INTM552120 - Hybrids: hybrid transfers (Chapter 4): conditions to be satisfied: condition D - case 2

Case 2 - under-taxed amounts

In case 2 mismatches, ordinary income does arise to the payee in respect of a hybrid transfer, but the income in question represents an under-taxed amount for a permitted taxable period.

As with Case 1, the amount must be under-taxed for one of the reasons set out in s259DC(7), that is, because

• the dual treatment condition is satisfied in respect of an arrangement under which a payment or quasi-payment is made, or
• the payment or quasi-payment is a substitute payment

If the amount of relevant under-taxed income would have been reduced had the arrangement not contained those relevant characteristics, then it will satisfy the requirements for a hybrid transfer deduction/non-inclusion mismatch.

Ordinary income is under-taxed if the highest rate at which the payee is taxed on such income is less than the payee’s full marginal rate, taking into account (on a just and reasonable basis) any credit for underlying tax on profits used wholly or partly to fund the payment.

This full marginal rate is the highest rate at which the taxpayer would be taxed on ordinary income arising from a financial instrument (s259DD(4)).

The ‘highest rate’ of tax referred to is the effective rate after taking into account underlying tax credit relief, assuming no other reliefs are also applied to that income.

For example, under a complex repo arrangement, the temporary holder of the share receives a taxable dividend payment in respect of which underlying tax credit relief can be claimed. That dividend, or rather the quasi-payment reflecting the financing return on the repo, of which the dividend forms a part, will be an under-taxed amount due to the underlying tax credit.