ATAD II – general scope and application of anti-hybrid rules
Hybrid mismatches arise when two or more jurisdictions qualify an entity, financial instrument, PE or transfer differently for tax purposes. These mismatches can lead to double deductions of payments or deductions of payments without corresponding inclusions in the other jurisdiction’s tax base. The hybrid mismatch rules under ATAD I only cover intra-EU situations between associated enterprises and structured arrangements involving hybrid instruments and entities. Under the ATAD I rules, a mismatch resulting in a double deduction is neutralised by denying a deduction in the investor’s jurisdiction. A mismatch resulting in a deduction without inclusion is neutralised by denying a deduction in the payer jurisdiction.
ATAD II extends the scope of the hybrid mismatches covered by ATAD I to the following hybrid mismatch arrangements between associated enterprises in EU member states and third countries:
- reverse hybrid mismatches, such as CV-BV structures;
- hybrid mismatches involving PEs, such as the frequently used structures involving a Luxembourg financing company with a hybrid US PE;
- dual resident mismatches;
- imported mismatches, and
- hybrid transfers.
Like ATAD I, ATAD II only applies when a hybrid mismatch occurs between associated enterprises, between a head office and PE, between two or more Pes, or mismatches under a structured arrangement. Generally, the term “associated enterprise” covers direct and indirect interests of 50% or more. For certain types of mismatches, such as mismatches as a result of hybrid financial instruments, the interest percentage required is reduced to 25%. ATAD II also extends the definition of associated enterprise to groups of persons acting in concert and entities that are part of the same consolidated group for financial accounting purposes as the taxpayer.
In addition, ATAD II extends the definition of a hybrid mismatch which results in a deduction without inclusion – which was already covered by ATAD I for intra-EU mismatches – to deductions without an inclusion within a reasonable period of time. A safe haven is available if the payment is included by the payee jurisdiction in a tax period that begins within twelve months of the end of the payer’s tax period, or if it is reasonable to expect that the payment will be included by the payee jurisdiction in a future period and the terms of the payment are those that would be expected to be agreed between independent enterprises.
As a result of the extension of the scope of hybrid mismatches to third countries, ATAD II also extends the rules for neutralising hybrid mismatches that give rise to double deductions or deductions without inclusion. Under the rules of ATAD II, a mismatch resulting in a double deduction is neutralised by denying a deduction in the investor jurisdiction, and where this is not possible, denying the deduction in the payer jurisdiction. A mismatch resulting in a deduction without inclusion is neutralised by denying a deduction in the payer jurisdiction, and where this is not possible, requiring an inclusion in the payee jurisdiction. These new rules are necessary because it is not certain that a third country will deny a deduction. The added rules make sure that the mismatch is eventually eliminated.
Specific hybrid mismatches covered by ATAD II
Reverse hybrid mismatches
ATAD II introduces a new rule that aims to counter reverse hybrid mismatches. A reverse hybrid mismatch is a mismatch that may occur when an entity that qualifies as transparent for tax purposes in the member state of incorporation or establishment is qualified as a taxable entity by the jurisdiction of one or more associated entities who hold an aggregate interest of more than 50% in the hybrid entity. One structure that employs a reverse hybrid is the CV-BV structure commonly used by US multinationals. In this case, ATAD II prescribes that the hybrid entity must be regarded as a resident taxable entity of the member state of incorporation or establishment and must be taxed on its income to the extent that this income is not taxed under the laws of any other jurisdiction, including the member state of incorporation and establishment.
PE hybrid mismatches
ATAD II also introduces new rules that address several PE mismatches, such as the frequently used structures involving a Luxembourg financing company with a hybrid US PE. These include payments that give rise to a deduction without inclusion as a result of (i) differences in the allocation of payments between the head office and the PE or between two or more PEs of the same entity, (ii) deemed payments between the head office and PE that are disregarded under the payee jurisdiction and (iii) payments to a disregarded PE. A PE is disregarded if the head office jurisdiction treats the taxpayer as having a taxable PE in another jurisdiction, but this jurisdiction does not treat the taxpayer as having a PE.
In each of these PE mismatches, the deduction must be denied in the member state which is the payer jurisdiction. If the deduction is not denied in the payer jurisdiction, for instance because this is not an EU member state, the amount of the payment that would give rise to a mismatch must be included in the income in the payee jurisdiction.
Dual resident mismatches
Third, ATAD II introduces a rule that aims to prevent double deductions as a result of a deduction made by a taxpayer resident for tax purposes in two or more jurisdictions. In this case, the member state in which the taxpayer is resident will now deny the deduction to the extent that the other jurisdiction allows the duplicate deduction. If both jurisdictions are member states, the member state where the taxpayer is not deemed to be a resident (according to the tax treaty between the two member states concerned) must deny the deduction.
Imported mismatches shift the effect of a hybrid mismatch between parties in third countries into the jurisdiction of a member state through the use of a non-hybrid instrument, and could therefore undermine the effectiveness of the hybrid mismatch rules if no countermeasure is implemented. ATAD II includes a provision where a member state must deny a deduction for a payment by a taxpayer to the extent that this payment is, directly or indirectly, set-off against a deduction that arises under a hybrid mismatch arrangement between third countries. This rule does not apply if any of the third countries involved has made a similar adjustment in respect of the hybrid mismatch.
Finally, ATAD II prevents mismatches as a result of hybrid transfers. Hybrid transfers are arrangements where a financial instrument is transferred and the underlying return on the instrument is treated as derived for tax purposes by more than one of the parties to the arrangement. Examples of hybrid transfers include arrangements that generate foreign tax credits by structuring loans as a share sale for one jurisdiction and a loan for the other jurisdiction.
Hybrid transfers that give rise to a double deduction or deduction without inclusion are neutralised by the general rules governing hybrid mismatches. If the hybrid transfer is aimed at generating foreign tax credits for more than one of the parties involved, the member state of the taxpayer must limit the benefit of that relief in proportion to the net taxable income regarding payments under such arrangements.
ATAD II provides for an exception for mismatches resulting from hybrid financial instruments issued with the sole purpose of meeting the issuer’s loss-absorbing capacity requirements. This exception may be applied until 31 December 2022. In addition, ATAD II also provides for an exception to the rule that in the case of a deduction without inclusion, the payee jurisdiction should include the mismatch outcome in the taxable income in that member state. Until 31 December 2022, member states will be allowed to exclude certain hybrid mismatches from this rule.
Entry into force
Member states must implement the provisions of ATAD I by 31 December 2018, and the provisions of ATAD II by 31 December 2019, and apply the provisions of ATAD II as from 1 January 2020 at the latest. However, the deadline for reverse hybrid mismatches are different: these rules have to be implemented by 31 December 2021 and be applied from 1 January 2022 at the latest. The Dutch government initially requested a postponement of the ATAD II implementation date until 31 December 2023, but this request has been denied.