27 Mar

'Hybrid Mismatch Rules: International Tax Planning Just Got More Complicated' Gary Poon, Tax Partner, BDO

Individuals or businesses that work or have operations across multiple countries have always battled the risk of being taxed in more than one country which can increase the tax paid to unbearable levels.  Reducing double taxation and achieving a reasonable level of effective tax rate for individuals or business owners has been the task of tax advisors since taxation of income was introduced over 100 years ago in Australia.  With the introduction of the new ‘Hybrid Mismatch’ rules in Australia and in Britain, this task has become even more difficult

The legislation that introduced the Hybrid Mismatch rules seeks to eliminate the non-taxation of income brought about by an entity being treated differently under the laws of two or more countries. This difference in treatment is referred to as a ‘hybrid mismatch’ and the application of these rules may mean that you will have to pay more tax. The expectation of the Australian government is that there will be significant gain in tax revenue as a result of the implication of the new laws. The new legislation received royal assent on 24 August 2018 and is applicable for income years starting on or after 1 January 2019.

Australia – UK connection

The new rules could be applicable to many types of entities including limited liability partnerships, Australian/UK entities with UK/Australian branches, and Australian/UK parent entities with UK/Australian subsidiaries. These example are by no means exhaustive, and there are also specific rules that deal with hybrid financial instruments.

Following the OECD

The new laws are based on OECD recommendations initially released in September 2014. The UK has also introduced new hybrid mismatch rules largely based on the OECD recommendations. Many EU member states and other countries around the world have introduced, or will very soon introduce hybrid mismatch rules based, at least in part, on the OECD recommendations.

No Threshold

In recent times there has been considerable scrutiny placed on the payment, or non-payment of income tax by large multinational corporations in Australia. This has meant that the focus has been predominantly on those entities with income in excess of AUD1 billion. Interestingly, the new hybrid mismatch rules do not contain a de minimis threshold. This means that taxpayers of all income levels, even individuals, may need to consider if the new rules apply to their particular situation.

This rather unfortunate position means that all taxpayers that perform work, have investment properties or have business operations in more than one country could be affected by these rules. Tax agents, whether they are advising a large corporate, or are a local tax agent that is helping an individual (e.g. who has recently arrived in Australia, have a foreign investment property or who has worked overseas for a short period of time) will need to be across these rules to effectively advise their clients.

 

So What’s the Problem?

Most countries have tax laws which enables the taxpayer to obtain a tax credit for tax paid overseas or for income that is taxed overseas to be exempt from tax in the home country.  This is great in theory and generally works for individuals, but for companies it can still lead to a higher level of taxation in the hands of the ultimate shareholder.  For example, if the overseas income is first taxed in a legal structure, such as a company, the subsequent dividend could be further taxed in the hands of the shareholder, resulting in an effective tax rate that is higher than if the business operated domestically only.  

Tax advisors have assisted individuals and businesses to solve or reduce the impact of this problem when working or operating abroad by utilising financial instruments or legal structures which have assisted in lowering the global effective tax rate to a level that is closer to the domestic tax rate.

The problem with these tax planning arrangements, is that by virtue of trying not to pay tax twice on the same economic gain, either the home country or the overseas country could lose out on tax collected.  The hybrid mismatch rules seek to correct this outcome by increasing the tax liability of the business or individual in one country.  At a helicopter level, two scenarios can arise which can attract the application of these ‘Hybrid Mismatch’ rules being the following:

  • an individual payment (e.g. expense) results in a tax deduction being available in more than one country, or  
  • an individual payment results in a deduction in one country, but that same payment does not result in income in the other country in the hands of the recipient.

There are other provisions which determine whether either of these scenarios should result in a tax adjustment, but if it is a scenario that gives rise to a possible adjustment, there is one further consideration.

Multi-Country Tax Analysis

The ‘Hybrid Mismatch’ rules contains criteria that determine whether the home country or the overseas country has the primary responsibility (referred to as “primary response”) for making a tax adjustment in the taxpayer’s tax return. This is necessary because the aim of the new legislation is to prevent a tax benefit arising from a single transaction in two different countries. However, if no rules exist to determine which country should deny the tax benefit, the result could be that both countries or neither country deny the tax benefit. Generally, (there are exceptions) that Australia is the primary response country if a deduction is not allowable. In the situation that an adjustment is required to include additional income, Australia is usually the secondary responsibility country (“secondary response”). The secondary response is usually only required if the primary response country has not introduced similar hybrid mismatch rules, or those rules are not applied in the same way.

Should You Restructure Out of the Problem?

If a taxpayer finds themselves with a hybrid mismatch that requires an adjustment, they should consider whether it would be worthwhile to undertake a restructure to remove any hybrid element from their transactions. The ATO has released a guideline to help taxpayers understand what types of restructurings are considered acceptable and what types fall into the realms of tax avoidance or schemes.  Note that the usual tax implications will still need to be considered to assess the tax cost of the restructure.

What Next

As these rules apply to all types of taxpayers, from the largest to the smallest, your tax advisor will need to not only know the rules in Australia, but also have access to expertise in any other country in which the taxpayer is working, doing business or otherwise investing. More than ever, the ability of your tax advisor to access global expertise will be essential to managing your tax obligations in Australia. 

 

By Gary Poon, Tax Partner, BDO

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