additional rule: deny the deduction for payment funding the expenditure (art. 9, § 3 Dir) 37
5 CONCLUSION: HYBRID ENTITIES -8 basic conflicts in mismatches P/R => only dealing with 4 cases, focusing on the fight against tax avoidance, based on 2 possible conflicts (DD and D/NI) -extension of solutions for ‘imported mismatches’ => entity of Member state provides the funding against which a deduction is applied: refusing deduction as a 3 th solution => Exciting to follow up how it will be implemented !! 38
Any questions / commentaries ? Thank you for your attention !!
Prof. dr. Bart Peeters DEPARTMENT OF TAX LAW RE 21 E T bart. peeters@ugent. be +32 9 264 84 70 www. ugent. be Ghent University @ugent Ghent University
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