BEPS Action Plan: Action 2 – Hybrid mismatch arrangements

The OECD’s second action point in the BEPS Action Plan is to “neutralise the effects of hybrid mismatch arrangements”. Our commentary, and links to content, on action 2 are included here.


11 July 2017

The Netherlands has published a consultation in relation to the implementation of ATAD II but ….

the draft proposal does not include measures against hybrid mismatches on the basis, as our News Item explains, that there is time before these rules must be implemented in Dutch legislation (as of 31 December 2019 to become effective as of 1 January 2020).


5 July 2017

The OECD’s Tax Talks webcast #6 on 26 June included …

reference to the fact that the final guidance note on branch mismatch structures had been agreed and it was expected that it would be published early in July


29 May 2017

The EU’s Council (in the Competitiveness Council configuration) has …

formally adopted the Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries (ATAD II), as set out in our EUDTG Direct Tax Newsalert of 29 May 2017.


9 May 2017

Countries are starting to consider implementation with one or two taking the lead …

  • The UK’s Finance Act 2016 provisions implementing hybrid mismatch rules have been supplemented by draft guidance, which we expect to be finalised following further consultation, as we note in our blog post of 3 April 2017,
  • Australia announced in the Federal Budget 2017 that it will address hybrid tax mismatches that occur in cross-border transactions relating to regulatory capital known as Additional Tier 1 (AT1) but, as our Budget note suggests has been silent about year’s Federal Budget plan to implement the majority of the recommendations on hybrids in a wider manner from the later of 1 January 2018 or six months after the relevant law is enacted.
  • New Zealand carried out a consultation on proposals for addressing hybrid mismatch arrangements in accordance with the OECD recommendations calling for submissions on how that could best be done


30 March 2017

We have been starting to see new treaties being signed with provisions addressing hybrids issues ….

similar to those being addressed via the MLI. One of the countries with a number of treaties doing this is Japan, e.g in relation to treaties with Austria, Chile and Latvia.


28 February 2017

Political agreement on ATAD II has been reached by EU Member States in the ECOFIN Council …

and, once formally adopted, Member States (MSs) will need to transpose the provisions by 31 December 2019 and apply them per 1 January 2020. This applies to both mismatches between MSs and between MSs and third countries. By way of derogation, the specific reverse hybrid entity rule (requiring taxation of income to the extent not otherwise taxed) would need to be transposed by 31 December 2021 and applied per 1 January 2022, however payments to reverse hybrids would not be deductible anymore from 1 January 2020. See further our EUDTG Direct Tax Newsalert of 22 February 2017

Czech Republic has quickly afterwards issued a 28 page Ministry of Finance consultation, document about how it should implement the Directive.


1 December 2017

The multilateral instrument to effect BEPS modifications to existing treaties includes Action 2 related provisions which …

  • Article 3 Transparent entities - Para 1:-Preserves benefits in line with the conclusions of the Partnership Report and denies benefits where no taxation of income; Para 2:-No need to relieve double taxation where other state’s tax is levied exclusively on the basis of residence.
  • Article 4 Dual resident entities – Replaces the place of effective management as the determining factor by competent authority agreement.
  • Article 5 Application of Methods for Elimination of Double Taxation - Addresses (asymmetrically) non-taxation arising from the inclusion of the exemption method in treaties where income is not taxed in the source state by requiring a tax credit to be given for tax imposed in the other country on:
    • income that the treaty allows the other party to exempt or tax at a reduced rate (Option A)
    • dividends that are tax deductible in the other country (Option B)
    • all types of income that the treaty allows the other country to tax (Option C)


24 November 2016

The European Commission (EC) published a Tax Package including four new draft EU Directives on 25 October 2016 including one with proposals to:

introduce measures to address certain hybrid mismatches partly in relation to non-EU countries but partly more broadly by updating the Anti-Tax Avoidance Directive (ATAD), an amending document which we might call ATAD II (hybrids).

See further our Tax Policy Bulletin of 23 November 2016


27 September 2016

Our submission is one of 17 included in a consolidated document on branch mismatch structures on the OECD website.


