Government representatives at a May 15 consultation defended draft OECD guidance on hybrid mismatch arrangements that uses a 10 percent ownership threshold to determine whether parties to a hybrid instrument are related.
The guidance, released March 19, responds to action item 2 of the OECD’s base erosion and profit shifting (BEPS) initiative.
Speaking on behalf of the International Alliance for Principled Taxation, a group of about 24 multinationals, Carol Dunahoo argued that the drafts’ related party ownership threshold of 10 percent is too low.
In a commercial joint venture where the parties put together financing, for example, a party with a 10 percent ownership interest will be unable to compel the other party to provide information about their structure or financing arrangements, she said. In such cases it could be impossible to comply with the rules, argued Dunahoo, who is with Baker and McKenzie.
Dunahoo maintained that a greater than 50 percent voting control threshold would be more appropriate. Targeted “acting-in-concert” rules could apply to parties with less than 50 percent voting control to counter any abuses, she added.
Nigel Fleming of Blackrock also argued in favor of a 50 percent voting control threshold. Fleming said that determining if the 10 percent threshold is met “is not always easy” for financial institutions. In the case of an investment manager, one must amalgamate all the holdings under common management to test, he said. It will be impossible for some banks to know if they hit the threshold, he said.
The U.K’s delegate to working party 11 asked how raising the threshold for relatedness to 50 percent voting rights would help if it is truly impossible to know if ownership is at 10 percent or not. “How do you know whether you are a 10 percent owner, or if you are a 90 percent owner, if you can’t track what you own?”
A Blackrock representative responded that “there are many other non-tax rules in regulations” that cause companies to learn when they own more than 50 percent of another company. Regardless of what threshold is set, he said, the “common control” test should be replaced with an “acting-in-concert rule” so businesses do not have to add up all their investments to figure out if they are over the threshold.
A BEPS Monitoring Group representative noted that similar arguments were raised when the Foreign Account Tax Compliance Act (FATCA) was introduced. Determining control of related parties “is difficult, but it is not impossible,” she said.
Italy’s delegate to the OECD working party acknowledged that it does appear to be difficult to comply with the rules. He said he wondered, though, if issuers and subscribers could resolve their concerns once the hybrid mismatch rules are implemented by negotiating a requirement to provide information in contract terms.
China’s delegate said the final OECD report should provide countries with flexibility to decide if they wish to address hybrid mismatches between unrelated parties. Some jurisdictions have sufficient capacity to address these transactions, so there is no reason to prevent the adoption of such rules, she said.
The U.S.’s delegate asked industry reps whether it would be a hardship to require 30 percent common ownership. “We could maybe get that 10 percent is an issue, but once you get above that it gets harder to see,” he said.
Germany’s delegate asked if intragroup repos needed special exceptions from hybrid rules even if the threshold for related parties is raised. Are there good reasons not to cover repos? he asked. In response, a PwC representative said that applying hybrid mismatch rules to repos would cause “significant” collateral damage but do little to close down abuse. Any abuse could be picked up by structured arrangement rules, he said. The UK delegate said that it would be helpful to have more information on whether the proposals work well for stock lending transactions.
Philipp Domer, on behalf of the Swiss Bankers Association, and Barbara Angus of EY argued that hybrid regulatory capital should be exempt from the hybrid mismatch rules. Karen Gibian, on behalf of The Investment Company Institute Global, discussed the need for special rules for collective investment vehicles.
Italy’s delegate asked if problems applying the hybrid rules to regulatory capital could be solved by creating a rule forcing an inclusion or denying a dividend exemption in the hands of the holder so as to not destroy the deduction as a defensive rule. In response, a TD Bank representative said that he would allow the deduction and force the inclusion. Currently spreads are low, so banks need the deductions, he said.
Angus argued the hybrid mismatch rules should specify that GAAR rules do not apply to instruments that are subject to the hybrid construct. She said a GAAR rule’s “after the fact application” could cause a change in tax treatment of an instrument by one country, but leave the other country unable to respond. She also said the OECD Should not move forward with hybrid mismatch rules until more general BEPS interest rules are implemented
The OECD’s Achim Pross said the working the group is aware that it needs to coordinate the hybrid mismatch rules with guidance under BEPS action items on interest limitations. “There is some level of assurance that there is coordination because the group that is working on the hybrids is the same group – working party 11 – that will be working on interest expense. We are conscious of the fact this needs to integrate,” he said.
