Hybrids and Interest Limitation Consultation · 2019. 4. 4. · KPMG Telephone 1 Stokes Place Fax...

Hybrids and Interest Limitation Consultation

KPMG Response to Consultation

18 January 2019

KPMG 1 Stokes Place St. Stephen’s Green Dublin 2 D02 DE03 Ireland

Telephone Fax

Internet

+353 1 410 100 +353 1 412 1122 www.kpmg.ie

Private and confidential Hybrids and Interest Limitation – Public Consultation Tax Division Department of Finance Government Buildings Upper Merrion Street Dublin 2 D02 R583

Email: [email protected]

18 January 2019

Dear Sir,

Hybrids and Interest Limitation – Public Consultation

KPMG is pleased to respond to the public consultation on Ireland’s implementation of anti-hybrid rules and an Interest Limitation rule as set out under the European Union’s (EU) Anti-Tax Avoidance Directive (ATAD).

We recognise that some of the issues related to implementation of anti-hybrid rules and an Interest Limitation rule under ATAD are interlinked. This is particularly where the measures affect the tax treatment under Ireland’s corporation tax regime of payments in the nature of interest and other financial payments.

The ATAD rules will add protections from base erosion involving interest deductions and other financial payments to those already in Ireland’s corporation tax regime. The framework of the existing regime already provides a strong basis for protection from base erosion. In order to readjust the balance of protections from base erosion provided under Ireland’s corporation tax regime, we have suggested that a redesign of Ireland’s corporation tax regime for taxing interest and other financial payments should be done in tandem with implementation of an Interest Limitation rule (and in contemplation of some of the interlinked effects of the anti-hybrid rules).

For this reason, in Section 1 of this submission, we have summarised our findings from a review of the protections from base erosion that exist in Ireland’s regime. We have suggested how a redesign of that regime could be achieved by mapping the changes required to the existing regime in combination with proposed changes upon implementation of anti-hybrid rules and an Interest Limitation rule in order to outline a revised regime which contains a readjusted balance of protections.

Section 2 of our submission contains our responses to the consultation questions on implementation of anti-hybrid rules. Section 3 contains our responses to the consultation questions on implementation of an Interest Limitation rule.

In forming our responses, KPMG has reviewed the technical requirements of the ATAD measures and supplementary guidance available from the Organisation for Economic Cooperation and Development (OECD) which is set out in final reports under its plan to counteract Base Erosion and Profit Shifting (BEPS). The related guidance is set out in the OECD’s final reports under Actions 2 and 4 of its BEPS Plan.

Sharon Burke

Partner t: +353 1 410 1196 e: [email protected]

mailto:[email protected]

KPMG 1 Stokes Place St. Stephen’s Green Dublin 2 D02 DE03 Ireland

Telephone Fax

Internet

+353 1 410 100 +353 1 412 1122 www.kpmg.ie

We have also reviewed the detailed implementation of hybrid and interest limitation measures in other jurisdictions’ regimes which have features in common with Ireland’s regime. We have taken soundings from KPMG member firms in other EU Member States in order to understand the choices made by those Member States in implementing the ATAD measures. This combination of insights has been reflected in our responses set out in Sections 2 and 3 of this submission as well as in a series of Appendices which set out summaries of our findings in tabular form.

Finally, we have taken soundings from businesses based in Ireland in order to understand the potential impact upon them of implementation of the measures. Throughout our responses, we have addressed points for consideration in relation to the practical implementation of the measures so that, insofar as possible, the intended effect of these very complex measures can be understood and achieve certainty for business.

The contact point for this submission is Sharon Burke. Sharon’s contact details are:

Email: [email protected]; Direct telephone: (01) 410 1196.

Should you wish to discuss any aspect of the attached submission please do not hesitate to contact us.

Yours faithfully ,

Sharon Burke

Partner

Glossary of terms

Action 2

Action 2 of the OECD’s Plan which comprises 15 Actions to counteract Base Erosion and Profit Shifting (BEPS). Action 2 focuses on Neutralising the Effects of Hybrid Mismatch Arrangements and Branch Mismatch Arrangements.