19 September 2016

We have suggested in our comments to the OECD on the treatment of branch mismatch structures that …

Member States should have the option of implementing the recommendations addressing hybrid entities and hybrid instruments contained in the original Action 2 report but without the need to extend them to branches. Also that for those which do adopt them to exclude regulated entities from those rules. Further we suggest that consideration could therefore be given to limiting the application of the branch mismatch rules to payments within a controlled group.

We point out various difficulties in taxpayers having the required knowledge of the tax treatment applied by others as well as points specific to the four/ five situations such as:

  • Disregarded/ diverted branch structures - introducing a ‘subject to tax test’ in a Member State’s branch exemption appears to be going significantly further than merely neutralizing hybrid mismatches and indeed would be inconsistent with the territorial (or quasi territorial) tax policies adopted by a number of Member States. We also address matters of consistency
  • Deemed branch payments - care will need to be taken to ensure that mere differences in the method of profit attribution between a branch and its head office do not give rise to mismatches (where none exists in reality)
  • Double deduction (DD) branch payments - branch losses could become stranded, which would seem to go beyond the scope of the BEPS objectives
  • Imported branch mismatches - risk shifting the tax burden to the jurisdiction that is paying expenses that it would have incurred whatever the taxation in the recipient jurisdiction (or further up the chain) and creating a reallocation of taxing rights that does not align with the location of substance and value driving activities.

22 August 2016

A new discussion draft on Branch Mismatch Structures applies the analysis and recommendations set out in the Action 2 Report …

to mismatches that can arise through the use of branch structures.

The discussion draft identifies five basic types of branch mismatch arrangements and sets out preliminary recommendations (there is as yet no consensus) for domestic rules, based on those in the Action 2 Report, which would neutralise the resulting mismatch in tax outcomes.

The deadline for submissions is 19 September.

29 June 2016

Within the EU, there is a question as to whether the ATAD requirement to deny a deduction by the payer in a hybrid arrangement …

simply because there is no inclusion of the income by the payee is consistent with CJEU case law which has indicated that the fact that payments are taken into account in another Member State cannot justify discriminatory treatment in the source Member State (see, inter alia, Philips Electronics C-18/11).

There also remains a risk of non-uniform adoption of the OECD hybrid rules which may potentially result in more double taxation and controversy. This could impact investment decisions. Companies and other investors outside the EU may hesitate to locate profitable operations or make other substantial funding commitments in jurisdictions that apply these concepts in a manner likely to result in double taxation.

See further our Tax Policy Bulletin of 29 June 2016.


21 June 2016

Rules addressing mismatches between EU Member States arising due to hybrid entities or hybrid instruments …

are included in a revised draft Anti-Tax Avoidance Directive (ATAD) which has received political approval from those States.

To the extent a hybrid mismatch results in a double deduction, the deduction shall only be given in the Member State of source. Insofar resulting in deduction without inclusion, the Member State of the payer shall deny deduction.

The European Commission is asked to put forward a proposal by October 2016 on hybrid mismatches involving third countries with rules consistent with and no less effective than the recommended rules in OECD BEPS Action 2, with a view to reaching agreement by the end of 2016.

The European Commission has proposed a standard for the EU as part of its Anti-Tax Avoidance Directive that is somewhat different...

Our EUDTG Newsalert of 21 June, explains the different parts of ATAD. 


6 February 2016

although it only seeks to address mismatches between Member States’ tax systems (mismatches between Member States and non-EU countries will be further examined).

Under the proposed treatment in the ATA Directive, characterization of the entity or instrument in the Member State where the payment has its source would be followed by the other Member State involved in the mismatch.

This proposal would therefore result in treatment contrary to the G20/ OECD BEPS Action 2 recommendations. For example, in relation to hybrid instruments, those recommendations would, as a primary rule, require the payer jurisdiction to deny a deduction for mismatch payments, whereas the EU proposal would require the payee to include such payments as income.

The different approach might be driven in part by CJEU case law which has indicated that the fact that payments are taken into account in another Member State cannot justify discriminatory treatment in the source Member State (see, inter alia, Philips Electronics C-18/11).

