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By Gary Poon and Meera Pillai
The Bill implements the OECD’s BEPS Action 2—Neutralizing the Effect of Hybrid Mismatch Arrangements and updates the previously released exposure drafts (“draft law”) on March 7, 2018 and November 24, 2017, incorporates rules to address branch mismatch arrangements and introduces a unilateral “integrity rule” to discourage foreign interposed zero or low tax rate entities lending to Australia.
A “hybrid mismatch” arises if double non-taxation results from the exploitation of differences in the tax treatment of an entity or financial instrument under the laws of two or more countries. Double non-taxation occurs if a deductible payment is not included in a tax base (non-inclusion mismatch), or if a payment gives rise to two deductions (deduction mismatch).
Schedules 1 and 2 to the Bill implement the OECD hybrid mismatch rules that prevent multinational companies from gaining an unfair tax advantage due to differences in the tax treatment of a particular instrument or entity between jurisdictions. The rules also include an integrity rule which will apply where a taxpayer attempts to circumvent the hybrid mismatch rules by routing funds through foreign interposed entities with the aim of gaining an Australian income tax deduction and deliberately avoiding those hybrid mismatch rules. The hybrid mismatch rules build upon previous action by the Australian Government in recent years to address tax avoidance, including the introduction of stronger transfer pricing rules, the Multinational Anti-Avoidance Law and the Diverted Profits Tax (“DPT”). The government has also increased penalties for companies that fail to take reasonable care when making statements to the Australian Taxation Office (“ATO”) and has expanded the ATO’s capacity, through the tax avoidance task force.
In comparison to the draft law in March 2018, there have not been substantive changes, however, there has been a change to the integrity measure that applies where Australia makes a deductible interest (or equivalent) payment to an entity in a jurisdiction interposed between Australia and the ultimate parent jurisdiction. In the latest version of the draft law, for the rule to apply, the entity in the interposed jurisdiction was required to be subject to a tax rate of 10 percent or less. Under the Bill, this test has been changed to require that the payment is subject to foreign income tax in one or more foreign countries and the highest rate at which the payment is subject to foreign tax is 10 percent or less.
Previously the law had a carve-out where it was not reasonable to conclude that the scheme was designed to produce an Australian deduction and a 10% or less foreign tax rate. Under the Bill, the “design test” has been replaced with a “principal purpose” test. It is now a condition for the integrity rule to apply that the scheme was entered into for a principal purpose or for more than one principal purpose that includes a purpose of obtaining an Australian deduction and enabling foreign tax to be imposed on the payment at a rate of 10 percent or less. In considering the application of the principal purpose test, the Bill specifically requires consideration to be given to the source of funds provided by the interposed foreign entity to Australia and whether the interposed foreign entity engages in substantial commercial activities in carrying on a banking, financial or other similar business.
The Bill contains also changes to the mechanics dealing with the ability of foreign bank branches to obtain a notional deduction, the treatment of deductions that arise in different periods to when the payment is made and the interaction of the hybrid mismatch rules with various part of the existing taxation law including the Taxation of Financial Arrangements provisions, trading stock provisions, capital gains tax provisions, partnership and trust provisions, controlled foreign company provisions and foreign currency translation rules. Unlike the DPT, there is no carve out for collective investment, sovereign wealth or widely held entities.
The start date of the imported mismatch provisions in Div 832 H has been also delayed by one year to apply to assessments for income years starting on or after January 1, 2020. These provisions are aimed at stopping arrangements that seek to avoid the application of the hybrid mismatch rules by interposing one or more entities between the hybrid mismatch and a country that has hybrid mismatch rules by reducing or eliminating tax deductions for payments made by an Australian company which directly or indirectly fund a hybrid mismatch outcome in any country that has not adopted OECD hybrid mismatch rules. The exception to this is where the imported mismatch payment, i.e. the payment giving rise to the Australian deduction is made under a “structured arrangement” where the hybrid mismatch is priced into its terms or it is reasonable to conclude that the scheme has been designed to produce a hybrid mismatch.
Between announcing this measure and introducing the Bill into Parliament, the government missed its originally proposed implementation date of July 1, 2018 and the start date is now July 1, 2019. Consistent with the draft law in March 2018, there is no grandfathering of existing arrangements.
Taxpayers will need to review their existing arrangements to determine if the extended application date will apply. It is expected that the law will be enacted later this year after Parliament, which is currently in a Winter recess until August 13, 2018, resumes.