Action 4

Action 4 of the OECD’s Plan which comprises 15 Actions to counteract base Erosion and Profit Shifting (BEPS). Action 4 addresses Limiting Base Erosion Involving Interest Deductions and other Financial Payments.

AOA Authorised OECD Approach for the attribution of profits to branches.

ATAD (ATAD1, ATAD2)

Anti-Tax Avoidance Directive. In relation to the Interest Limitation Rule, the measures are included in Council Directive (EU) 2016/1164 of 12 July 2016. This is described as ATAD1. In relation to anti-hybrid rules, the measures are included in amending Directive (EU) 2017/952 of 29 May 2017 amending Directive 2016/1164 as regards hybrid mismatches with third countries. This is described as ATAD2.

BEPS Base Erosion and Profit Shifting.

CFC Controlled Foreign Company (or corporation) rule. This is a regime which taxes currently profits of a non-resident controlled company on its parent.

CIR Corporate Interest Restriction. This is the name commonly used to describe the Interest Limitation Rule adopted by the UK.

Coffey Report The 2017 report commissioned by the Irish Department of Finance entitled ‘Review of Ireland’s Corporation Tax Code’ which was prepared by independent expert, Mr. Seamus Coffey.

DCL Dual consolidated loss rules. These are measures adopted to limit the scope for offset of tax losses by an entity in two jurisdictions.

D/D outcome Double deduction outcome under a hybrid mismatch arrangement.

Deduction without inclusion

A tax deduction in the payor jurisdiction without that amount being included as taxable income in the payee jurisdiction.

Defensive response

Responses to counteract hybrid mismatch arrangements are framed as primary and secondary or defensive responses. The primary response is expected to be the main and first countermeasure to counteract a hybrid mismatch outcome. A secondary or defensive response may apply if the counterparty jurisdiction for the hybrid mismatch has not implemented the primary response.

Disregarded permanent establishment

An arrangement that is treated as giving rise to a permanent establishment under the laws of the head office jurisdiction but is not treated as giving rise to a taxable permanent establishment under the laws of another jurisdiction.

D/NI outcome Deduction/non-inclusion outcome under hybrid mismatch arrangements.

Double deduction A tax deduction for the same item in both the payor jurisdiction and the investor jurisdiction under a hybrid mismatch arrangement.

Dual inclusion income

Any item of income that is taxable under the laws of both jurisdictions where a mismatch outcome has arisen under a hybrid mismatch arrangement. Double deductions only give rise to an adjustment under anti-hybrid rules where the deduction is against income that is not dual inclusion income.

Glossary of terms

EBITDA

Earnings before interest, tax, depreciation and amortisation. In certain contexts these figures are based on tax adjusted amounts – in others, they are based on accounting figures in consolidated financial statements.

EU European Union.

EU Parent/Subsidiary Directive

Council Directive 2011/96/EU of 30 November 2011 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States.

FRS101

Accounting standard (GAAP) which sets out a reduced disclosure framework which addresses the financial reporting requirements and disclosure exemptions for the individual financial statements of subsidiaries and ultimate parents that otherwise apply the recognition, measurement and disclosure requirements of EU-adopted IFRS.

FRS102 The primary standard under Irish and UK GAAP which applies to the financial statements of entities that are not applying EU-adopted IFRS, FRS 101 or FRS 105.

GAAP Generally accepted accounting practice.

GAAR General Anti-Abuse Rule. In the case of Ireland, Section 811C, TCA 1997.

HMRC Her Majesty’s Revenue & Customs, the non-ministerial UK government department responsible for taxation.

Hybrid entity

Any entity or arrangement which is regarded as a taxable entity under the laws of one jurisdiction but which is regarded as transparent (whereby its income or expenditure is treated as income or expenditure of one or more other persons) under the laws of another jurisdiction.

IAS International Accounting Standards.

IFRS International Financial Reporting Standards.

Imported mismatches Arise where arrangements are entered into that shift the effect of an offshore hybrid mismatch into Ireland through the use of non-hybrid arrangements.

MNE Multinational entity. This is a group of companies operating internationally in two or more jurisdictions.

OECD Organisation for Economic Cooperation and Development.

OECD Recommendation

In its final reports (5 October 2015) under various Actions its BEPS Plan, the OECD set out a series of recommendations related to the design of measures to counteract BEPS. In its Action 2 report, these are summarised as Recommendations which are designed to neutralise hybrid mismatch arrangements.