See further our Tax Policy Bulletin of 5 February 2016.


23 October 2015

Although we anticipate broad take-up of these recommendations, there are various issues with respect to implementation and timing that suggest it is far from clear…

how coordinated actions will be in practice.

The final recommendations do not include any specific start date or transition rules. These should be determined as agreed in Recommendation 9.2:

  • the recommendations state transition rules will be without any presumption of grandfathering existing arrangements
  • when an effective date is agreed the report states that it should be far enough in advance “to give taxpayers sufficient time to determine the likely impact of the rules and to restructure existing arrangements to avoid any adverse tax consequences associated with hybridity”
  • all payments under hybrid mismatch arrangements that are made after the effective date of the legislation or regulation should then be affected according to the report – to avoid unnecessary complication and the risk of double taxation, the report suggests the rules should generally take effect from the beginning of a taxpayer’s accounting period.

On drafting, the report also recognises in design principles (Recommendation 9.1) that the wording of relevant legislation or regulations will have to be specific to each jurisdiction, that jurisdictions should ensure the counter measures apply automatically and aim to neutralise the mismatch between jurisdictions rather than reverse the tax benefit while minimising the administrative burden for taxpayers and tax authorities. The lack of a motive or purpose test in the recommendations may give rise to the potential for unintended consequences.

There is a considerable degree of complexity involved in how countries should apply these rules to multinationals, particularly where the tax years/ accounting periods are not coterminous or countries’ rules are not identical. The examples in the report will need to be supplemented further with more explicit examples if they are to deal with various situations that will arise in practice.

Having identified the interaction with measures on interest deductibility and CFCs, there is an added complication in having hybrids rules that apply in these situations. Further, while the acknowledgement of potential interaction between measures under different action items is welcome, and essential, some cross-over might also be considered in relation to other rules. The OECD and the European Commission (EC) have consistently stated that the EC has been actively involved in the BEPS deliverables and ensuring compliance with the Treaty on the Functioning of the EU and /or EEA agreement in intra-EU/EEA cases, but the application of EU law to the proposed recommendations is complex.

There is a recognition that ongoing review will be needed with a need for a regular exchange of information between jurisdictions on rules and specific taxpayer circumstances. The report also notes that tax administrations (and the OECD) should endeavour to make relevant information available to taxpayers.


21 October 2015

The recommendations that have been made to ensure that hybrid instruments and entities are not used to obtain the benefits of treaties inappropriately…

cover the following situations:

  • dual resident entities - the existing Model Treaty rule that is the dual resident tie-breaker (Article 4(3)) will state that residence in such cases should be determined not just by place of effective management, but should take into account effective management, place of incorporation or constitution and ‘other relevant factors’, creating subjectivity and greater uncertainty for business
  • transparent entities - a widening of the existing Model Treaty rule about persons covered (Article 1) will seek to ensure that income of a transparent entity attracts the benefits of tax treaties in appropriate cases but also that these benefits are not granted where neither Contracting State treats, under its domestic law, the income of that entity as the income of one of its residents, encouraging a tax and refund process, and
  • interaction between the domestic hybrid (and other) recommendations and the provisions of tax treaties - the OECD has considered and given its opinion on a number of specific issues but there are likely to be practical issues which will need to be addressed when they arise.

The OECD does contribute to greater certainty in suggesting that countries may consider a rule that an entity that is considered to be a resident of another state under a tax treaty, under the expanded rule, will be deemed not to be a resident under domestic law.


5 October 2015

The final Report confirms an agreed outcome of the September 2014 deliverable recommending domestic rules to neutralise the results arising from hybrid mismatch arrangements but:

there is now much enhanced guidance on both the implementation of the rules and transitional arrangements (though no specific start date). These cover the complex situations that may arise in the appropriate counteraction measures. This depends on the arrangement and its effect, so that in essence the payer jurisdiction denies deduction for payment or the payee jurisdiction includes payment as income.

Many more examples show how it might apply to structures involving ‘payments’ of interest, or royalties or for goods (but not notional interest deductions).

