Cross-border Tax Talks

Pillar Two Hybrid Arbitrage: stormy waters ahead?

Doug McHoney (PwC’s International Tax Services Global Leader) is joined by Raza Janjua, a Director in PwC’s ITS practice in New York and author of a recent article on Pillar Two hybrid arbitrage arrangements. Doug and Raza discuss the BEPS Action 2 origins and ATAD 2 implementation; how Pillar Two’s simplified safe harbors spawned detailed hybrid arbitrage rules; the core categories—deduction–non‑inclusion, duplicate loss, and duplicate tax recognition; real‑world traps like preferred equity treated as book debt, FX‑driven mismatches, valuation‑allowance hypotheticals, cash pools and back‑to‑backs; narrow dual‑inclusion relief and why it should be jurisdiction‑level; CFC‑regime interactions; retroactivity and early adoption; and what future administrative guidance and the G7 architecture could mean for US rules such as Sections 245A(e), 267A, and the DCL regime.  

• [00:06] Opening and Guest intro: Raza Janjua’s role and his career path to international tax 
• [03:52] What is a hybrid mismatch and why policymakers focus on it.  
• [05:35] Legislative adoption: ATAD 2 in Europe; US TCJA’s participation exemption, the hybrid rules, and long‑standing DCL rules.  
• [07:37] Pillar Two model rules; the section 3.2.7 guardrail and absence of explicit hybrid rules.  
• [08:50] Simplified safe harbors; simplified ETR mechanics; emergence of hybrid arbitrage rules.  
• [10:36] Retroactivity and current application of hybrid rules only to Safe Harbors 
• [13:10] – Complexity increases with Hybrids under Pillar Two: tax vs book—and even cross‑GAAP—dimensions.  
• [14:21] Specific hybrid arbitrage arrangements - Three categories defined: Deduction/Non-inclusion, duplicate loss, and duplicate tax recognition.  
• [16:22] Preferred equity example; Safe Harbor disallows the expense but not the income.  
• [21:03] FX volatility: functional‑currency differences create D/NI mismatches.  
• [22:30] Valuation‑allowance hypotheticals: testing commensurate increase using deferred tax attributes.  
• [24:40] Dual‑inclusion income exception; absent for D/NI—should be added to align with policy.  
• [27:00] Back‑to‑backs and cash pools: tracing indirect credit and selecting affected loans.  
• [28:44] Duplicate loss arrangements; book or tax duplication triggers adjustments; the narrow dual‑inclusion exception. 
• [32:20] Disregarded flows in hybrid entities: cost‑plus provider example and pitfalls.  
• [34:15] UK/Ireland solutions: opaque treatment to avoid mechanical double‑deduction outcomes.  
• [34:45] CFC‑regime inclusions: should count toward dual inclusion (Australia’s approach; GILTI questions).  
• [37:00] What’s next? Administrative guidance, permanent safe harbors, and G7 architecture priorities.  
• [38:00] US interactions: Sections 245A(e) and 267A, DCL; QDMTT/IIR considerations and circularity risks.  

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