Australia’s hybrid mismatch rules, which came into effect from 1 January 2019, are complex and capture a broad range of payments to overseas recipients.
Australian members of multinational groups should consider the application of the hybrid mismatch rules to ensure they are not adversely affected.
The hybrid mismatch rules were developed by the Organisation for Economic Cooperation and Development (OECD) to prevent multinational corporations from avoiding income tax or obtaining double tax benefits through hybrid mismatch arrangements.
Broadly, a hybrid mismatch arises where entities exploit differences in the tax treatment of an entity or instrument under the laws of at least two tax jurisdictions to defer or reduce the overall cost of income tax. Common hybrid arrangements may result in one of the following:
- A deduction/ non-inclusion mismatch: where a payment is deductible in one country, but receipt of the payment is not assessable in another country; or
- A deduction/ deduction mismatch: where one payment is deductible in two countries.
The rules neutralise the effects of hybrid mismatches for Australian taxpayers by cancelling deductions or including amounts in their assessable income.
An imported hybrid measure can also apply to deny deductions for payments made by Australian companies which do not themselves create hybrid outcomes, but which fund hybrid mismatches further up a chain of entities.
When implementing the hybrid mismatch rules, the Australian government went beyond the OECD’s recommendations and added a targeted financing integrity measure. This rule is designed to prevent offshore multinationals from circumventing the hybrid mismatch rules by routing investment or financing into Australia via an entity located in a no or low tax jurisdiction.
The integrity rule can apply to deny Australian related-party interest deductions on interest payments to foreign jurisdictions that tax the interest income at a rate of 10 per cent or less. Even where a debt deduction is denied, withholding tax will generally still apply to the interest payment.
The integrity rule will impact lending into Australia from tax havens that do not impose income tax. It will also impact more common funding jurisdictions, such as Singapore or Hong Kong, which do not tax foreign income that is not remitted onshore.
Although aimed at aggressive structuring by multinational corporations, the application of the hybrid mismatch rules is far-reaching. There is no minimum threshold, so the rules apply to all companies, regardless of their size.
The rules also catch a broad range of payments (including payments for services, interest, royalties and rents) and can apply to payments between both related parties and unrelated parties.
Taxpayers must self-assess whether the hybrid mismatch rules apply and, if necessary, complete the appropriate disclosures in their income tax return. Consequently, taxpayers are required to have a detailed knowledge of their global structure, as well as an understanding of the foreign income tax treatment of related entities and instruments.
To avoid any potential adverse impact of the rules applying, taxpayers should consider whether they can unwind or restructure existing hybrid arrangements with reference to the ATO’s guidelines, which outlines restructures it considers to be ‘low risk’ and to which the Commissioner would not seek to apply Part IVA.
The hybrid mismatch rules have effect for income years commencing on or after 1 January 2019, with no grandfathering or transitional rules available for pre-existing arrangements.
Therefore, to determine the risk of the hybrid mismatch rules resulting in the denial of deductions, or additional assessable income, Australian members of multinational groups should be reviewing all their arrangements to determine what actions, if any, need to be taken.