On June 21, 2018, the ATO released draft Practical Compliance Guideline PCG 2018/D4 which provides draft guidance as to how the ATO may apply Australia’s general anti-avoidance rules in Part IVA of the Income Tax Assessment Act 1936 (Part IVA) to restructures which seek to reverse the tax benefit that the hybrid mismatch rules see to neutralize.
The stated purpose of PCG 2018/D4 is to allow taxpayers to manage their compliance risk by illustrating various straight forward scenarios to confirm the type of restructures which may generally be considered “low risk” by the ATO from a Part IVA perspective. BDO support the government to be upfront about the compliance risks when restructuring an existing hybrid mismatch arrangement to avoid new rules that target them. The guidance assumes the new rules—currently before parliament within a broader bill—will be passed into law.
The draft PCG is split into the following three sections:
The draft PCG highlights that restructures which result in the elimination of a hybrid mismatch and the preservation of an Australian tax benefit may not attract the operation of Part IVA. Instead, the ATO will consider whether the arrangements should be considered “ordinary commercial dealings” of the taxpayer. The ATO also states that there is an expectation that where there is the elimination of a hybrid mismatch which results in the preservation of the Australian tax outcomes, that the “tax benefits in the foreign counterparty jurisdiction will no longer be available.” The ATO also takes the position that it should not be assumed that a restructure in anticipation of the hybrid mismatch rules cannot be subject to Part IVA. In particular, PCG 2018/D4 states this may be the case where parts of the relevant scheme continue to be carried out or are given effect after the enactment of the hybrid mismatch rules.
The ATO considers a low-risk restructure would involve removing the hybrid feature of the structure while keeping all associated facts and circumstances unchanged. In this regard, the ATO is focused on the overall commerciality of the arrangement rather than the technical existence of the tax benefit itself. The hybrid feature may be removed, for example, in the context of a deduction/non-inclusion mismatch where income is included in the tax base of an entity or, in the context of a deduction/deduction mismatch, where there is no longer a deduction available in one of the jurisdictions.
The following features have been identified in PCG 2018/D4 as being consistent with low-risk restructures:
PCG 2018/D4 also provides four examples of restructures that satisfy these assumptions, and are therefore considered to be low risk:
Two examples are provided in PCG 2018/D4 of arrangements that, whilst removing the hybrid element of the arrangement, may nonetheless attract the application of Part IVA. These include:
PCG 2018/D4 reminds taxpayers that a ruling could be obtained in relation to restructures that are not covered by the low risk scenarios and notes that some taxpayers may be required to disclose information about hybrid arrangements or any restructures in the Reportable Tax Positions schedule.
PCG 2018/D4 will be effective from the date of enactment of the hybrid mismatch rules, however, it will apply to restructures entered into before and after the date of enactment. “The enactment of the rules with a deferred date of commencement is intended to allow taxpayers time to review their existing hybrid arrangements and to unwind or restructure out of such arrangements in advance of the rules if they so choose,” the ATO said in its guidance.
Some multinational companies will consider restructuring their hybrid mismatch arrangements before the new rules are enacted and then seek to rely on the Federal Court’s 1998 decision in CPH Property Pty Ltd & Ors v. Commissioner of Taxation  FCA 1276 (October 13, 1998), which broadly held that Part IVA couldn’t apply to a restructure carried out before relevant tax amendments were enacted. It seems though the ATO is alert to this possibility. In its guidance, it warns that “it should not be assumed” such an action will not be subject to scrutiny, “particularly where such arrangements continue to be carried out and given effect after enactment.”
The views expressed in PCG 2018/D4 may provide reassurance for some taxpayers that are able to restructure in a manner that satisfies all of the assumptions required to qualify as a low risk restructure, however it also does little more than provide support for the existing assumption that “vanilla” restructures should not attract the focus of the ATO. It would have been beneficial have examples with different Australian tax outcomes.
For taxpayers that have any element of additional complexity to restructure arrangements, the PCG provides limited practical reference points and therefore the restructure arrangement is likely to require substantial analysis to properly assess the Part IVA risk. PCG 2018/D4 is not intended to provide detailed technical Part IVA guidance, makes a number of assumptions without any explanation and includes examples with only minimal facts, therefore a detailed analysis of the application of Part IVA to a taxpayer’s circumstances or separate engagement with the ATO may still be required.
With the hybrid mismatch rules legislation also on the verge of enactment, Australian taxpayers with cross-border transactions should contact BDO for assistance with:
Gary Poon is a Corporate Tax Partner and Meera Pillai is a Tax Senior Manager at BDO Australia.
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