Hybrid financing rule in tax reform legislation

President Trump has signed tax reform legislation into law. As we take in all the changes and prepare for their implementation by Treasury and the IRS, it is easy to overlook some provisions with potential for significant impact for multinational companies. One such provision is the ‘hybrid’ financing rule denying deductions for certain interest and royalties paid to related foreign persons, specifically in instances where the payments either are not includible or are deductible to the recipient in their home jurisdiction. The provision is effective for tax years beginning after December 31, 2017.

Why should you care? Many multinational business transactions include instruments that potentially could generate hybrid dividends. Under the new statute (i.e., absent regulations potentially scaling the rule back), any payments of interest or royalties to a foreign reverse hybrid entity could be subject to deduction disallowance. Interestingly, the provision directs the Treasury to issue appropriate guidance, including with respect to: 

• The use of foreign branches
• The use of dual resident companies
• Potentially, imported hybrid mismatch arrangements
• The use of ‘structured arrangements’ 
• Treating a greater-than-25 percent reduction in income as a result of a tax preference as an exclusion of income, there by triggering the hybrid rules.

What should you do? There has been little guidance with respect to the hybrid rules and potential impact for multinational companies. As tax reform gets implemented over the coming year, companies should pay special attention to whether the IRS and Treasury will expand the rules. Stakeholders should remain engaged in the interpretation and implementation process.