Finance Bill

Written evidence submitted by the Chartered Institute of Taxation (CIOT) (FB 07)

Finance Bill 2016 - Clause 62 (Hybrid and other mismatches)


1. This clause and Schedule 10 introduce new rules intended to counteract tax avoidance through hybrid and other mismatch arrangements. That is, they aim to prevent multinational companies taking advantage of differences between laws in different countries to artificially reduce their tax bill using techniques such as claiming the same deduction twice.

2. This legislation implements recommendations made by the G20/OECD project to tackle Base Erosion and Profit Shifting (BEPS). This legislation will translate into statute a specific policy intention, which is to prevent the reduction of tax liabilities by multinational enterprises by the use of hybrid instruments and entities. The CIOT supports the policy intention. Our comments are thus focused on whether the legislation translates the policy intention into statute accurately and effectively and without unintended consequences.

3. In this regard we have concerns that these provisions may apply in some normal commercial situations, and that they will have a number of unintended consequences for branches of multinational companies where there is no mismatch involved.

4. Additionally, the provisions go beyond the scope of the actions recommended by the G20/OECD’s BEPS project. Where they do so, whilst they may counteract arrangements that lead to base erosion, the counteraction may be disproportionate to such an extent that it calls into question whether this is the right legislative response. Action taken by the UK that has an excessive result may be seen by other countries, as well as taxpayers, as a "grab for tax" rather than a principled anti-base erosion measure. To this extent, we would not consider the legislation an accurate and effective translation of the policy.

5. Our concerns largely relate to the most recently published additions to the legislation concerning hybrid instruments regarding permanent establishments, which bring into scope more arrangements involving transactions for goods and services. We agree that the base erosion arrangements involving goods and services should be tackled, but we believe it is likely that there are more appropriate methods that could be employed than those in this legislation.

Foreign Branches

6. Chapter 8 of new Part 6A TIOPA 2010 (Taxation (International and Other Provisions) Act 2010) "contains provision that counteract deduction/non-inclusion mismatches that it is reasonable to suppose would otherwise arise from payments or quasi-payments because a payee is a multinational company" (new section 259H(1)).

7. The proposed rules have a number of unintended consequences for branches where there is no mismatch involved and we think there are circumstances where, as currently drafted, this chapter would apply to normal commercial payments that have no tax avoidance purpose. We set out below one example of where this occurs.

8. We suggest that the Bill should be amended to ensure bone fide commercial trading payments are not caught.

9. Example

A company which is resident in the UK for tax purposes (UK Co) may have foreign branches which are treated as exempt from UK tax, due to an election made under Corporation Tax Act 2009 (CTA 2009) section 18A. If the jurisdiction in which the foreign branch is operating does not levy an income or corporation tax on the branch’s activities, we are concerned that Chapter 8 will subject payments by group companies to the foreign branch to UK tax as a result of the relevant conditions in draft TIOPA 2010 section 259HA being met, regardless of whether or not the foreign branch is substantial and whether or not the payments being made to it are on arm’s length terms.

10. We suggest that the relevant conditions in draft TIOPA 2010 section 259HA would be met in relation to payments by group companies to the foreign branch because:

o there is a payment made due to agreed inter-group trading policies, which, in the absence of any qualification to the term would appear to constitute an "arrangement", and thus Condition A is satisfied;

o UK Co is a "multinational company" and hence Condition B is met;

o UK Co is within the charge to corporation tax for the relevant period, so Condition C is met;

o Condition D is met wherever an inter-company payment is made to the foreign branch and a tax deduction is permitted for the group company making the payment, as no amounts would be included as ordinary income of UK Co for tax purposes in the foreign branch jurisdiction (because, as mentioned above, tax is not levied on income there) or in the UK (due to the foreign branch exemption election) and the mismatch appears to arise by reason of UK Co being a multinational company; and

o Condition E is met in relation to payments made by group companies to the foreign branch (they are in the same group).

11. This leads the counteraction provision in new TIOPA 2010 section 259HD to apply, and, it would appear to us that the relevant amount to be brought into tax is the full amount of the payment.

12. So, to take a particular scenario we are aware of, a UK-based multinational with a branch in Dubai carrying out genuine commercial activity there (we are not talking about just a ‘brass plate’ presence) appears to face having, in effect, its Dubai activity taxed in the UK by having any inter-company payments (which are a perfectly normal and necessary part of how multinationals operate) from other group companies to its Dubai branch brought into charge for UK tax purposes, even where these are made at arm’s length and on a commercial basis. This is because the UAE levies no corporation tax, so the legislation assumes any inter-company payment to the Dubai branch is for tax avoidance purposes and so should be brought into charge for UK tax purposes.

