(Draft) explanatory memorandum
Updated 8 November 2022
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This publication is available at https://www.gov.uk/government/consultations/draft-regulations-amendment-to-the-hybrid-and-other-mismatches-rules-to-retain-an-exemption-for-certain-hybrid-instruments-issued-by-banks/draft-explanatory-memorandum
1. Introduction
This explanatory memorandum has been prepared by Her Majesty’s Commissioners for Revenue and Customs (HMRC) on behalf of Her Majesty’s Treasury and is laid before the House of Commons by Command of Her Majesty.
2. Purpose of the instrument
These regulations will retain an exemption in the hybrid and other mismatches rules in section 259N(3)(b) of the Taxation (International and Other Provisions) Act 2010 (TIOPA 2010) and the Hybrid and Other Mismatches (Financial Instruments: Excluded Instruments) Regulations 2019 (SI 2019/1345) for certain regulatory capital instruments issued by banks.
This exemption will otherwise fall away after 31 December 2022 due to a ‘sunset clause’ in SI 2019/1345. These regulations will remove the sunset clause using existing negative regulation-making powers so that the exemption continues to apply after 31 December 2022.
3. Matters of special interest to Parliament
Matters of special interest to the Select Committee on Statutory Instruments
None.
4. Extent and territorial application
The territorial extent of this instrument is the United Kingdom (UK).
The territorial application of this instrument is the UK.
5. European Convention on Human Rights
As the instrument is subject to negative resolution procedure and does not amend primary legislation no statement is required.
6. Legislative context
Upon introduction in 2016, the UK’s hybrid and other mismatches rules provided an exemption for financial instruments that were regulatory capital securities for the purposes of the Taxation of Regulatory Capital Securities Regulations 2013 (SI 2013/3209).
Following the repeal of SI 2013/3209, Finance Act 2019 introduced a power (section 259N(3)(b) TIOPA 2010) to amend the hybrid and other mismatches rules by secondary legislation. This regulation-making power was used when the Hybrid and Other Mismatches (Financial Instrument: Exclusions) Regulations 2019 (SI 2019/1251) were laid in September 2019 with effect from 1 January 2019.
It was necessary to repeal and replace these regulations with effect from 1 January 2020 in order to give effect to amendments to the European Union’s Anti-Tax Avoidance Directive (ATAD). These amendments required the scope of the hybrid and other mismatches exemption to be limited to certain regulatory capital issued by the banking sector only, and for its duration to be limited. These requirements applied from 1 January 2020, and European Union (EU) Member States (including the UK at that point) were not able to apply any exemption after 31 December 2022.
The current ATAD-based exemption is contained in SI 2019/1345 and has effect from 1 January 2020 until 31 December 2022.
This amending instrument is made using the powers contained within section 259N of TIOPA 2010 to remove the time limitation, so that the exemption continues to apply from 1 January 2023.
7. Policy background
What is being done and why?
The hybrid and other mismatches rules in Part 6A of TIOPA 2010 are an anti-avoidance regime that seeks to counteract mismatches in tax treatment of instruments and structures across jurisdictions. Banks issue regulatory capital instruments that as a result of regulatory requirements may include some ‘hybrid’ features, meaning that they have some equity-like as well as debt-like characteristics. This may mean there is a mismatch in tax treatment across jurisdictions.
The UK’s general approach is that interest paid on regulatory capital instruments should be deductible, on the basis that the hybrid features are regulatory requirements which provide stability for the financial sector and for the entire UK economy.
The exemption from the hybrid and other mismatches legislation supports this policy by allowing a deduction for interest paid on these instruments. It was not intended that this treatment should be displaced by the hybrid and other mismatches rules. This position is supported by the Organisation for Economic Co-operation and Development’s Base Erosion and Profit Shifting (BEPS) Project recommendations, which give countries freedom in their policy choices as to whether their hybrid and other mismatches rules should be applied to tax mismatches that arise on intra-group hybrid regulatory capital.
There is currently an exemption from the hybrid and other mismatches rules for certain regulatory capital instruments. However, this will fall away on 31 December 2022 due to a sunset clause in the current regulations required by an EU directive. If the sunset clause is not removed the resulting change in tax treatment from 1 January 2023 could affect certain banks’ regulatory capital instruments. The UK is no longer obliged to comply with the EU Directive requiring the sunset clause now that it has left the EU.
These amending regulations will therefore remove the sunset clause ensuring the existing exemption continues to apply after 31 December 2022.
8. European Union withdrawal and future relationship
This instrument does not relate to withdrawal from the European Union.
9. Consolidation
There are no plans to consolidate the legislation.
10. Consultation outcome
[Outcome of the consultation will be inserted.]
11. Guidance
HMRC’s International Manual explains this exemption at INTM551060.
The guidance will be updated when the instrument comes into force.
12. Impact
The impact on business, charities or voluntary bodies is limited to a small number of banks. These regulations simply ensure that the existing exemption for these hybrid regulatory capital instruments continues to apply after 31 December 2022. Businesses impacted by this change will incur insignificant one-off costs of familiarisation with the amendment. There are not expected to be any continuing costs to those businesses from the amendment.
There is no, or no significant, impact on the public sector.
A tax information and impact note covering this instrument will be published.
13. Regulating small business
The legislation does not apply to activities that are undertaken by small businesses.
14. Monitoring and review
HMRC will monitor the impact of the regulations through information collected on tax returns and through communications with affected taxpayer groups.
The regulations do not include a statutory review clause. They amend United Kingdom tax legislation and therefore fall within the exceptions at section 28(3)(a) of the Small Business, Enterprise and Employment Act 2015.
Contact
If you have any queries regarding the instrument, please contact Samuel Louks or Andrew Martel at financialservicesbai@hmrc.gov.uk.
Richard Thomas, Deputy Director for Financial Products and Services, at Her Majesty’s Revenue and Customs can confirm that this explanatory memorandum meets the required standard.
[Name of Minister] at the [name of department] can confirm that this explanatory memorandum meets the required standard.