INTM561650 - Hybrids: special provision concerning transparent funds - structured arrangements

The structured arrangement tests applicable to the various chapters to which Chapter 13A of Part 6A could apply all contain two limbs. A structured arrangement will exist either if an arrangement is designed to secure a hybrid benefit, or if the terms of an arrangement share the economic benefit of a hybrid benefit or otherwise reflect the expectation of the benefit. The latter limb is much less likely to be relevant in practice. The question of design is much more likely to be in point and so the following discussion focusses on this.

Where any specific investor is putting enough money into a fund structure that they are party to structuring discussions, it is likely that if they derive a hybrid benefit then that was by design such that a structured arrangement will exist.

However, where a hybrid benefit arises by reference to an investor which was not party to the fund structuring and/or the nature of the fund’s investments, then the necessary element of design to give rise to a structured arrangement will often not be present. An exception to this would be if a fund was structured with a view to enabling a given class of investor the opportunity of securing hybrid benefits, even if no specific parties had been identified at the time of the structuring.

For example, suppose a private equity fund adopts a legal form which is seen as transparent by the great majority of jurisdictions in which it is marketed. Within those jurisdictions, there is one which sees it as opaque with the result that counteractions under Chapter 7 could potentially arise in respect of payments to it from its investee companies. We would not generally regard a structured arrangement as arising if there was no particular marketing drive in the single jurisdiction which sees the fund as opaque, even if some residents of that jurisdiction invested. However, if there was a marketing focus on that jurisdiction in which the potential tax benefit played a part, then there would be a strong presumption that a structured arrangement existed.

The most difficult questions around the possible presence of a structured arrangement will arise where a jurisdiction is involved in a structure which allows the tax status of an entity to be changed by election. In practice, the jurisdiction in question will usually be the US, due to its ‘check the box’ rules (and the remainder of this guidance assumes that that is the case). The making of such an election can create hybridity when there is none inherent in the structure. Such an election should be regarded as part of any arrangement considered by the relevant chapters of Part 6A, so where it is made it can potentially be seen as reflective of the arrangement being designed to secure a hybrid benefit.

The obtaining of hybrid benefits is not the only reason why check the box elections are made, as may be evidenced by their continued popularity following the introduction of Part 6A. A check the box election might therefore not be considered as giving rise to a structured arrangement if it was made in relation to an entity after the introduction of the hybrids rules and before the announcement of the policy change that would lead to the introduction of Chapter 13A. In those circumstances it would normally be the case that no hybrid benefit could be expected notwithstanding the election, so the element of design would be absent.

Similarly, where a fund acquires a group containing companies in respect of which check the box elections have been made, the arrangement tested by the various structured arrangement provisions is the structure post-acquisition, within which the election is an established fact. This may cause the element of design to be absent, although regard must also be had to the acquiror’s structure and any check the box elections made within that.

If, at the time an election was made to treat an otherwise opaque entity as transparent for US purposes, the expectation was that the checked open entity would receive large amounts of dual inclusion income on an ongoing basis, that would be a strong indicator that the making of the election was not an element of design to secure a hybrid benefit.

On the other hand, where a fund contains US investors and a check the box election is made in relation to a previously unchecked newly acquired company which potentially gives rise to hybrid benefits, that will be a strong indicator that a structured arrangement is present and hence that the relieving provisions of Chapter 13A will not be in point.

Taxpayers will almost invariably have been advised in relation to structures where entity classification elections are made, and even where not advised they will have considered the implications of an election. They will know whether the securing of a hybrid benefit was a factor in the making of an election, or whether it was truly incidental to a wider purpose such that securing the hybrid benefit was not a factor in the design.