INTM552160 - Hybrids: hybrid transfers (Chapter 4): the extent of the mismatch

Case 1 mismatch

Where case 1 applies, the extent of the mismatch is the excess of the deductions over the amounts treated as ordinary income by the payees, making all the relevant assumptions, as necessary.

Case 2 mismatch

Where case 2 applies the calculation of under-taxed amounts has two stages. First it is necessary to identify the under-taxed amounts. Then for each amount a simple formula is applied to each under-taxed amount

  • UTA multiplied by (FMR minus R) divided by FMR

Where

  • UTA is the under-taxed amount
  • FMR is the payee’s full marginal tax rate for the permitted taxable period, as a percentage
  • R is the highest rate at which tax is charged on the profits that are under-taxed, as a percentage, taking into account the effect of any credit for underlying tax on a just and reasonable basis.

For the purposes of the establishing the undertaxed amount, withholding tax is disregarded.

The full marginal tax rate is the highest rate that could be charged on the taxable profits of that payee on finance related income. It does not include a higher tax rate that may be imposed under the Diverted Profits Tax.

The under-taxed amount is the relevant proportion of ordinary income that is subject to tax at a rate lower than the full marginal tax rate.

The highest rate at which tax is charged (R) recognises both income and capital taxes corresponding to the charge that would be imposed under the UK’s income tax, capital gains tax or corporation tax regime.

Example

The non-UK party to a repo (under which the UK party is the in-substance borrower) is subject to tax on the return on the repo, but as a capital gain subject to less than the non-UK payee’s full marginal rate on ordinary income.

The UK company is entitled to a deduction for deemed interest of 80.

In this example, the normal corporate income tax rate (the full marginal rate) is 30% but capital gains are taxed at 18% (ignoring indexation or any other computational adjustments of the gain).

Applying the formula - UTA multiplied by (FMR minus R) divided by FMR

  • UTA is 80, the under-taxed amount
  • R is 18%, the rate actually suffered on the amount
  • FMR is 30%, being the full marginal rate

The deduction denied would be - 80 multiplied by (30% minus 18%) divided by 30% equals 32.

The UK company’s deduction for deemed interest would be restricted by 32: from 80 to 48.