MTT41410 - Particular entities and adjustments: Tax transparent entities: Treatment of tax transparent, hybrid, and reverse hybrid entities

In certain cases, a reallocation of profits or taxes is required to properly align the profits and taxes of tax transparent entities.

For hybrid entities, and certain reverse hybrid entities, profits or taxes may be pushed down from an owner to the hybrid.

For flow-through entities, profits may be pushed up from the flow-through entity to an owner.

Additionally, adjusted profits of a flow-through entity may be excluded where they are held by an external investor.

Hybrid entities

A hybrid entity is regarded as tax transparent by the territory of an owner, but opaque by its own territory.

Where an owner records adjusted profits relating to the hybrid, those profits will be reallocated to the hybrid (see MTT41430).

Where an owner is taxed on the profits of the hybrid, that tax will be pushed down to the hybrid (see MTT41470).

Reverse hybrid entities

A reverse hybrid entity is regarded as tax transparent by its own territory, but opaque by the territory of an owner.

An owner which sees the reverse hybrid entity as opaque cannot suffer any tax on the reverse hybrid’s profits.  However, where an indirect owner sees the reverse hybrid as transparent, and also sees the entities between itself and the reverse hybrid as transparent, that indirect owner may suffer tax on the reverse hybrid’s profit.  Such tax may be pushed down to the reverse hybrid.

Flow-through entities

A flow-through entity is regarded as tax transparent by its own territory, and is not tax resident elsewhere.

An entity may also be treated as a flow-through entity in certain circumstances where it is not tax resident anywhere, but only to the extent that it is regarded as tax transparent by its owners.

A flow-through entity will have one or more reference entities. A reference entity is a non-flow-through entity that has a direct ownership interest or an indirect ownership interest held entirely through intermediate flow-through entities. A flow-through UPE may be a reference entity in certain cases.

The adjusted profits of a flow-through entity will be reallocated to its reference entities which see it (and all entities between them and it) as transparent. However, where the entity is not treated as a flow-through entity to a certain extent, profits will not be reallocated (see MTT41440).

Flow-through entities – exclusion of profits

The adjusted profits of a flow-through entity that are attributable to persons outside the group will be excluded in certain circumstances (see MTT41450). The most common circumstance is where the entity with profits is treated as a flow-through entity in relation to all members of the group and the person outside the group holds a direct interest in it.

Where the ultimate parent is a flow-through entity, its adjusted profits will be excluded where certain conditions are met (see MTT41460).

Treatment of tax expense

In general, amounts of qualifying covered tax expense will be reallocated or excluded along with the profits.

In certain cases where there is no reallocation of profits because they were not reflected in the underlying profits, an amount of tax expense may still be reallocated.

Tax expense may also be reallocated to a reverse hybrid entity in certain circumstances.

Amounts of tax expense that are in respect of mobile income to be reallocated are subject to a cap.

See MTT41470 for the treatment of tax expense in relation to tax transparent entities.

Location of flow-through entities

Special rules apply when determining the location of a flow-through entity. See MTT18030 for further guidance.

Application of the SBIE in relation to flow-through entities

See MTT32030 for guidance on the application of the substance based income exclusion in relation to flow-through entities.