INTM550020 - Hybrids: introduction: what is a hybrid or other mismatch

Part 6A of Taxation (International and Other Provisions) Act 2010 (TIOPA 2010) addresses arrangements that give rise to hybrid mismatch outcomes leading to a tax mismatch.

The legislation is based on the Organisation for Economic Co-operation and Development (OECD) recommendations in relation to Action 2 of the Base Erosion Profit Shifting (BEPS) project. The legislation is deliberately broader in scope than the OECD recommendations in some areas. Consequently, outcomes under this legislation may differ from those under the OECD recommendations.

For example, the UK’s hybrid mismatch legislation includes

• rules to deal with mismatches involving permanent establishments, and
• rules that counter hybrid mismatches where a hybrid entity is in a territory with no corporate income tax

Mismatches can involve either double deductions for the same expense, or deductions for an expense without the corresponding receipt being fully taxed.

Hybrid mismatch outcomes can arise from hybrid financial instruments and hybrid entities, and from arrangements involving permanent establishments. They can also arise from hybrid transfers and dual resident companies.

The legislation aims to neutralise the tax mismatch created under these arrangements by altering the tax treatment of either the deduction or the receipt, depending on the circumstances. The rules are designed to work whether both the countries affected by a cross-border arrangement have introduced rules based on the OECD recommendations, or just the UK.

This legislation follows the OECD recommendations in providing alternative responses to mismatches which fall within the scope of the legislation. These are described as a ‘primary response’ and a ‘secondary response’.

In the case of deduction/non-inclusion, the primary response is generally to deny a deduction to the payer. If this does not occur, the secondary defensive response is to bring the receipt into charge for the payee.

In the case of double deductions, the primary response is to deny a deduction to the parent or investor company. If this does not occur (because the tax law in the country in which the parent or investor company is resident does not provide for this), the secondary response is to deny the deduction to the hybrid entity or permanent establishment, as appropriate.