13. It is our understanding that the G20/OECD’s BEPS project, from which this new legislation derives, was not intended to lead to measures adversely affecting commercial transactions that simply result in value being recognised where it is created. It is therefore not clear to us why the anti-hybrid rules in new Part 6A TIOPA 2010 should apply in a commercial situation in the circumstances described above.

14. Any tax mismatch does not arise as a result of any difference in treatment of the foreign branches between different territories, but rather because the jurisdiction of the foreign branch does not levy tax on income and the income is not taxed in the UK because UK Co is making use of a statutory exemption.  The anti-diversion rule in the foreign branch exemption rules already prevents profits being artificially diverted to a foreign permanent establishment to avoid tax. 

15. In our view, the legislation should be amended so that Chapter 8 only applies to "structured arrangements" where it is reasonable to suppose the arrangements are designed to secure a mismatch.

UK distributor companies

16. Chapter 11 (section 259K) "contains provision denying deductions in connection with payments or quasi-payments that are made under, or in connection with, imported mismatch arrangements where the payer is within the charge to corporation tax for the payment period".

17. The effect of these measures on some common centralised intellectual property (IP) ownership / sales models may be viewed as disproportionate and, from the perspective of other countries, a ‘tax grab’ by the UK. Whilst these models do raise some base erosion concerns and are thus a legitimate target for action, we suggest there are better ways to counteract the base erosion that arises and make some suggestions below.

18. A common operating model for many foreign multinational companies is to have many local distributor companies, including one in the UK whose activities bear only limited risks and are, therefore, rewarded on an arm’s length basis with a profit of a low percentage of sales, say 3 or 4%. Any residual profit from the group’s operations accrue to companies that bear higher risks, including those that own IP.

19. The typical fund flows of this model would be:

o UK distributor sells to UK customers

o UK distributor buys goods from an intra-group logistics / warehousing company based outside the UK (often, but not always, based in the Netherlands), leaving the 3 or 4% profit margin in the UK that is fully taxed

o The logistics company organises all aspects of supply and interacts with manufacturers and acquires goods from those manufacturers, leaving only a small profit in that company

o The residual profit is earned by an offshore IP owner / manufacturer(s) that is / are often a hybrid entity (for example a Dutch CV [1] ), either directly or indirectly, and is often not taxed because of the hybrid nature

20. Chapter 11 (Imported mismatches) would seem to apply to these arrangements as:

o a payment is made by a UK company (cost of goods purchased (COGS))

o there may well be a "series of arrangements" due to the on-payments in the structure

o there would seem to be a hybrid payee deduction / non-inclusion mismatch within the arrangements (per section 259GB via section 259KA(6)(a)(iv)) between the logistics company and the hybrid IP owner / manufacturer(s)

o that mismatch would seem to be the total UK payment made as there is no ordinary income arising to the hybrid (or any other entity) as this is not brought into account anywhere

21. The counteraction would be denial of deduction for the whole COGS payment leaving the UK taxing the entire turnover with no deduction for any COGS.

22. To understand the impact of this, imagine a UK distributor company (part of, say, a US multinational group) which purchases goods for £100 million, incurs additional UK costs of £5 million and sells the goods for £108 million. The profit of the UK distributor is £3 million and this is the amount which would currently be taxed, resulting in a payment of £0.6 million under a 20% rate of corporation tax. Under the proposed changes the amount taxed would be £103 million, resulting in a demand for payment of £20.6 million, significantly more than the UK distributor’s total profits.

23. There does not seem to be anything in the current drafting of the legislation that would limit the restriction of the UK deduction to the "profit" earned by the hybrid rather than its "gross" receipts that are linked to the UK purchases.

24. We appreciate that this counteraction may be in line with policy, as the hybrid rules are intended to deny deductions where there are hybrids involved.  However, a counteraction that results in a UK distributor being taxed, effectively, on turnover rather than an arm’s length commercial trading profit goes beyond the remit of BEPS Action 2.

25. If enacted in its current form, this measure may drive a behavioural change regarding the use of such structures for sales into the UK. It may well be that this is the Government’s intention. But unless other countries follow suit, the structure could continue to be used for sales elsewhere. However, it could also be difficult for a group to change a long standing organisational structure for just one country such as the UK but leave it in place for other countries, in which case there would be a disproportionate hybrid counteraction in the UK. Other countries may view the disproportionate counteraction as a "tax grab" by the UK at their expense rather than an appropriate measure to prevent base erosion. It may be worth probing whether the Government have considered this possibility.

