The Anti-Tax Avoidance Directive II, ATAD II [the 'Directive'], is a new EU legislation on hybrid mismatches between EU and third countries. The amendments aim to combat aggressive tax planning used by [mostly] multinational enterprises to avoid tax liabilities.
ATAD I 1, which the Directive amends, used to deal only with hybrid mismatches arising between EU Member States.
Hybrid mismatches are differences in the tax treatment of an entity or an instrument under the laws of two or more jurisdictions. If a mismatch happens, it is neutralised by disallowing a deduction or including the amount in assessable income depending on the situation. The rule on hybrid mismatches aims to prevent companies from exploiting national mismatches to avoid income tax liability or getting double taxation treaty benefits.
By way of an example, company A may perceive the payment made by company B as a dividend payment and thus not taxable, while B perceives it as interest payment and thus deductible. This would constitute a hybrid transfer.
Mismatches are evaluated by comparing tax treatments of the entity/transaction in different jurisdictions.
The Directive states that Member States should use OECD's Report on Base Erosion and Profit Shifting ['BEPS'] on Action 2 as a source of interpretation. In fact, if one looks at the Report, some of the definitions and interpretations are taken word for word.
Furthermore, if another Directive already neutralizes the mismatch in tax outcomes then this Directive does not apply.
Notice the pattern of what the OECD's Report refers to as 'defensive actions'. Often times if one jurisdiction does not neutralize the mismatch, then the other jurisdiction can fictitiously add the mismatched sum to the taxpayer's income statement/computation or, alternatively, deny the deduction.
Three Kinds of Mismatch Outcomes
D/NI - Deduction or Non-Inclusion
Payments that are deductible under the rules of the payer jurisdiction and are not included in the ordinary income of the payer. This kind of mismatch usually happens when a payment, or a part thereof, is considered as a tax deductible in one jurisdiction and is not included in the income statements in the other jurisdiction.
DD - Double Deduction
Payments that give rise to two deductions in respect of the same payment in two jurisdictions.
Indirect D/NI - Indirect Deduction or Non-Inclusion
Payments that are deductible under the rules of the payer jurisdiction and that are set-off by the payee against a deduction under a hybrid mismatch arrangement
What does the new Directive provide for?
The Directive expands and now provides rules for:
Hybrid permanent establishment mismatches One jurisdiction considers the business to be carried out in a particular jurisdiction through a permanent establishment while another jurisdiction does not consider it to be so. As a result, the business is not taxed where it is truly carrying out its business activity [because the income is not included in its tax assessments] and it also gets the exemptions for profits in the other jurisdiction where it is resident or where the head office is located. Hybrid transfers Type of arrangement involving transfer of a financial instrument where the underlying return is treated from the tax perspective as deriving at the same time by more than one of the parties to the arrangement. Hybrid financial instrument mismatches Happens when financial instruments are treated differently in terms of taxation in different jurisdictions. The Directive allows an option for Member States to exempt certain financial institutions instruments until 31 December 2022. Dual resident mismatches For taxation purposes the taxpayer is considered to be resident in two jurisdictions and it deducts the same sum from both...