There are still outstanding issues for a number of matters including in particular stock lending, hybrid regulatory capital and interaction with CFC regimes.


24 September 2014

The discussion paper has been turned into a comprehensive set of proposed rules with …

no substantive change to the treaty recommendations, relatively minor changes to the domestic law recommendations but more work to do in 2015 on imported mismatches, repos, interaction with controlled foreign companies (CFCs), regulatory capital and collective investment vehicles, and to take account of deliverables from other workstreams.

The principle of automatic application with no motive or purpose test, and a structure of primary and defensive linked rules with a hierarchy, has been preserved.

Hybrid payments are broadly defined and can include royalties or even payments for goods, but do not include deemed payments, for example notional interest deductions.

The reverse hybrid & imported mismatch rules have been revised somewhat to make them clearer and more consistent with other recommendations.

A bottom-up approach is taken to scope and in several areas is now restricted to related parties, structural arrangements or controlled groups (including generally treating a person as holding any investments held by an investor that is acting together with that person). Rules against deductible dividends and double deduction situations are proposed to have no scope restriction. Where a related party threshold is used it has been raised to 25%.

The OECD and G20 will consider the coordination of the timing of the implementation of these rules. It is possible that this may not be until after a Commentary and guidance have been produced, foreseen by September 2015.


3 June 2014

The OECD’s Annual Conference in Washington DC provided insight into several outstanding issues  …

including the fact that there seems to be convergence toward the bottom-up approach that would see matters within scope being specifically included rather than a top-down blanket definition with limited carve-outs. .

It was reiterated that EU representatives have been involved in the discussions and their current work for example on the Parent-Sub Directive is consistent with the overall BEPS approach.

Timing issues are something that the group is still working on though it was acknowledged that this was something that they were struggling with.

On thresholds, it was mentioned that the current thinking was for a 25% control test on various financial instruments with a 50% standard otherwise.


26 May 2014

The OECD’s webcast today noted that the Working Party/Task Force was discussing …

a number of outstanding technical issues. It was again stipulated that there has been "very close coordination" with the European Commission in coming to solutions which will be widely applicable.


15 May 2014

The bulk of the discussion at today’s public meeting repeated points made in general feedback and related to the OECD recommendations for domestic law change such that …

the OECD Secretariat claimed most people supported a linking approach rather than a motive or abuse test (yet very many comments through the day suggested strong support for a motive/ abuse test).

Concerns were voiced about whether there would be widespread acceptance and implementation in practice - if not, the difficulties would be exacerbated. There were also questions raised about whether the proposals were too broad given the intended target of abuse.

There was overwhelming push back from the meeting against the proposals for a 10 per cent threshold of relevant ownership for related party test on the basis it is much tougher than is needed and is impossible to apply in practice. A threshold is needed that secures effective control in this context. The secretariat reported that it had received a range of suggestions on the precise level of ownership and was interested in comments as to whether, say, a 30 per cent test would work as a mid point.

It was pointed out that making domestic rules depend on the operation of foreign law would be difficult and is unattractive, raising significant compliance/ implementation issues. Concerns were also expressed about alignment with EU proposed rules on hybrids and also conflict with EU law - which suggests the OECD rules should operate only in cases of abuse (but reported by the Secretariat that the work on BEPS generally and hybrids also is being done with participation of the European Commission).

There was some discussion of treaty issues. A suggestion made to the OECD was to apply a more consistent approach to the distributive articles (6-21 of the OECD Model) by using the standard phrase "derived by" rather than the various phrases currently used such as "paid to" etc.  The OECD was resistant to the suggestion as it potentially required changes to many articles in the treaty ( though it was pointed out the change could be delivered by a change to the definition rules in art 3 alone)

The Secretariat recognised the competent authority process needed to be improved.


8 May 2014

A 457-page consolidated document comprising 69 responses (including our own) on Hybrid Mismatch Arrangements ...

has been published by the OECD.


