Australia's hybrid mismatch rules largely follow The Organisation for Economic Cooperation and Development (OECD) hybrid mismatch and branch mismatch rules from Action Item 2External Link of the OECD Base Erosion and Profit Shifting (BEPS) action plan.
The ATO, in consultation with the Board of TaxationExternal Link, designed and implemented hybrid mismatch rules to prevent multinational companies from gaining an unfair competitive advantage by avoiding income tax or obtaining double tax benefits through hybrid mismatch arrangements.
Hybrid mismatch arrangements exploit differences in the tax treatment of an entity or instrument under the laws of 2 or more tax jurisdictions. This has an overall negative impact on competition, efficiency, transparency and fairness.
The rules apply to payments that give rise to hybrid mismatch outcomes which can be summarised as:
- deduction or non-inclusion mismatches (D/NI) where a payment is deductible in one jurisdiction and non-assessable in the other jurisdiction
- deduction or deduction mismatches (D/D) where the one payment qualifies for a tax deduction in 2 jurisdictions
- imported hybrid mismatches where receipts are sheltered from tax directly or indirectly by hybrid outcomes in a group of entities or a chain of transactions.
These rules operate in Australia to neutralise hybrid mismatches by cancelling deductions or including amounts in assessable income.
The rules also contain a targeted integrity provision that applies to certain deductible interest payments, or payments under a derivative, made to an interposed foreign entity where the rate of foreign income tax on the payment is 10% or less.
Subject to some exceptions, the rules apply to certain payments after 1 January 2019, and to income years commencing on or after 1 January 2019. Limited transitional arrangements – impacting frankable distributions – apply for Additional Tier 1 regulatory capital issued by banks or insurance companies.
In addition, the imported mismatch rules will only apply in respect of 'structured arrangements' for income years commencing on or after 1 January 2019. The complete imported mismatch rule will be delayed to income years starting on or after 1 January 2020. This aligns with the EU introduction of the hybrid mismatch rules.
The rules apply to payments between:
- related parties
- members of a control group
- parties under a structured arrangement.
Unlike the diverted profits tax or multinational anti-avoidance law measures, the hybrid mismatch rules do not have a de minimis or materiality threshold.
Australia's hybrid mismatch rules have been updated with a number of technical amendments in order to clarify and improve the rules' operation.
In the 2019–20 Budget on 2 April 2019, the government announced the measure Tax Integrity – clarifying the operation of the hybrid mismatch rules. Subsequently, the government handed down the 2019–20 Mid-Year Economic and Fiscal Outlook (MYEFO) on 16 December 2019 and announced Tax integrity – improving the operation of the hybrid mismatch rules. These measures announced a number of minor technical amendments to Australia’s hybrid mismatch rules to clarify and improve their operation.
On 3 September 2020 the Treasury Laws Amendment (2020 Measures No.2) Act 2020External Link, which fully implemented the above measures and some additional changes, received royal assent.
- clarify the operation of the hybrid mismatch rules for trusts and partnerships
- clarify the circumstances in which an entity is a deducting hybrid
- clarify the operation of the dual inclusion income rule by:
- deeming certain types of foreign sourced income to be subject to Australian income tax in determining if that income is dual inclusion income
- removing the need for non-corporate entities to reduce their dual inclusion income where they have a foreign income tax offset
- clarifying the operation of the dual inclusion income on-payment rule
- expanding the definition of dual inclusion income group such that, if in a country 2 or more entities share the same multiple liable entities (and those alone), then those entities are members of a dual inclusion income group in that country.
- amend the definition of 'foreign hybrid mismatch rules' so that it refers to a foreign law corresponding to any of Subdivisions 832-C to 832-H of the Income Tax Assessment Act 1997 (ITAA 1997) and clarify the operation of provisions that have regard to the operation of corresponding foreign hybrid mismatch rules
- clarify that, for the purpose of applying the hybrid mismatch rules, foreign income tax does not include foreign municipal or State taxes (except in considering the application of the integrity rule)
- clarify that the hybrid mismatch rules apply to multiple entry consolidated (MEC) groups in the same way as they apply to consolidated groups
- ensure that the integrity rule can apply appropriately to financing arrangements that have been designed to circumvent the operation of the hybrid mismatch rules
- allow franking benefits on franked distributions made on certain Additional Tier 1 (AT1) capital instruments that would otherwise be denied.
