Global Tax Alert | 28 November 2017

Australia releases draft anti-hybrids law

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Executive summary

On 24 November 2017, Australia’s Treasurer released Exposure Draft legislation (ED) of the Treasury Laws Amendment (OECD Hybrid Mismatch Rules) Bill 2017 (TLAB) for public consultation. The amendments in the ED are to implement the Organisation for Economic Co-operation and Development’s (OECD’s) October 2015 Report on Base Erosion and Profit Shifting (BEPS) Action 2 (Countering the effects of Hybrid Mismatch Arrangements, the hybrid mismatch rules).

The ED follows consideration of the implementation of the rules by the Board of Taxation (BoT) and the release in 2016 of the BoT reports Implementation of the OECD Hybrid Mismatch Rules and Application of Hybrid Mismatch Rules to Regulatory Capital.

Submissions on the ED are due by 22 December 2017. EY is preparing a submission and is engaging with Treasury and the Australian Taxation Office (ATO) before the deadline.

The rules are far-reaching for affected arrangements and many existing common Australian financing and business arrangements will be impacted, requiring action. For affected entities, the restructure of arrangements in response to the law might require consideration of issues including taxation implications in multiple countries, notifications to the Foreign Investment Review Board and consideration of stamp duty issues. These issues may involve significant lead times, requiring action to commence the work program.

Detailed discussion

Proposed start date of the new rules and timing of application

The hybrid mismatch rules will apply to payments made on or after the day six months following the day TLAB receives Royal Assent. There is no grandfathering of arrangements in place prior to this date.

TLAB is expected to be introduced into Parliament in the 2018 Parliamentary sittings commencing 5 February 2018. Accordingly, the earliest start date expected likely will be in the second half of 2018.

The Treasurer’s media release announced two additional EDs that will be issued in the future: an integrity rule to counter certain arrangements not covered by the ED and an amending law to implement OECD recommendations with respect to intra-entity branch hybrid arrangements. The start date for these EDs will be the same as the TLAB but no expected release date has been provided (it is likely that these drafts will be issued in early 2018).

Overview of the law

A hybrid mismatch arises, broadly, under one of two scenarios:

1) The same payment results in a deduction in more than one jurisdiction (a deduction/deduction mismatch)

2) The same payment results in a deduction in one jurisdiction and a non-inclusion in another jurisdiction (a deduction/non-inclusion mismatch)

The ED rules will apply to an accruals deduction in the same way they apply to an actual payment.

To the extent a hybrid mismatch has been identified, the mismatch is neutralized by:

  • A deduction being denied in Australia where the Australian taxpayer has the deduction element of the hybrid mismatch
  • An amount being included in assessable income where the Australian taxpayer has the non-inclusion element of the hybrid mismatch (and the country with the deduction element has not otherwise neutralized the hybrid mismatch)

The hybrid mismatch rules are very broad in application and may apply to any transactions with foreign entities that result in deductions in Australia or otherwise reduced assessable income. While the rules are clearly directed at interest payments, they can also apply for example to royalties, decline in value of assets, and payments for inventory and services.

A hybrid mismatch will only be covered by the hybrid mismatch rules if it is in relation to one of five defined types of hybrid mismatch arrangements as outlined below.

Hybrid financial instruments mismatches

A hybrid financial instrument mismatch arises where:

  • A payment is made in relation to a debt, equity or derivative financial arrangement (certain transfers of financial instruments such as securities lending arrangements are also captured)
  • The mismatch is attributable to differences in the treatment of the relevant instrument between Australia and the foreign jurisdiction

A mismatch will also occur under these rules where the foreign jurisdiction either does not tax the return or taxes the return at a lower tax rate than would ordinarily be imposed on interest in that jurisdiction.

A carve out applies to instruments where the interest or arrangement is three years or less.

The draft explanatory memorandum (EDEM) has this example of a hybrid financial instrument (see PDF file for diagram of example).

An Australian company has issued redeemable preference shares giving rise to a deduction in Australia and non-inclusion in Country B. The deduction in Australia is to be denied under the hybrid financial instruments mismatch rule.

Hybrid payer mismatch

A hybrid payer mismatch arises:

  • Where an entity makes a payment and that payment is disregarded for the purposes of the tax law of one country (resulting in non-inclusion)


  • Is deductible for the purpose of the tax law of another country; and
  • The hybrid mismatch is attributable to the hybrid nature of an entity.

Any amount of hybrid mismatch is reduced by any “dual inclusion income” (income that is taxed in Australia and the foreign jurisdiction).

The EDEM provides this example of a hybrid payer mismatch (see PDF file for diagram of example).