19 March 2014

The OECD has released two discussion draft papers on hybrid mismatch arrangements. Links to the press release and the papers:

If the recommendations are widely adopted they are likely to have a significant impact on multinational enterprises (MNEs). The OECD reports have a strong focus on intra-group financing, although other arrangements are not excluded. It is not surprising, given the scope of Action 2 of the OECD Action Plan, that the reports focus on the incidence of double non-taxation, and measures to combat such incidences. To ensure appropriate balance, it will be important that the OECD addresses the potential for double taxation which could, inadvertently or otherwise, arise as a consequence of the proposed changes.

The draft reports describe “hybrid mismatch arrangements” as being the result of a difference in the characterisation of an entity or arrangement under the laws of two or more tax jurisdictions that result in a mismatch in tax outcomes. The hybrid mismatch arrangements targeted in the reports are those that result in a lower aggregated tax burden for the parties involved. The OECD considers these arrangements to harm competition, economic efficiency, transparency and fairness.

Click here to read our Tax Policy Bulletin on the Discussion Draft.


21 February 2014

There has been much speculation about what will be in the OECD’s proposed Discussion Draft of recommendations on tackling hybrid mismatches but dates …

have now been announced provisionally by the OECD for publication of the draft (4 April), the deadline for comments to be made to the OECD (4 May) and a public consultation meeting at the OECD (15-16 May).


2 September 2013

Various countries have in the past taken actions through domestic law provisions (eg Denmark, Germany, UK). These are likely to contribute to the …

design of what is considered best practice – and the OECD already has done detailed work in this area in identifying problems and possible solutions (see our bulletin on the OECD report on Hybrid Mismatch Arrangements of March 2012).

Hybrid instruments

  • The EU intends to adapt the ‘parent subsidiary directive’, as noted in The EC Action Plan of 6 December 2012.
  • This would, in particular, give effect to the political agreement reached in 2010 by member states in the Code of Conduct Group on profit participating loans (PPLs).
  • The EC plan aims to stop the directive requiring exemption from taxation of distributions received when they are deductible for tax purposes in the source country.
  • This could even result in a new approach with the directive specifically mandating a tax charge rather than permitting a relief in specified circumstances.
  • The main problem that has faced action on hybrid instruments is though that they are in practice difficult to define.

Hybrid entities

  • Hybrid entities are arguably easier to define in theory and identify in practice and consensus on how to deal with them might be more easily reached.
  • Although potentially of significant scope, short-term action in the US at the entity level (eg cutting back on check-the-box) is likely to be hampered though by political deadlock and the wider domestic tax reform agenda in the US.


26 July 2013

An interesting point of interest in this area is the extent to which the coherence of tax rules to produce a level playing field between MNCs and nationally-based entities …

has become a more important influence in some territories. MNCs should not, they suggest, have access to more sophisticated planning techniques than those entities operating solely within a domestic market. This line of argument clearly adds pressure for action against hybrids.


19 July 2013

As indicated in the Action Plan, the focus on hybrids is premised on the need to address gaps created by the interactions between domestic tax laws. The Plan states …

there is a need to create standards to establish international coherence in corporate income taxation. The action on hybrids in particular is explained by reference to the use of such instruments to achieve unintended double non-taxation or long-term tax deferral (e.g. by double deductions, or generating deductions without corresponding income inclusions).

The action point is multi-faceted and includes work on the Model Treaty and recommendations for domestic law change. Model Treaty provisions are to be developed to prevent undue benefits under treaties for such hybrid arrangements (presumably countering the ability of such instruments to access treaty withholding tax reductions) and various changes for domestic law are to be considered, primarily in relation to deductibility. The work on hybrids will be coordinated with the work on interest expense deduction limitations, CFCs and treaty shopping (see below). On hybrids in particular, the OECD presumably has a head start from its recent work culminating in its report on Hybrid Mismatch Arrangements, as discussed in our April 2012 Bulletin

The Action Plan calls for recommendations in relation to the Model Treaty and domestic law to be completed within one year, by September 2014.


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Stef van Weeghel
Leader, Global Tax Policy & Administration Network
Tel: +31 (0) 88 792 6763

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