Opaque A term typically used to describe an entity that is taxable on its net profits (as distinct from its profits being taxable on its owners or members).

PBIE Public Benefit Infrastructure Exemption. Under the ATAD1 Interest Limitation rule, Member States are afforded the choice of excluding from the scope of the rule loans used to fund a long-term public benefit infrastructure project. This is defined under

Glossary of terms ATAD1 as a project to provide, upgrade, operate and/or maintain a large-scale asset that is considered in the general public interest by a Member State.

Permanent Establishment or PE

A taxable branch presence.

Primary response

Responses to counteract hybrid mismatches are framed as primary and secondary or defensive responses. The primary response is expected to be the main and first countermeasure to counteract a hybrid mismatch outcome. A secondary or defensive response may apply if the counterparty jurisdiction for the hybrid mismatch has not implemented the primary response.

Repo Repurchase transaction. Commonly used term to describe transactions in stocks or securities under which a counterparty commits to repurchase the stock/security at the end of the ‘repo’ period.

Reverse hybrid An entity which is treated as transparent under the laws of the jurisdiction where it is established but treated differently under the laws of the jurisdiction of an investor.

Roadmap

Ireland’s corporation tax roadmap policy document, released by the Department of Finance in September 2018, which incorporates implementation into Ireland’s corporation tax regime of ATAD related measures and recommendations made in the Coffey Report.

Stock lending The act of loaning a stock, derivative or other security to an investor or firm.

Structured arrangement

An arrangement involving a hybrid mismatch outcome, where the mismatch outcome is priced into the terms of the arrangement or where the arrangement is put in place to produce a hybrid outcome.

TCA 1997 Taxes Consolidation Act, 1997.

TFEU The Treaty on the Functioning of the European Union.

Transparent

A term typically used to describe an entity that is ‘looked through’ for tax purposes such that its members are taxed on its net profits instead of the entity itself. Sometimes, the measure of taxable income assessable on the members is computed by reference to the profits arising to the entity and then allocated to and finally assessable to tax on its members.

UK United Kingdom.

US United States of America.

Table of contents

Section 1: Redesign of regime for taxing interest 1

Section 2: Anti-hybrid rules 11

Section 3: Interest Limitation rule 61

Appendices:

Appendix 1: Ireland’s corporation tax regime for interest 107

Appendix 2: Public Benefit Infrastructure 121

Appendix 3: Group based ratio choices 125

Appendix 4: Deductible borrowing costs and taxable interest revenues 129

Hybrids and Interest Limitation Consultation| 1

Section 1: Redesign of regime for taxing interest

1. General Introduction

1.1 Overview: Base erosion involving interest deductions and hybrid mismatch arrangements

The measures set out in European Union (EU) Anti-Tax Avoidance Directive1 (ATAD1) published on 12 July 2016 are designed to give effect in EU law to recommendations set out in the October 2015 final reports of the Organisation for Economic Cooperation and Development (OECD) in relation to its plan on Base Erosion and Profit Shifting (BEPS Plan).

ATAD1 and the amending Directive ATAD22 are the “preferred vehicles for implementing OECD BEPS conclusions at the EU level”3. The recitals to ATAD1 note that the Directive sets out a common minimum level of protection by setting out general provisions and leaving the detailed implementation to Member States.

The OECD’s 2015 final report under Action 4 on Limiting Base Erosion Involving Interest Deductions and Other Financial Payments recommended as best practice the adoption of a fixed ratio rule to limit deductions for interest and other financial payments. The report was updated as a result of additional work by the OECD during 2016. The October 2015 report was retained as Part I with the addition of more detailed recommendations at Part II on the design and operation of a group ratio rule. The 2016 updated report also explored at Part III approaches to address BEPS involving interest in the banking and insurance sectors.

ATAD1 is the vehicle for implementing OECD BEPS conclusions under Action 4 of its BEPS Plan on limiting deductions involving interest by requiring Member States to implement an Interest Limitation rule which mirrors the fixed ratio rule recommended by the OECD.