Under the example, Aus Co makes a payment to its parent for the provision of services, but Aus Co is treated as a disregarded entity in Country B. Aus Co is a hybrid payer because the payment is taken into account as a deduction in Australia and disregarded in Country B. In this example, the deduction will be denied in Australia under the hybrid payer mismatch rule.

Reverse hybrid mismatch

A reverse hybrid mismatch arises where a payment is made by an entity that is:

  • Transparent for the purposes of the tax law of the country in which it is formed
  • Non-transparent for the purposes of the tax law of the country in which its investors are subject to tax (resulting in non-inclusion)

However, if an amount is included in income under a foreign accruals taxation regime that corresponds to the Australian controlled foreign company rules, there would not be a mismatch for the purposes of the reverse hybrid rule.

The EDEM provides the following example of a reverse hybrid mismatch (see PDF file for diagram of example).

Aus Co makes a payment to RHP which is considered a partnership in Country C. Country C considers Investor Co in Country B as the recipient of the payment for tax purposes while Country B considers Country C the recipient. The payment gives rise to a deduction/non-inclusion mismatch. The deduction for the payment would be denied in Australia.

Deducting hybrid mismatch

A deducting hybrid mismatch arises where:

  • A hybrid entity makes a payment that is deductible in more than one jurisdiction (a double deduction)
  • The two jurisdictions have a different view on the entity that is subject to tax (for example one jurisdiction taxes the partnership while the other the partners) or through the residency treatment of the same legal entity (for example being resident in both jurisdictions)

The EDEM provides these examples of deductible hybrid mismatches (see PDF file for diagram of example).

This example has ABC Ltd as the head company of an Australian tax consolidated group and Foreign GP is a subsidiary member of that tax consolidated group. Foreign GP is a corporate entity in Country B and has an external interest expense. The Foreign GP is treated as the liable entity in Country B, however in Australia, ABC Ltd is the liable entity. The deducting hybrid rules are to apply to deny the interest deduction in Australia.

Another example has ABC Co resident in Country B with a borrowing attributable to its Australian permanent establishment (see PDF file for diagram of example).

Country B taxes residents on worldwide income, so the interest is deductible in Australia and in Country B. Unless Country B has a rule that has substantially the same effect as the hybrid mismatch rules, Australia would deny the interest deduction.

Imported hybrid mismatch

An imported hybrid mismatch arrangement arises where:

  • A payment is made either directly or indirectly by an Australian taxpayer to a nonresident
  • That payment funds the return on a hybrid arrangement (that is not otherwise neutralized by hybrid mismatch rules in a foreign jurisdiction)

This is an integrity rule aimed at stopping arrangements that seek to avoid hybrid mismatch rules by interposing one or more entities between the hybrid mismatch and a country that has hybrid mismatch rules.

It is now critical that Australian entities, and their foreign parent and associated entities, be aware of the foreign tax treatment of payments made to and between jurisdictions outside of Australia. Under the imported mismatch rule, Australian deductions can be denied even when the Australian entity is not directly entering into any hybrid arrangements or dealing with hybrid entities. If hybrid arrangements exist anywhere in the global group and indirectly fund Australia the hybrid mismatch rules may deny deductions.

Entity relationships and structured arrangements

The hybrid mismatch rules will apply where either of the two following conditions apply:

  • The relevant parties to the arrangement are members of the same control group (a group that is consolidated for accounting purposes or where the entities have at least 50% common ownership)
  • The arrangement is a structured arrangement, meaning:
    • The hybrid mismatch is priced into its terms
    • Or
    • It is reasonable to conclude that the scheme has been designed to produce a hybrid mismatch

Dealings between unrelated parties will therefore still attract the hybrid mismatch rules if the arrangement is a structured arrangement. However an entity that is not a “party” to a structured arrangement will not be subject to the hybrid mismatch rules. Broadly, for an entity not to constitute a party it must be reasonable to expect that neither the entity nor a member of its own controlled group would be aware that the scheme gives rise to a hybrid mismatch.

The hybrid financial interest rules have a lower threshold for application. These rules also apply where the entities have a 25% common ownership.

Further integrity and branch packages to come

The Treasurer’s media release to the ED also noted that two additional EDs will be prepared for future release. The start date for these rules will be the same as the TLAB but no expected release date has been provided (it is likely that these drafts will be issued in early 2018).

Integrity rule to come

A new integrity rule will address multinational groups investing into Australia which seek to effectively achieve a double non-taxation outcome by using investment structures and arrangements that may not fall within the scope of the hybrid mismatch rules. The example provided in the media release is foreign headquartered groups investing into Australia using financing arrangements through interposed entities in zero tax countries but there is little detail on the extent of the proposed rule.

Branch rules to come

Branch mismatch rules will address the OECD’s report Neutralising the Effects of Branch Mismatch Arrangements (released in July 2017). That report recommended that countries address double non-taxation outcomes which arise in relation to branch structures that are not otherwise caught by the hybrid mismatch rules.

