New Australian hybrid mismatch rules passed Parliament on 16 August 2018 and will be effective from as early as 1 January 2019. The rules target “hybrid arrangements”, which are differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions that cause a mismatch. A simple example of a hybrid mismatch would be a payment made by an Australian entity for which a deduction is claimed in Australia but for which there is no assessable income overseas. Under the new rules, a mismatch would usually be neutralised by disallowing a deduction or including an amount in Australian assessable income.
For Australian companies, an understanding of both the domestic and foreign tax treatment of a range of transactions and entities will be required in order to identify potential hybrid arrangements. Starting this process early is critical as, otherwise, Australian income tax deductions could be denied or additional assessable income could be included from as early as 1 January 2019.
Impact of the new legislation
The hybrid mismatch rules are targeted at payments (including, for example, interest, royalties, rent, purchases of stock and, in some case, amounts representing a decline in the value of an asset) that:
- are deductible under the tax rules applicable to the payer, and not included in the income of the recipient (deduction/no inclusion or ‘D/NI’), or
- give rise to duplicate deductions from the same expenditure (double deduction or ‘DD’).
The hybrid mismatch rules can operate to eliminate these D/NI or DD outcomes by denying a deduction or including additional amounts in assessable income.
The rules also contain “imported mismatch” provisions which are targeted at payments made by Australian companies which do not of themselves create hybrid outcomes, but which fund hybrid mismatches further up the chain of entities.
A targeted integrity rule can also apply, in some circumstances, 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. This rule could be particularly relevant for interest payments made to common funding jurisdictions, including Singapore and Hong Kong (among others).
Critically, there will be no transitional periods or ‘grandfathering’ under the provisions, meaning no concession will be provided for existing structures. The provisions will apply on a staggered basis from 1 January 2019 for entities with December year ends, and 1 July 2019 for entities with June year ends.
A few common examples of structures that might be affected by the hybrid mismatch rules are included below.
Common examples of structures that could be affected
Note: The above examples are in no way a complete list of hybrid outcomes, and we recommend that all Australian multinational entities consider the application of these rules in their specific circumstances.
How companies can prepare
The hybrid mismatch rules present the following unique challenges:
- A need to gather information from foreign group companies - Companies will require an unprecedented level of knowledge of the foreign income tax treatment of related entities and instruments.
- The rules need to be considered regardless of size - The rules apply to all companies, meaning that Australian taxpayers with small and less complex operations will still need to consider these rules in detail.
- The provisions do not allow for a long transition period - Given the severity of potential impacts, including denial of deductions, and the inclusion of assessable income with no grandfathering or relief from other provisions, companies should perform estimates of the impact on current and deferred tax balances to be prepared for changes, if implemented.
- Restructuring to address the rules will need to be carefully thought through - The provisions are complex and interact with a range of other Australian and foreign provisions (including the anti-avoidance rules). Additionally, non-tax provisions (eg. accounting reflex, debt profile, operational constraints, legal/regulatory issues) will need to be considered.
Australian multinational companies (inbound and outbound) should consider, and plan to apply, the hybrid mismatch rules as a priority to ensure that no nasty surprises arise after their effective date.
Ronen Vexler, partner, John Ratna, partner and Rohit Raghavan, director, PwC