INTM552200 - Hybrids: hybrid transfers (Chapter 4): the financial trader exclusion – conditions to be satisfied: condition C

Condition C is set out at s259DE(6). The condition is satisfied if both of the following apply

  • the return on the underlying security must not be one to which Chapter 3 of the UK hybrid and other mismatches provisions, nor an equivalent foreign provision, would apply. This counters the use of hybrid transfers as a means to avoid counteraction on the underlying instrument.
  • the hybrid transfer arrangement giving rise to the substitute payment is not a structured arrangement, see INTM552150

Part 6A and Equivalent Foreign Provision

The example in INTM552550 looks at the situation where equivalent foreign provisions to the UK hybrid and other mismatches provisions deny the financial trader exclusion. In this case we have L Co which is resident in country L which holds shares in I Co which is resident in country I. L Co lends the stock in I Co to U Co which is resident in the UK. U Co is a financial trader and it uses the borrowed stock as part of its trade to sell these shares short. (The repurchase price is expected to be less than the sale price allowing a profit on the transaction.)

In this example U Co, L Co and I Co are related parties. Country I allows a deduction for dividends paid. However, it also has equivalent hybrid and other mismatches provisions. These provisions act to deny a deduction for dividends paid in country I if the payment is made to a related party. This means that if a dividend were paid direct from I Co to L Co then the deduction in I Co would be denied.

In the example the dividend is paid from I Co to U Co followed by a substitute payment to L Co. Here the deduction from I Co is allowed. However, because the direct payment of the underlying return from I Co to L Co would trigger the equivalent foreign hybrids and mismatches provisions in Country I then under condition C the financial trader exclusion is not allowed. As shown in this example this satisfies the conditions for there to be a hybrid transfer deduction/non-inclusion mismatch and a counteraction is required.

Structured arrangements

The example in INTM552540 shows condition C is failed because the hybrid transfer arrangement giving rise to the substitute payment is a structured arrangement. This is because the transaction was structured giving rise to taxable benefits both to L Co and U Co and both the deductibility of the substitute payment paid by U Co and the non-taxation of the receipt of the substitute payment to L Co are critical to the design of the arrangement.