INTM553100 - Hybrids: hybrid payer (Chapter 5): counteraction - hybrid payer
The counteraction where the hybrid payer is within the charge to UK corporation tax is set out at s259EC TIOPA 2010.
The counteraction is to restrict use of the relevant deduction to the sheltering of dual inclusion income. If the hybrid payer has insufficient dual inclusion income in the period of the deduction to fully utilise it, the remainder of the restricted deduction may be carried forward and set against dual inclusion income in future periods.
Dual inclusion income
Dual inclusion income for s259EC means an amount that is ordinary income of both
- the hybrid payer for the relevant payment period, and
- an investor in the hybrid payer for a permitted taxable period for the purposes of any tax charged in the investor jurisdiction
An investor is defined at s259BE
- If the payer is a hybrid entity because its income or profits are treated as the income or profits of another person, an investor is any person who is treated as having that income, or
- If the payer is a hybrid entity because it is treated as a distinct and separate person in one territory but as part of another person in another territory, then the investor is the person in that other territory
A permitted taxable period of an investor is a taxable period of that investor which
- begins at any time before the end of 12 months after the end of the accounting period within which the relevant deduction is claimed by the hybrid payer, or
- where the period begins after that
- a claim has been made for the period to be a permitted period in relation to the amount of ordinary income, and
- it is just and reasonable that the ordinary income arises in that period instead of the earlier period
If there is additional dual inclusion income in a later period any such claim to extend the permitted period should precede or accompany the Corporation Tax return and self-assessment to which it related and be within the normal assessing time limits.
Deemed Dual Inclusion Income
The types of income which could be treated as Dual Inclusion Income as described above were increased by the Finance Act 2021 with the introduction of rules in s259EC(6) to (11). These rules deem certain types of income to have the characteristics which would cause them to be fall within the definition of dual inclusion income in s259EC. Companies had until 31 December 2021 to elect to deem that these rules had retrospective effect in relation to their affairs and so would be deemed to have always been in place since the hybrid’s rules came into effect on 1 January 2017. We refer to income within these provisions as ‘deemed dual inclusion income’.
The deemed dual inclusion income rules operate such that the second limb of the test for dual inclusion income (that is, that the amount is ordinary income of the investor in the hybrid entity for the purposes of tax charged in the investor jurisdiction) can also be satisfied in certain circumstances if there is an amount that is not deductible, under the law of any territory, in calculating taxable profits but which is taxable in the hands of the hybrid payer. This means that deductions subject to a counteraction under s259EC can be set against this income in the same way as they can be set against normal dual inclusion income.
The requirements for an amount to be deemed to be income of an investor (and so meet the criteria of dual inclusion income) are set out in s.259ED(7). The purpose behind these requirements is to limit the treatment to amounts which are not deductible for the payer but taxable for the recipient, in cases where that disadvantageous outcome arises due to the hybridity of the recipient.
First, the amount must not be deductible in any jurisdiction.
Secondly, where zero-tax jurisdictions are involved, the position must be tested on the assumption that entities resident in such jurisdictions were UK resident. If a deduction would then have resulted, the amount will not qualify for the favourable treatment. This is because in such a case the non-deduction/inclusion mismatch in respect of the amount should not be regarded as arising due to hybridity as opposed to the payer not being subject to tax at all.
In considering a person’s residence in a zero tax territory, section 259B(5) (determination of residence where no concept of residence for tax purposes exists) applies.
To illustrate how the requirement works for a person resident for tax purposes in a zero-tax territory, consider a payment being made to a UK hybrid entity A, by Person B.
The payment is assumed to give rise to ordinary income of A. If the payment is not deductible for tax purposes in any jurisdiction, then the requirements for being treated as deemed dual inclusion will prima facie be met.
However, if B is resident for tax purposes in a zero-tax territory, then we must consider whether it would be entitled to a deduction for the payment had they been resident in the UK. If B is a company, then this test is straightforward: if the payment would have been deductible for corporation tax purposes, no deemed dual inclusion income results.
If B is a partnership or other entity seen for UK tax purposes as transparent, the assumption of UK residence does not require the entity to be assumed to be opaque when the potential UK deducibility of the payment is tested. The residence assumption does not impact the legal character of the entity. Accordingly, it would inevitably be the case that no UK deduction would arise even if the transparent entity was assumed to be resident in the UK.
However, the legislation requires that no deduction be available anywhere in respect of the amount. So, if the payer of the amount is a partnership or similar entity, the possibility of deductions arising to its partners must also be considered. Where those partners are not resident in zero-tax jurisdictions, the application of the test is straightforward: to the extent any deductions arise, the amount cannot be treated as deemed dual inclusion income.
If any of those partners is resident in a zero-tax jurisdiction, the position must be tested on the assumption that that partner is UK resident.
We do not regard a US LLC which has not been checked closed as resident within a zero-tax territory for these purposes, and accordingly where an amount potentially within the rules arises in respect of a payment which is made by such an entity, it is not necessary to test whether the amount would have been deductible had the entity been UK resident.
The final requirement is that the amount would have been deductible in the investor jurisdiction if the entity recognising ordinary income had not been a hybrid. In testing the position assuming non-hybridity, the non-hybridity is only to be considered to the extent relevant to the question of who the recipient of the payment is. The limitation relating to the identity of the recipient prevents the legislation failing to apply in a case to which it should, as follows:
Assume a US parent owns a checked open UK subsidiary, which in turn owns a US LLC. The LLC makes a payment to the UK subsidiary. This payment would amount to ordinary income for the UK subsidiary, being income for CT purposes. It does not give rise to a US deduction because, due to the hybridity of the UK subsidiary and the US transparency of the LLC, it is treated as being made by the investor to itself and so is disregarded. If in applying the rules the position was tested on the basis that the UK subsidiary was not a hybrid for all purposes, no deduction would arise to the LLC because the payment could no longer be regarded as made by the investor. The limitation of the scope of the assumption relating to non-hybridity means that in the tested counterfactual situation a deduction would arise to the investor. Accordingly, the condition for the amount being deemed dual inclusion income would be met.
Example
The table below shows the position for each accounting period of a hybrid payer within the charge to tax in the UK.
| Accounting period | Relevant deduction | Mismatch amount | Restricted deduction | Dual inclusion income (DII) | Restricted deduction after DII | Restricted deduction c/f |
|---|---|---|---|---|---|---|
| 31/12/2017 | 300,000 | 200,000 | 200,000 | Nil | 200,000 | 200,000 |
| 31/12/2018 | 350,000 | 300,000 | 300,000 | 60,000 | 240,000 | 440,000 |
The relevant deduction of 350,000 in the accounting period ending 31/12/2018 has been met by 50,000 of ordinary income in a payee, and therefore the hybrid payer deduction/non-inclusion mismatch is 300,000. There is 60,000 of dual inclusion income in that period therefore 240,000 of the 300,000 mismatch amount will be restricted. As at 31/12/2018 this hybrid payer has accumulated unused restricted deductions of £440,000 to carry forward and deduct from dual inclusion income arising in later accounting periods.