BEPS Action 2: Board of Tax releases anti-hybrid discussion paper
The Board of Tax has responded to the Government’s request to review the OECD’s recommendations for addressing tax loss through the use of hybrid instruments, entities and arrangements through a discussion paper (DP) released on 20 November 2015. The OECD’s anti-hybrid recommendations are summarised in the RSM tax insight 'BEPS project final reports released: OECD calls 'paradigm shift'', and require both tax treaty changes and changes to domestic tax law. The DP focuses on potential changes to Australia’s domestic tax law provisions.
It is clear from the DP that dealing with hybrids will be a very much more challenging task than addressing some of the other BEPS recommendations, e.g. automatic exchange of information.
Co-ordinated, harmonised global action is required to eradicate hybrid abuse, but for many reasons, progress can be expected to be slow, as nations watch what others do and react accordingly. The unspoken concern is that being at the leading edge, is likely to result in bleeding tax revenue.
Australia is expected to be under some pressure to move quickly and fully adopt the anti-hybrid recommendations, because of our long and close involvement in the BEPS project. But there are many issues to consider and these are the substance of the DP.
Australia’s self-assessment regime
A key issue for Australia is how to make the alternative possible outcomes under Action 2 operate in our corporate self-assessment environment. For most hybrid situations, there is both a primary rule and a defensive rule. For instance, with a hybrid financial instrument, which generates a deductible payment in one country which is not taxable in the other country, the primary rule will disallow the payer’s deduction. But if the primary rule does not operate, the secondary (defensive) rule will require the recipient in the other jurisdiction to include the payment as ordinary income.
What level of action will be required of an Australian company, in these circumstances? Will it be sufficient if the company knows the general laws of the counterparty country, or will the Australian company have to go further, and know the actual tax treatment of the payment in the hands of the recipient company?
And this is a simple case. In more complicated instances, a transaction may be characterised in more than one way under the hybrid matrix, or may be affected by another BEPS Action point. Under one characterisation, the response may be to deny a tax deduction to the payer, but under another characterisation the response may be to include the payment in the recipient’s ordinary income. But if the payer is denied a deduction, and the recipient is taxable on the receipt, double taxation replaces double non taxation.
Cost, confusion and endless amendments?
One of the objectives of the BEPS project has been to minimise the compliance costs associated with implementation of the recommendations. But in the case of hybrids, it seems hard to avoid a costly and inconvenient outcome – amended corporate tax returns would seem a certainty as counterparty treatment of hybrids becomes clarified, post lodgement of the Australian company’s tax return. And with that comes the issue of penalties, interest and professional costs.
Tax and economic competition
Another major concern permeating the DP is the effect of any changes on capital flows, and whether Australia’s tax competitiveness might be reduced by being an early adopter of the recommendations. As a small open trading economy, Australia has no choice but to be economically ‘open’ in order to attract foreign capital investment. There is an underlying implicit question in the DP as to whether it is in Australia’s best interests to be policy leader in this area, or whether we should advance together with the global pack. The risk is that being a global leader in the implementation of anti-hybrid rules could result in the loss of foreign capital and further loss of tax revenues, which is the opposite of the result sought.
Integration with existing Australian tax law and start date
The DP posits 41 consultation questions on the interaction of the OECD’s anti-hybrid recommendations and Australia’s existing domestic tax law. Consideration will be required as to how our existing international tax rules (debt/equity rules; CFC rules; TOFA rules; thin capitalisation rules; exemption rules, withholding taxes, and foreign tax offset rules; and Part IVA and the new Multinational Anti Avoidance Law (MAAL) ) will coordinate with the anti-hybrid recommendations.
And there is no recommendation by the OECD as to when the new anti-hybrid rules should commence to operate. The UK has taken an early step and proposes to have new rules operative from the start of 2017, but the UK already has some anti-hybrid rules in place. Otherwise, the global response has been muted, and other countries will no doubt be doing the same risk assessment as Australia, by way of this Board of Tax review.
We may see the anti-hybrid treaty changes occurring first (by way of the Action 15 multilateral instrument) with the domestic law changes coming in behind them by way of back-stop rather than leading the way.
Accounting for tax uncertainty
The interaction between the entire BEPS package and the various accounting tax uncertainty regimes around the world, has been the subject of previous comment. With no proposed start date, and limited indications of the responses proposed by countries to the anti-hybrid recommendations, there will be particular difficulty in determining whether, and if so, the quantum of any tax uncertainties arising from hybrid instruments, entities or arrangements. It will be no easy thing to catalogue the potential hybrid exposures that a multinational group may have in place – some may not even be intentional or identified.
But assuming the list is complete, what will the existing treatment be compared with – given there is nothing more than the OECD Action 2 recommendations? The December 2015 year end and halfyear reporting will present a real challenge for auditors of groups which have hybrid arrangements in place.
Given the early stage of the review, with the focus on the effects at the macroeconomic level, it is too early to expect any comments about whether there will be a carve-out for SME’s. With the $2 million thin capitalisation threshold in mind, it may well be the government takes the pragmatic approach to exclude SME’s on the basis the compliance costs would be disproportionate to the revenue which may be threatened, or potentially raised.
Alternatively, the Government could limit the changes to ‘significant global entities’ (those with revenue in excess of $A 1 Bn, and subject to the MAAL and country by country reporting requirements). Whilst this would catch those groups who make greatest use of hybrids, it would seem to leave too much potential tax revenue ‘on the table’. Time will tell.