INTM557030 - Hybrids: hybrid entity double deduction mismatches (Chapter 9): conditions to be satisfied: condition A

Condition A of s259IA is met if it is reasonable to suppose that an amount, or part of an amount, could be deducted by both a hybrid entity and an investor in that entity, in a taxable period. Because the condition refers to amounts that it is reasonable to suppose could be deducted for a taxable period, it can be met even when one part of the deduction is computed in a different way or is taken in a different period.

Hybrid entity

A hybrid entity is defined at s259BE.

Whether an entity has the relevant characteristics to be treated as a ‘hybrid entity’ is discussed in more depth at INTM550580. Generally, an entity may be treated as having those characteristics if it is regarded as a person for tax purposes under the law of any territory, and

  • its income or profits are treated wholly or partly as the income or profits of another person, or
  • it is not regarded as a separate person for tax purposes under the law of another territory

Investor and Investor Jurisdiction

An investor is defined at s259BE(4).

If an entity 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.

If an entity is a hybrid entity because it is treated as a person in one territory but is not recognised as a separate and different person under the law of another territory, an investor is any entity that is

  • recognised in the first territory as a separate and distinct person to the hybrid entity, but
  • not recognised in the other territory as a separate and distinct person to the hybrid entity

An investor jurisdiction is any territory in which an investor is within the charge to a tax.

A hybrid entity may have multiple investors.

It is possible that not all investors will have an investor jurisdiction.

Reasonable to suppose

There is no definition of the term reasonable to suppose in Part 6A, so the phrase takes its ordinary meaning. Generally, this does not require either party to know how the transaction has been treated by the counterparty but only that, given the facts and circumstances, it would be reasonable to conclude that a double deduction will arise.

US Dual Consolidated Loss (DCL) rules

The dual consolidated loss provisions of the US Internal Revenue Code (IRC) and regulations are intended to prevent an entity from using a loss to offset income of a domestic affiliate in the US while using the same loss to offset income of a foreign affiliate which is not subject to US tax. The DCL rules are not ‘equivalent’ to the rules in Part 6A TIOPA 2010, because they were enacted before the OECD BEPS Action 2 report was published and so do not satisfy the requirement to be ‘based on’ those rules in s.259BA(2)(b) TIOPA 2010. They are however in some respects similar in their impact. When considering Condition A they may therefore be relevant.

Where an expense could be deducted in both the US and the UK, then Condition A will ordinarily be met. However, if the deduction in the UK is utilised against single inclusion income, it should be disallowed in that period in the US under the DCL rules, which would mean condition A is not met. We therefore accept that the UK deduction can be set against single inclusion income as long as the consequence of that is that the equivalent US deduction is denied. If on the other hand the deduction in the UK is utilised against DII only, there should be no counteraction in the US, meaning Condition A is met. But the resulting counteraction is of no consequence since by definition the UK relief is being used to shelter dual inclusion income.

The DCL rules do though contain provision for a Dual Use Election (DUE). Whereas normally under the DCL rules a deduction that is denied in a period is carried forward to use against DII in the future, if a DUE is made the loss can be utilised to offset any income in the US, including non DII income. When a DUE is made, condition A will be met in all circumstances and so a counteraction will arise if the other conditions are met.

Consider the following example. A US parent company has two UK subsidiaries, UK1, which is subject to a check the box election and is disregarded for US tax purposes, and UK 2 which is not checked open for US tax purposes and so is recognised as an opaque entity. UK1 has income of 20 and expenses of 120, so makes a loss of 100. As this chapter explains, ordinarily Chapter 9 would operate to restrict the use of the deduction of 120 that is also deductible in the US. However, if the US DCL rules deny the use of the loss in that period and restrict the use of it to set against DII in future APs, then condition A is not met in respect of the 100. However, if a DUE is made and the 100 is utilised by the US parent company, then condition A will be met.