For further information on these amendments and their specific administrative treatment, refer to Franked distributions on AT1 capital instruments.
Application dates for the amendments
The amendments will apply to income years starting on or after 1 January 2019, except for amendments:
- to the integrity rule (other than the state and municipal taxes changes), which will apply to income years commencing on or after 2 April 2019
- to the definition of 'foreign hybrid mismatch rules', which will apply to income years commencing on or after 1 January 2020.
As a number of the changes have retrospective effect, taxpayers will need to either:
- decide to comply with the law (pre-amendments), or
- 'anticipate' the amendments (now enacted law) for the purposes of their income tax return lodgements.
We will not apply our resources to checking whether these self-assessments are correct (in accordance with the law (pre-amendments)), but taxpayers will need to review their lodged returns now that the proposed amendments have been enacted.
Taxpayers should refer to Administrative treatment of retrospective legislation for further information and practical guidance on our administrative approach to law change proposals with retrospective effect.
Taxpayers should also refer to Lodgment and payment obligations and related interest and penalties, which sets out our administrative approach to lodgment and payment obligations and related charging of interest and penalties where taxpayers may be affected by the introduction of a new tax measure.
For further information about how we administer retrospective changes refer to Law Administration Practice Statement PS LA 2007/11 to explore its applications and provisions.
Where franked distributions made on AT1 capital instruments give rise to a foreign income tax deduction, the retrospective changes ensure:
- franking benefits on those distributions continue to be allowed (assuming relevant requirements are satisfied, such as the holding period rule, the related payments rule and the dividend washing integrity rule)
- an amount equal to the amount of the foreign income tax deduction is included in the assessable income of the entity that makes the distribution.
We will continue to work with issuers of AT1 instruments to identify when franked distributions give rise to foreign income tax deductions on these capital instruments, to ensure correct application of the new law.
For investors in AT1 capital instruments, your ability to claim franking benefits attached to franked distributions that are paid on these capital instruments, will not be impacted by a foreign income tax deduction that arises for that distribution.
The hybrid mismatch rules received royal assent on 24 August 2018 (as contained in Schedule 1 and 2 of Treasury Laws Amendment (Tax Integrity and Other Measures No. 2) Act 2018External Link.
The amending legislation clarifying the operation of the hybrid mismatch rules received royal assent on 3 September 2020 (as contained in Schedule 1 of The Treasury Laws Amendment (2020 Measures No. 2) Act 2020)External Link.
Law companion rulings
The following LCRs have been released so far:
- On 13 January 2021 we finalised Law Companion Ruling LCR 2021/1 OECD hybrid mismatch rules – targeted integrity rule. This outlines the ATOs interpretation of the hybrid mismatch targeted integrity rule set out in subdivision 832-J of the Income Tax Assessment Act 1997. The finalised version incorporates feedback received on the two previous drafts and addresses changes introduced as part of the amending legislation.
- On 24 July 2019 we finalised Law Companion Ruling LCR 2019/3 OECD hybrid mismatch rules – concept of structured arrangement. This outlines the ATOs view of the law about the phrases 'structured arrangement' and 'party to the structured arrangement' set out in section 832-210 of the Income Tax Assessment Act 1997.
On 29 June 2022 we published Taxation Determination TD 2022/9 Income tax: is section 951A of the US Internal Revenue Code a provision of a law of a foreign country that corresponds to section 456 or 457 of the Income Tax Assessment Act 1936 for the purpose of subsection 832-130(5) of the Income Tax Assessment Act 1997?
This Taxation Determination explains the ATO's view that section 951A of the US Internal Revenue Code, known as the global intangible low-taxed income 'GILTI' regime, does not correspond to section 456 or 457 of the Income Tax Assessment Act 1936 (the operative provisions of Australia’s controlled foreign companies regime). Rather, section 951A and other related provisions of the US Internal Revenue Code are widely considered to be a US ‘minimum tax regime’ for which there is no equivalent in Australia.
Practical compliance guidelines
To date, the following Practical compliance guidelines (PCGs) have been released.
On 16 December 2021 we finalised Practical Compliance Guideline PCG 2021/5 Imported hybrid mismatch rule - ATO's compliance approach. This contains practical guidance on the ATO's assessment of the relative levels of tax compliance risk associated with hybrid mismatches addressed by Subdivision 832-H of the ITAA 1997 (the imported mismatch rule).
