INTM559250 - Hybrids: imported mismatches (Chapter 11): conditions to be satisfied: condition E

The Finance Act 2021 amended the wording of Condition E at s259KA. Prior to the Finance Act, the condition was that it is reasonable to suppose that there is

  • a mismatch payment and Chapters 3 to 5 or Chapters 7 to 10 do not apply in relation to the tax treatment of any person, or
  • a mismatch payment and there is no non-UK equivalent of Chapters 3 to 5 or Chapters 7 to 10 that applies in relation to the tax treatment of any person, or
  • an excessive PE deduction in respect of which Chapter 6 (or a non-UK equivalent provision) does not apply in relation to the tax treatment of any person

The new Condition E will apply to relevant payments made after 10 June 2021 (the date of Royal Assent of the Finance Act 2021), or in the case of quasi-payments, to payment periods beginning after that date.

New Condition E

New Condition E is that it is reasonable to suppose that the relevant mismatch is not capable of counteraction.

A relevant mismatch is capable of counteraction if there is a person other than the UK payer, P, whose tax treatment is capable of alteration under the law of a territory that is OECD mismatch complaint.

A territory is OECD mismatch compliant if it has given effect to the Final Report on Neutralising the Effects of Hybrid Mismatch Arrangements published by the OECD on 5 October 2015 (or any replacement of supplementary publication within the meaning of s259BA(3)).

Therefore, in considering whether Condition E is satisfied, a company does not need to know whether another person has been subject to a counteraction in an OECD mismatch compliant jurisdiction, or if so, what the extent of that counteraction is. It is enough to know that there is a person other than P who is party to the series of arrangements that include the relevant mismatch, that could be subject to counteraction by a jurisdiction that has implemented OECD compliant hybrids mismatch rules.

HMRC accepts that territories that have fully adopted EU Council Directive 2017/952 of 29 May 2017 (ATAD 2) are OECD mismatch compliant for the purposes of considering Condition E. This is the case even if the outcome of adopting ATAD 2 and/or the local law of the territory in question is different to that which would have resulted from applying Part 6A to a similar fact pattern. However, in the event that any EU member state should be held by any of the EU Commission, the European Court of Justice or a court of competent jurisdiction in that Member State to have failed properly to implement ATAD 2 in any respect which is material to the UK tax analysis, HMRC may regard chapter 12 as applicable on the basis that the supposition made as to OECD mismatch compliance, which was reasonable at the time made, has subsequently proved to be mistaken.

The following example sets out a fact pattern when condition E would be met.

UK company makes a payment to company A in jurisdiction A. That company passes the payment on to company B in jurisdiction B, who uses the payment to issue a convertible bond to company C in jurisdiction C. All companies are in the same corporate group.

The payment from Company B to Company C results in a relevant mismatch. The terms of the convertible bond issued by company B to company C are such that the interest repayments made by company B will be deducted as interest in calculating company B’s profits, but the receipts of those payments are regarded as exempt dividends by company C and so are not ordinary income of that company. Therefore, the terms of the instrument have created a deduction/non-inclusion mismatch.

None of jurisdiction’s A, B or C has implemented the OECD recommendations on neutralising the effects of hybrid mismatch arrangements. Therefore, the relevant mismatch is not capable of counteraction by any of the three jurisdictions. If any of jurisdiction’s A, B or C had implemented the OECD recommendations, the relevant mismatch would have been capable of counteraction, and so Condition E would not have been satisfied. It is not necessary for the UK company to check the details of the rules or whether the mismatch had in fact been countered; it is enough to know that any of the three other jurisdictions has implemented the OECD recommendations for condition E not to be met.

If only a proportion of the mismatch is capable of counteraction by a jurisdiction that has implemented the OECD recommendations, New Condition E is met only in relation to the rest of the relevant mismatch (that is not capable of being counteracted). Any determination about the extent to which a relevant mismatch is capable of counteraction is to be made on a just and reasonable basis. This rule would be relevant in the following example:

P makes a payment of 1,000 to Company A, which is resident in a jurisdiction which has not implemented the OECD recommendations. Company A pays 400 to Company B and 600 to Company C. Company B is resident in a jurisdiction which has implemented the OECD recommendations, but Company C is not. Companies B and C pay 400 and 600 respectively to Company D, which is not resident in a jurisdiction which has implemented the OECD recommendations. Company D pays out the 1,000 in circumstances giving rise to a relevant mismatch of 1,000. In this case it would be just and reasonable to treat 600 of the mismatch to be considered as incapable of counteraction, and so Condition E will be treated as satisfied to that extent.