INTM550030 - Hybrids: introduction: examples of hybrid mismatches

Hybrid financial instrument

An example of a hybrid financial instrument is an instrument giving rise to a payment which the law of the payer jurisdiction treats as deductible interest, by recognising the instrument as a debt instrument, but which the payee jurisdiction recognises as an exempt dividend in the hands of the payee since it sees the instrument as an equity instrument. This would result in the payer getting a deduction, without the recipient being taxed on a receipt.

Hybrid entity

An example of a hybrid entity is a UK limited liability partnership (LLP) which is treated as transparent by one jurisdiction (the UK), but treated as opaque by another jurisdiction. The effect is that one jurisdiction applies its tax rules to the partnership, whilst the other looks through the partnership and applies its tax rules to the partners. In the case where a payment is made to an LLP with overseas members from a payer company, the UK would consider the receipt to be taxable on the LLP’s members in the overseas territory, but the overseas territory might consider the receipt to be taxable in the UK as it considers the LLP to be an opaque entity, with the consequence that the receipt would be untaxed in both territories. Permanent establishments can be used in a similar way to generate mismatches.

Hybrid transfer

An example of a hybrid transfer is where a person sells shares to another party on condition that the shares will be returned 12 months later, during which time a dividend is paid in respect of those shares to the transferee. In form, the ownership of the shares has transferred and therefore the transferee is treated as the beneficial owner of the dividend. In substance, however, the transferor has not actually sold the shares and therefore may be treated as the beneficial owner of the dividend. This asymmetry presents opportunities for obtaining a deduction/ non-inclusion mismatch.