28 November 2017
On Friday 24 November, Treasury released draft text for the promised anti-hybrid rules. The Exposure Draft (ED) sets out two distinct measures:
* a rule limiting the exemption for non-portfolio distributions received by an Australian company and another limiting imputation benefits for Australian shareholders. These rules are examined in a separate Riposte; and
* a suite of dedicated anti-hybrid rules modelled on the OECD/G20 recommendations published in October 2015.
This Riposte summarises some of the highlights of the second measure - the anti-hybrid package. Our more detailed Tax Brief on these rules will be published shortly.
Although the text of the ED runs to 45 pages, there are just three operative provisions:
* a rule which denies an allowable deduction (or the consequences of a deduction) in 5 situations;
* a rule which adds an amount into assessable income in 2 situations; and
* a rule which can reverse the impact of a denied deduction by reinstating it in a later year if circumstances subsequently change.
The rest of the ED consists of preconditions, qualifications, exceptions, quantifications, rules fitting the anti-hybrid regime alongside other regimes (such as consolidation and TOFA), rules switching the regime on and off depending on the activities of other countries, ordering rules where multiple anti-hybrid rules might all apply, handling different Australian and foreign tax years, and pages of definitions.
But while their impact can be described quite simply, defining the precise scope of the anti-hybrid provisions and the circumstances in which they will be triggered requires a very slow and exacting journey through many pages of legislation. It is a legislative maze. And it would be wrong to view this regime as a general rule against all hybrid outcomes; it is better seen as a targeted regime against cross-border (i) debt-equity mismatches and (ii) taxable-transparent entity mismatches.
The offending situations
The operative rules can be enlivened in six separate types of transaction:
1. a financial instrument (that is debt, equity, a derivative or a repo or securities lending arrangement over one of them) produces a deduction/non-inclusion outcome.
2. the transfer of one of those instruments produces a deduction/non-inclusion outcome (typically because one country sees a sale and purchase while the other country sees borrowing with security).
3. a payment to an entity that exists for the law of the paying country but does not exist for the tax law of the recipient country, resulting in a deduction/non-inclusion outcome (typically, there is a disagreement between the paying country and the recipient country).
4. a payment to a recipient that is transparent in the place where it is formed, but exists so far as the country of residence of the investors is concerned, resulting in a deduction/non-inclusion outcome (typically, there is a disagreement between the recipient country and investor's country).
5. a payment by an entity where two countries will allow a deduction for the same payment resulting in a double deduction outcome (typically, two countries include the paying company within their tax system, e.g. a dual resident payer or a company that is included in two corporate groups).
6. a structure where the impact of one of the above (deduction/non-inclusion or double deduction) is "imported" into Australia by some other transaction. This is potentially a very difficult area to monitor since the treatment of the Australian entity will depend on the hybrid features of transactions to which it is not a party. For this reason the Board of Taxation had recommended that this rule not be adopted yet, but the Government has decided to include the rule.
Most of the detail in the legislation lies in the definitions of these six situations.
Some preliminary observations
There are situations where the anti-hybrid rules are enlivened because of the hybrid features of a financial instrument and situations where a hybrid entity can enliven the rules. This should mean that taxpayers do not need to be concerned about transactions that do not involve financing and do not involve entities where countries disagree on their tax status.
Transactions must involve related parties (set at 25% common ownership), members of the same control group (consolidated for accounting or 50% common ownership) or the taxpayer is a party to a situation referred to as a structured arrangement (an instrument which has been designed or priced based on the hybrid features), depending on the situation. This should mean that taxpayers need not be concerned about ordinary transactions with unrelated entities just because they happen to produce hybrid outcomes.
The rules are only triggered by transactions - the making of a "payment", the incurring of a loss or the provision of a non-cash benefit. This should mean that taxpayers need not be concerned about inconsistent outcomes which arise, say, where the tax law of a country creates a purely fictional deduction without a cash-flow.
The rules are only enlivened by either a deduction/non-inclusion outcome or where two entities are claiming the benefit of the same deduction. Other kinds of hybrid outcomes are not affected. There is a lot of detail in the rules determining when an amount is viewed as included in income, whether inclusion in income that receives concessional treatment will suffice, and so on. For example, an amount may be sufficiently "included" in income if it will be included in income and within three years.
And not all deduction/non-inclusion outcomes are impugned; only those where that outcome is "attributable to..." the hybrid features of the instrument - i.e. the disagreement as to classification as debt, equity or derivative between the two countries.
Since the triggering and impacts of these rules depend on tax effects occurring under foreign law, one difficult aspect of these rules is going to be monitoring the laws of other countries. Sometimes, however, the legislation adopts a lesser standard than reality: Australian tax consequences will be triggered if the foreign law "is expected to..." result in a particular outcome. In other cases the test is stricter: the payment must "give rise to..." the hybrid outcome.
Treasury is inviting submissions on the Exposure Draft. Submissions are due by 22 December.