It is understood that Member States may look for insights to the OECD’s reports under Action 4 when implementing ATAD1 measures in relation to the Interest Limitation rule.

ATAD2 sets out general provisions for implementing measures to counter hybrid mismatch arrangements. The Directive expressly advises Member States to “use the applicable explanations and examples in the OECD BEPS report on Action 2 as a source of illustration or interpretation to the extent that they are consistent with the provisions of this Directive and with Union law4.”

1 Council Directive (EU) 2016/1164 of 12 July 2016. 2 Council Directive (EU) 2017/952 of 29 May 2017 amends Directive (EU) 2016/1164 (ATAD1) as regards hybrid mismatches with third countries. 3 Recital 2, ATAD1 4 Recital 28, ATAD2

1.2 The consultation and KPMG’s response

The November 2018 public consultation on ATAD Implementation focuses on Ireland’s implementation of ATAD measures to counter hybrid mismatch arrangements and to introduce an Interest Limitation rule. As noted above, these measures are the subject of separate provisions set out in ATAD1 (Article 4, Interest Limitation rule) and ATAD2 (hybrids).

The consultation document suggests that implementation issues associated with the two sets of measures should be considered in tandem given that a number of Ireland’s interest limitation rules are hybrid or anti-hybrid in nature.

In this submission, KPMG has responded in detail to the questions raised in the consultation on hybrids (Section 2 of this submission) and the Interest Limitation rule (Section 3). In so doing, we have considered the interlinked nature of the provisions. We have made suggestions related to implementation that contemplate the operation of the measures in a corporation tax regime that has both anti-hybrid rules and an Interest Limitation rule in effect.

In framing our responses, we have also reviewed in detail the operation of the measures in the wider context of Ireland’s corporation tax regime for interest deductions and other financial payments. The consultation document notes that Ireland’s policy makers consider that Ireland’s targeted rules for addressing BEPS risk, while structurally different to the ratio-based approach under ATAD1, are equally effective at preventing BEPS risks.

The findings from our review suggest that the combined impact of anti-hybrid rules, the Interest Limitation rule and the protections in Ireland’s existing regime for taxing interest deductions will result in undue restrictions on interest deductions.

We recommend that Ireland undertakes a redesign of its corporation tax regime for deducting interest and other financial payments in tandem with adoption of an Interest Limitation rule. This is so as to rebalance the effect of protections afforded within the existing regime with those available under the anti-hybrid rules, the Interest Limitation rule and future changes to Ireland’s transfer pricing regime.


SECTION 1:

| Redesign of regime for taxing interest |

In this Section of our submission, we have explored how to redesign Ireland’s regime for deducting interest expense. This anticipates the introduction of an Interest Limitation rule and anti-hybrid measures under ATAD. We have explored in detail the manner of operation of measures related to taxing interest under Ireland’s corporation tax regime and the balance of protections they provide against BEPS.

Where an equivalent measure of protection from BEPS involving interest deductions is provided under an Interest Limitation rule, our findings suggest that the scope for deductions under Ireland’s corporation tax regime involving interest and other financial payments could be broadened and a number of existing targeted protections are no longer required.

At the end of this Section, we have summarised in tabular form the:

existing provisions under Ireland’s regime that relate to deductions involving interest expense as well as offering protection from base erosion,

ATAD hybrid and Interest Limitation rule measures (based on our responses to the consultation implementation questions in Sections 2 and 3 of this submission),

changes to existing protections to achieve a readjusted balance that reflects the strength of protection from base erosion that is afforded by an Interest Limitation rule and anti-hybrid rules, and a

revised regime for deducting interest expense, taking into account the overall balance of amended protections.

We have also illustrated in diagrammatic form at the end of this Section the order of priority in which we anticipate that this different mix of protections might operate to limit excessive deductions for interest expense under Ireland’s corporation tax regime.

As we have noted above, we believe that applying a 30% of EBITDA Interest Limitation rule under ATAD is likely to result in undue restrictions on interest expense where it is applied in addition to existing measures.

Should this occur, it is important that disallowed ‘interest relief as a charge’ which is carried forward for use in future periods is treated for tax purposes as paid in the period in which there is capacity to absorb a deduction for the expense. This is so that other limitations on the use of such carried forward, unrelieved amounts do not operate to permanently deny a deduction for the expense.

