INTM557075 - Hybrids: hybrid entity double deduction mismatches (Chapter 9): counteraction - hybrid entity

The counteraction where a hybrid entity is within the charge to UK corporation tax is set out at s259IC.

The section applies where it is reasonable to suppose that either

• no equivalent provision applies in the investor jurisdiction to counteract the double deduction in the investor jurisdiction, or
• such a provision does apply, but the hybrid entity double deduction amount exceeds the amount that is prevented or counteracted under those provisions. That is, an element of the double deduction as quantified at s259IA has not been counteracted, and in addition
• either the hybrid entity and any investor are in the same control group at any time in their deduction periods, or they are party to a structured arrangement

Where this section applies, the amount of the hybrid entity double deduction (after adjusting for any illegitimate overseas deduction) can be utilised by the hybrid entity only to the extent that it is set against dual inclusion income or 259ID income of the hybrid entity deduction period.

Where the amount deducted by the hybrid entity exceeds the dual inclusion income and 259ID income in the period, the excess may be carried forward to use against dual inclusion income (see below for definition) of the hybrid entity in future accounting periods.

Illegitimate overseas deduction

The amount of the double deduction allowed to the hybrid entity is reduced by the amount of any illegitimate overseas deduction.

An illegitimate overseas deduction arises where it is reasonable to suppose that all or part of the hybrid entity double deduction amount is, in substance

• deducted under the law of a territory outside the UK
• from the income of any person (other than the investor, with effect from 10 June 2021) for a taxable period, and
• the income from which it is deducted is not dual inclusion income of the hybrid entity for an accounting period

This may occur, for example, where the double deduction creates a loss for an investor in the hybrid entity, and that loss is surrendered under a group relief regime.

The illegitimate overseas deduction is treated as if it had already been allowed in a previous accounting period. It will not form part of any unused hybrid entity double deduction amount carried forward.

Permitted taxable period

A taxable period of an investor is a permitted taxable period if it

• begins at any time before the end of 12 months after the end of the accounting period within which the amount is deducted by the hybrid entity, or
• begins in a later period if a claim is made, and it is just and reasonable that the ordinary income arises in that period instead of the earlier period

Dual inclusion income

Dual inclusion income is the amount of income arising during an accounting period to the hybrid entity, where that income is ordinary income of both

• the hybrid entity for that accounting period, and
• an investor in the hybrid entity for a permitted taxable period for the purposes of any tax charged in the investor jurisdiction

Ordinary income means income that is brought into account when calculating taxable profits on which tax is charged. The full definition (including restrictions on what may be regarded as ordinary income and where specific reliefs may be treated as reducing the amount of ordinary income) is at s259BC and the concept is discussed further at INTM550560.

There are special recognition rules at s259BD in instances of non-inclusion in ordinary income for treating an amount of income as if it had been included where it has been subjected to another territory’s controlled foreign companies (CFC) charge. This is discussed at INTM550570.

Deemed Dual Inclusion Income

The definition of Dual Inclusion Income above was expanded by the Finance Act 2021 with the introduction of rules in section 259ICA TIOPA 2010 deeming certain types of income to have the characteristics which would cause them to be dual inclusion income for the purposes of ch.9.Companies had until 31 December 2021 to elect to deem that these rules had retrospective effect 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 (in the second bullet above) for dual inclusion income can also be satisfied if rather than being ordinary income of the investor, 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 Chapter 9 when the hybrid entity is within the charge to Corporation Tax, can be set against this income in the same way as they can be set against normal dual inclusion income.

It is possible for an amount to qualify as deemed dual inclusion income if it would have been deductible for the investor if certain assumptions were made. These are that under the laws of the investor jurisdiction, the hybrid entity was not in fact seen as a hybrid entity, because either the income or profits of the entity would not be treated as its income or profits, or it would not be regarded as a distinct or separate entity. This ensures that deemed DII only results where the inclusion/no deduction mismatch arises due to hybridity and not the nature of the payment.