It will be important to monitor these law developments where taxpayers have branch structures or are otherwise restructuring out of the hybrid mismatch rules.

Restructuring: impact of General Anti-avoidance regime (GAAR)

During the BoT consultation process, a consistent concern was raised whether the Commissioner would seek to apply the Part IVA GAAR in circumstances where a taxpayer restructures existing hybrid arrangements in response to the hybrid mismatch rules. The ED is silent on the interaction with Part IVA.

While strong arguments exist that Part IVA should not apply to restructures to remove hybrid mismatches that occur prior to the law being implemented, given the importance of this issue legislative or administrative safeguards on the application of Part IVA is appropriate.

The ATO has advised us that a Practical Compliance Guide will be issued to outline how it would administer Part IVA in relation to restructures of hybrid arrangements.

Thin capitalization interactions

An inappropriate thin capitalization outcome will arise where a debt deduction is denied under the anti-hybrid provisions but the debt remains included in the calculation of “adjusted average debt” for thin capitalization purposes. Treasury has not responded to past submissions to address this inequity in the ED.

This is an important issue for taxpayers that might leave hybrid structures in place due to commercial constraints to restructure or on the basis that a denial of an Australian deduction is not a sufficient impetus to restructure given that the income might not be taxed or a deduction is still available in another jurisdiction.

Taxpayers which do not restructure and have deductions denied under the hybrid mismatch rules may be adversely impacted by the transactions nonetheless affecting their thin capitalization capacity.

Consequential amendments

The ED proposes to modify domestic tax law to:

  • Deny imputation benefits on franked distributions made by an Australian corporate tax entity if the entity was entitled to a foreign income tax deduction in respect of all or part of the distribution.

Transitional rules are to apply to Additional Tier 1 capital instruments issued by authorized deposit-taking institutions before 9 May 2017. The amendments to deny imputation benefits do not apply in relation to distributions on the instrument that are made before the first available call date of the instrument that occurs on or after 9 May 2017.

  • Prevent certain foreign equity distributions received, directly or indirectly, by an Australian corporate tax entity that holds a participation interest of at least 10% in the foreign company from being non-assessable non-exempt income if the foreign company that made the distribution was entitled to a foreign income tax deduction in respect of the distribution.

Practical implications and next steps

The hybrid mismatch rules will impact arrangements commonly seen including but not limited to:

  • RPS financing: Australian companies issuing redeemable preference shares to foreign subscribers
  • Foreign GP financing: Foreign general partnerships established by Australian partners
  • Australian LP financing: Australian limited partnerships with foreign partners
  • Australian reverse hybrid financing: Australian entities that have issued debt to a Australian transparent entity such as a general partnership or trust that is treated as opaque for foreign purposes
  • Offshore permanent establishment financing: Australian groups that have established foreign branches with payments between members of the same Australian tax consolidated group
  • Foreign entities with Australian branches
  • Australian subsidiaries in multinational groups where hybrid structures exist “up the chain” in the multinational group
  • Royalties, decline in value of assets and payments for inventory and services caught by the rules

As there will be no grandfathering of arrangements under the rules, taxpayers with potential hybrid arrangements in place should consider the impact of the hybrid mismatch rules now and consider unwinding hybrid arrangements.

Restructuring hybrid arrangements involves a range of issues, which might involve significant lead times. These include:

  • Analysis of implications and planned changes in other countries
  • Australia’s Foreign Investment Review Board (FIRB) has oversight of various internal reorganizations. Affected reorganizations may require FIRB approval, requiring early consideration of FIRB requirements and impacts on timing and disclosure
  • Impact on tax consolidation and any deconsolidation and reconsolidation issues, including announced consolidation changes, and taxation of limited partnerships
  • Stamp duties on refinancing, including any corporate reconstruction reliefs
  • Impacts under taxation of financial arrangements and foreign currency rules
  • Impacts for transfer pricing and advance pricing arrangements


EY has been active on the consultation of the rules to date and is preparing a submission on the TLAB, with an initial Treasury meeting ahead of the submission. If you have any issues you would like considered as part of the consultation process or wish to discuss existing arrangements further, please contact the people listed below or your EY team members.

Taxpayer submissions on the law can be forwarded to

For additional information with respect to this Alert, please contact the following:

Ernst & Young (Australia), Sydney
  • Sean Monahan
  • Stephen Chubb
  • Lachlan Cobon
Ernst & Young (Australia), Melbourne
  • Brendan Dardis
  • Peter Janetzki
Ernst & Young (Australia), Perth
  • Andrew Nelson
  • David S Browne
Ernst & Young LLP, Australian Tax Desk, New York
  • David Burns

EYG no. 06716-171Gbl