26. Earlier in the BEPS process the CIOT pointed out that not every BEPS work stream should seek to solve every BEPS problem, and this appears to us to be a case in point, as the UK counteraction is clearly excessive and applies just because there is a hybrid recipient but where the underlying UK commercial profit position would be identical whether or not there was a hybrid recipient (for example where a low taxed centralised IP owner / manufacturer exists). The counteraction as currently drafted therefore applies purely because a hybrid exists, and not because the UK distributor company’s UK tax position is enhanced by the hybrid, as well as the counteraction clearly being excessive.

27. On the assumption that some form of counteraction will be retained in the rules where a hybrid exists as this is the policy intent, we would suggest that a more appropriate counteraction in a situation like a centralised IP ownership / manufacturing model is to limit the UK deduction restriction by reference to the profit that is made by the ultimate recipient(s) and not the gross payment made by the UK distributor: that is, take into account costs incurred by the IP owner / manufacturer(s). We recognise that this may be difficult to draft, but perhaps the section 259KB(3) onwards legislation could be adapted for this purpose and allow P’s share of the relevant mismatch to be reduced where there are costs incurred in other non-UK companies related to the earning of the profit from selling goods to the UK distributor. Alternatively, could the definition of ordinary income take into account such costs in a situation such as this, leaving a smaller hybrid mismatch to counteract?

28. Both of these suggestions would produce a more proportionate measure than the current drafting.


29. We also have some concerns with the definition of "Control group" in new TIOPA 2010 section 259NA. This does not include an exclusion for "control" arising only as a result of a loan creditor relationship.

30. We are concerned that this could mean that the legislation could apply in circumstances where a UK taxpayer has no tax avoidance motive, in particular Chapter 11 of new TIOPA 2010 Part 6A which "contains provision denying deductions in connection with payments or quasi-payments that are made under, or in connection with, imported mismatch arrangements where the payer is within the charge to corporation tax for the payment period."

31. For example consider a company resident in the UK for tax purposes (UK Borrower) which is borrowing from a foreign fund constituted in the form of a company (Lender). Lender may be entitled to the majority of assets on a winding up of UK Borrower.

32. Because there is no tax motive requirement for an over-arching arrangement (as defined in section 259KA(5)), if Lender is involved in tax structuring outside the UK, UK Borrower could be denied a deduction for payments of interest even though it is an ‘innocent’ party: that is assuming circumstances where there was nothing available to UK Borrower to suggest that there is any tax structuring being undertaken by its lender (for example, it was not being charged a reduced interest rate and was not sharing in any tax benefits).

33. As mentioned above, it is not clear to us why the anti-hybrid rules in new Part 6A TIOPA 2010 should apply to UK Borrower when it has entered into commercial borrowing arrangements in circumstances such as those described above.

34. In our view, the definition of control group should be amended to include a loan creditor exclusion in cases where the only connection between the UK borrower and anyone else who is a party to the over-arching arrangements is the fact that the borrower is a borrower under a loan facility.

Appendix: The Chartered Institute of Taxation

The Chartered Institute of Taxation (CIOT) is the leading professional body in the United Kingdom concerned solely with taxation. The CIOT is an educational charity, promoting education and study of the administration and practice of taxation. One of our key aims is to work for a better, more efficient, tax system for all affected by it – taxpayers, their advisers and the authorities. The CIOT’s work covers all aspects of taxation, including direct and indirect taxes and duties. Through our Low Incomes Tax Reform Group (LITRG), the CIOT has a particular focus on improving the tax system, including tax credits and benefits, for the unrepresented taxpayer.

The CIOT draws on our members’ experience in private practice, commerce and industry, government and academia to improve tax administration and propose and explain how tax policy objectives can most effectively be achieved. We also link to, and draw on, similar leading professional tax bodies in other countries. The CIOT’s comments and recommendations on tax issues are made in line with our charitable objectives: we are politically neutral in our work.

The CIOT’s 17,600 members have the practising title of ‘Chartered Tax Adviser’ and the designatory letters ‘CTA’, to represent the leading tax qualification.

July 2016

[1] A form of partnership under Dutch law treated as transparent by the Netherlands and so not liable to Dutch corporation tax (the Dutch rules instead seeing the individual partners (which may be corporate partners, which could be, and often are, subsidiaries of the same multinational) as the entities to be taxed), but treated as non-transparent by (in particular) the United States so US partners in the partnership do not pay US tax (the US authorities instead seeing the partnership itself as the entity to be taxed). Setting up a partnership of this kind in the Netherlands where the partners are US-resident subsidiaries of a multinational would in theory result in the profits of the partnership not being taxed at all – at least not until they are extracted from the partnership.


Prepared 4th July 2016