The position of persons resident for tax purposes in zero tax territories (where the person is either not chargeable to tax or chargeable to tax at a nil rate) must be considered. The position of all persons who could be potentially entitled to a deduction (for example, both a partnership and, if that is seen as transparent, the partners) must be considered. If the amount could not have been deducted in calculating the profits of the person(s) had they been resident in the UK, then that payment is capable of meeting the non-deduction test and so qualifying as dual inclusion income.

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 by person A to UK resident, hybrid entity person B. The payment is ordinary income of person B (the hybrid entity), so the condition at s259IC(10)(a) is met. If A is resident for tax purposes in a zero-tax territory, then we must consider whether they would be entitled to a deduction for the payment had they been resident in the UK and chargeable to Corporation Tax. If A was a partnership, then they would not be entitled to a deduction had they been resident in the UK as partnerships are not subject to corporation tax in the UK. Here testing the position of the person for UK Corporation Tax purposes does not change the characteristics of the person; we do not for example assume the partnership becomes a corporate body because the test assumes the person is resident in the UK for tax purposes. Therefore, the involvement of person A would not prevent the conditions for deemed dual inclusion income being met in this example.

However, if A in this example had a corporate partner, also resident in a zero-tax jurisdiction, then we would also test whether that partner would be entitled to a deduction had they been resident in the UK for Corporation Tax purposes. As a corporate body they would have, so to the extent that partner would be entitled to a deduction (had they been resident in the UK for CT purposes) for the payment to UK person B, then the conditions for deemed dual inclusion income would not be met.

In applying the conditions to a transparent entity in a non zero-tax jurisdiction, the fact that the entity is seen as transparent, and so itself is not recognised as a taxable entity its home jurisdiction, does not mean that it should be considered resident for tax purposes in a zero-tax territory. For example, a Limited Liability Corporation (LLC) in the US, that has not been subject to an election that treats it as opaque for US tax purposes, and so is seen as transparent and not subject to US Federal Corporate Income Tax, will not be seen as resident in a zero-tax territory for these purposes. So, the fact that the LLC would be entitled to a deduction for expenses for the purpose of Corporation Tax, were it resident in the UK, does not cause the test here to be failed.

Section 259ID income

S259ID was introduced in Finance Bill 2018, but repealed in Finance Bill 2021, where it was effectively superseded by the rules on deemed dual inclusion income. If an election is made by a taxpayer to deem the dual inclusion rules to have been in place in relation to it since the introduction of the hybrid’s rules, then s259ID will similarly be disapplied with retrospective effect in relation to that taxpayer. However, if no claim is made to deem the changes to apply retrospectively, s259ID will still be relevant until commencement of the relevant provisions of Finance Act 2021.

S259ID applies where the hybrid entity is within the charge to corporation tax, the restricted deduction exceeds the dual inclusion income of the hybrid entity (if there is any) and four conditions, A to D are met.

The conditions are

• Condition A: the investor in the hybrid entity makes a payment to the hybrid entity, and no amount is deductible, under the law of the investor jurisdiction, from the income of the investor in respect of the payment.
• Within this section ‘payment’ takes its ordinary meaning and not that as defined at 259BB
• Condition B: as a result of the payment, an amount of ordinary income arises to the hybrid entity for the hybrid entity deduction period.
• Condition C: the payment, made by the investor to the hybrid entity, is made in direct consequence of a payment made to the same investor by an unrelated person to either the investor or the hybrid entity.
• Section 259NC defines related person.
• The phrase ‘in direct consequence’ is not defined and takes its ordinary meaning, that is an effect that is a result of an event or occurrence suggesting something that follows on, and/or there is a prescribed order to the events.
• Condition D: as a result of the payment made by the unrelated party, an amount of ordinary income arises to the same investor that makes the payment to the hybrid entity referred to in condition A.

Note that the legislation refers specifically to ‘the’ investor and should not be interpreted more widely to include ‘any’ investor.