On 24 July 2019 we finalised Practical Compliance Guideline PCG 2019/6 OECD hybrid mismatch rules – concept of structured arrangement. It contains practical guidance for taxpayers when assessing the risk of the newly legislated hybrid mismatch rules applying to their circumstances – in particular with relation to the concept of 'structured arrangement' in section 832-210 of the ITAA 1997.
This PCG should be read in conjunction with LCR 2019/3.
On 25 October 2018, we finalised PCG 2018/7 Part IVA of the Income Tax Assessment Act 1936 and restructures of hybrid mismatch arrangements to help clients wishing to eliminate hybrid tax outcomes that would otherwise fall foul of the newly legislated hybrid mismatch rules.
This PCG will help clients manage their compliance risk by outlining straightforward (low risk) restructuring to which we will not seek to apply Part IVA. The PCG also encourages early engagement with us by those taxpayers whose arrangements fall outside the low-risk parameters outlined in the PCG.
Clients potentially affected by the rules and considering restructuring should refer to this PCG to understand our compliance approach.
All references are to the Income Tax Assessment Act 1997, unless otherwise stated.
We have been asked whether an intercompany payment between members of a US consolidated group can be regarded as ‘subject to foreign income tax’ in the US in a foreign tax period under subsection 832-130(1).
To the extent an intercompany payment is included as gross income in the calculation of the recipient member’s ‘separate taxable income’ for US federal income tax purposes for the foreign tax period, the intercompany payment can be regarded as ‘subject to foreign income tax’ in the US under subsection 832-130(1).
The calculation of the ‘separate taxable income’ of a member of a US consolidated group for US federal income tax purposes is addressed by the US federal tax regulations, and is subject to certain modifications, including modifications for transactions between members of a US consolidated group.
You must also consider the effect of subsections 832-130(3) and (4) however, in ultimately determining whether an intercompany payment can be regarded as ‘subject to foreign income tax’ in the US.
The following example illustrates our view.
US Parent, US Sub 1 and US Sub 2 are each US resident corporations that file on a consolidated group basis for US federal income tax purposes. US Parent is the representative head of the group that files the consolidated return as agent for the group members. A ‘check-the-box’ election has been made to treat Aus Co as a ‘disregarded entity’ of US Sub 1 for US federal income tax purposes.
US Parent made a $100 interest-bearing loan to Aus Co in Year 1, in return for payment of $10 of interest annually by Aus Co at the end of each year, and repayment of $100 at the end of Year 5. For US federal income tax purposes, US Sub 1 is treated as the borrower in respect of the loan and the related interest expense of Aus Co is treated as an expense of US Sub 1.
If the full $10 of interest income received by US Parent in a foreign tax period is included as gross income in the calculation of US Parent’s ‘separate taxable income’ for the foreign tax period, the full $10 of interest income can be regarded as ‘subject to foreign income tax’ in the US under subsection 832-130(1).
For example, the full $10 of interest income received by US Parent may be included as gross income in the calculation of US Parent’s ‘separate taxable income’ if no amount of the $10 of interest income is required to be redetermined or adjusted in accordance with any US federal income tax law or regulation.
This outcome is notwithstanding that for US federal income tax purposes:
- US Sub 1 may be entitled to deduct the full $10 of corresponding interest expense in calculating its ‘separate taxable income’ for the same foreign tax period; and
- US Parent’s and US Sub 1’s ‘separate taxable incomes’ are combined in calculating the consolidated taxable income of the US consolidated group for the foreign tax period.
Subject to the operation of subsection 832-130(3), the $10 interest payment will not give rise to a deduction/non-inclusion mismatch under section 832-105. However, the interest payment will instead give rise to a deduction/deduction mismatch under subsection 832-110(1) if US Sub 1 is entitled to deduct all or part of the interest payment in working out its ‘separate taxable income’.
When we engage with you, we will likely request copies of relevant parts of the US consolidated tax return and relevant supporting documents as evidence of the extent to which an intercompany payment has been included in a recipient member’s ‘separate taxable income’ in a foreign tax period.
- Treasurer's media release – Making sure multinationals pay their fair share: Addressing hybrid loopholes, 7 March 2018External Link
- Treasurer's media release – Turnbull Government clampdown on multinational tax avoidance hits hybrids, 24 November 2017External Link
- Joint media release – A new Tax Avoidance Taskforce, 3 May 2016External Link
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