We suggest that, in tandem with the introduction of an Interest Limitation rule and anti-hybrid measures, Ireland changes its

corporation tax regime for deductions involving interest expense and other financial payments by:

Broadening the base of deductible interest and other financial payments by applying a general standard of deducting expense to the extent it is expenditure incurred ‘wholly and exclusively’ for the purposes of both trading and non-trading profits of the business,

Permitting the offset of interest expense against interest income,

Dis-applying the capital versus revenue distinction to permit deductions for both types of expenditure,

Removing the provisions related to ‘interest as a charge’ under section 247, Taxes Consolidation Act 1997 (TCA 1997) as they will be replaced by the revised general standard for deduction of expense incurred for non-trading purposes, and

Potentially broadening the scope of existing relief from withholding tax on payments of yearly interest.


SECTION 1:


2. Analysis

Article 4 of ATAD1 sets out the minimum standard of protection from BEPS involving interest deductions which is required under the Directive. Where supplementary insights are required into the objectives of the measures set out in Article 4 and, in particular, in seeking to assess where equivalent protection might already be afforded under the measures in Ireland’s existing regime, we have looked for guidance to the OECD’s report on Action 4 of its BEPS Plan.

We have also assessed the effectiveness of the measures when compared to the standard of protection afforded under the German tax regime for interest expense deductions which is understood to be closely aligned with the ATAD measures and the OECD’s fixed-ratio rule described in its Action 4 report.

In the summary of main risks of base erosion involving interest deductions and other financial payments, the OECD described the main risks of base erosion as arising in three basic scenarios:

1. Groups placing higher levels of third party debt in high tax countries,

2. Groups using intra group loans to generate interest deductions in excess of the group’s actual third party interest expense, and

3. Groups using third party or intra group financing to fund the generation of tax exempt income.

In Appendix 1 of this submission, we have analysed in more detail the manner in which the existing protections from base erosion involving interest deductions operate in Ireland’s corporation tax regime and the manner in which they address the main risks arising in the three basic scenarios described by the OECD above.

We have summarised below the range of protections from base erosion involving interest deductions from intra group debt that exist in Ireland’s current corporation tax regime. We have compared these with those that exist in the German corporate income tax regime which has had for a number of years an earnings stripping rule that is closely aligned with the ATAD1 Interest Limitation rule.

5 The profits of securitisation companies are measured under the tax principles applicable to the conduct of a trade.

2.1 Overview of Irish base erosion protections from excessive intra group debt

The following is a high level summary of base erosion protections that apply under the taxation framework of Ireland’s current corporation tax regime related to interest expense and similar payments.

A 12.5% rate of corporation tax applicable to income from a trade – the class of income with the broadest base for financing expense deductions. This rate of tax is comparatively low in international terms and reduces the comparative risk of the Irish operations of a multinational entity (MNE) bearing disproportionate or excessive debt levels in comparison to the level of third party debt borne by the group as a whole.

Withholding tax of 20% on yearly interest paid to

non-residents. Reliefs for payments to non-

resident group members are confined to lenders

resident for corporate income tax purposes in the

EU or tax treaty jurisdictions with a tax regime that

generally subjects such foreign receipts to tax.

The automatic characterisation of interest paid to

a non-resident 75% group member as a non-

deductible distribution – with limited overrides

which generally confine the override to restore the

interest deduction to borrowers engaged in the

conduct of a trade who are borrowing from EU or

tax treaty residents. In the case of lenders who are

not resident either in the EU or in a tax treaty

jurisdiction, the extent of the override of

distribution treatment is limited either to

circumstances where Irish withholding tax at 20%

is deducted or the lender company is taxed at a

rate of at least 12.5%.

In practice, interest paid by Irish residents to 75% group members who are not resident in tax treaty jurisdictions will either be subject to withholding tax at 20% or subject to tax in jurisdictions with a tax rate of at least 12.5%.

No offset of interest expense against non-trading

interest income. Essentially this is interest income

arising outside a financial services trade5.

No offset of interest expense against capital gains

(taxed at 33%).

No offset of interest expense against tax exempt

income.


SECTION 1:


In the case of interest expense potentially deductible at 12.5%:

The borrowing must be incurred wholly and

exclusively for the purposes of the trade,

The expense must be revenue and not capital in

character, and

The loan arrangement must be priced on arm’s

length terms in accordance with OECD guidelines.

The transfer pricing regime provides for upward

adjustments only. There is no basis to deduct a

notional expense by reference to a market rate of

interest where the income is not taxed on the lender.

Additional ‘ring fencing’ measures potentially apply to

cap current period relief for interest incurred on the

provision of specified intangible assets under section

291A, TCA 1997. The relief for interest expense and

capital allowances on the assets6 is capped at 80% of

current period (pre-interest and capital allowances) tax-

adjusted profits from a deemed separate trade

encompassing the management, development and

exploitation of the specified intangible assets.

Anti-avoidance measures applicable to interest and

financing expense related to borrowings used for the

purposes of the trade:

Deny a deduction where the borrowing is from a

connected person and used to acquire an asset from

a connected person. Exceptions apply for

borrowings used to fund the acquisition of trading

stock and certain intangible assets. If the assets

acquired represent a trade previously not taxed in

Ireland, interest deductions are capped at the Irish

taxable profits of the acquired trade.

Deny a deduction for the interest expense, where the

borrowing replaces capital previously withdrawn.

Defer a deduction for interest otherwise deductible

on an accruals basis if and until the income is taxed

where there is a connected lender which is Irish

resident or the lender is a non-Irish resident and is

controlled by Irish residents.

Deny a deduction (by re-characterising interest

payable as a distribution) where a loan has ‘equity

type’ characteristics.

For closely held companies, cap interest payable on

loans advanced by director shareholders (broadly

defined) and their associates.

6 For expenditure incurred on or after 26 October 2017.

Deny a deduction where one of the main purposes

of the borrowing is to obtain a reduction in tax due

to tax relief for the interest.

Deny a deduction under the General Anti-Abuse

Rule (GAAR), where a tax advantage arises under a

tax avoidance transaction which represents an

abuse or misuse of the relief.

Interest deductible under the ‘interest as a charge’ regime is confined to interest solely when paid on borrowings to acquire a material interest in shares of companies which meet defined conditions and in lending to such companies. The conditions to avail of the relief which allow interest to be offset against current period taxable group profits are prescribed and complex. They must be met not just at the date of the borrowing but throughout the period that interest is paid on the loan.

The relief is denied for connected party borrowings used to acquire shares already held by connected persons; for circular lending arrangements; and for borrowings to fund loan advances unless there is equivalent additional income taxed in the Irish group. Disposals of any shareholdings or intra group debt trigger ‘recovery of capital’ measures which deny a deduction for ‘interest as a charge’ by deeming borrowings to be repaid (even if the financing is unrelated to the recovery event).

Relief is available for interest expense against rents from immovable property but is confined to interest expense incurred on the purchase, improvement or repair of a rental property (or refinancing such loans).

Outside the rules applicable to trading and rental profits, there is limited scope to deduct interest expense.

Outside the rules applicable to trading profits, there is also limited scope to deduct different types of financing expense which are included within the scope of the ATAD interest limitation rule as expenses that are economically equivalent to interest and other costs related to borrowing. These include loan discount and premium expense, expense on interest-based derivatives, loan guarantee fees and loan arrangement fees.

A separate regime applies to shari’a finance which broadly operates to apply the principles associated with deducting interest expense under trading principles to defined payments under shari’a finance arrangements.

Separate rules apply under the securitisation regime for qualifying companies taxed under Section 110, TCA 1997. Section 110 generally applies taxing principles


SECTION 1:


used to measure the profits from a trade to the measure of profits and gains of a qualifying company under section 110.

2.2 A contrast in balancing protections against base erosion risk: overview of the German corporate income tax regime for interest deductions

The German tax regime for earnings stripping measures is very closely aligned with the framework of measures set out in Article 4, ATAD1. If the Interest Limitation rule measures are considered to provide effective protection from base erosion in the context of the German regime, we have considered whether the Irish regime (before the Article 4, ATAD1 measures) could be said to be equivalent to the German regime.

We have found that it is fundamentally different. The features of the Irish regime that reduce the risk of base erosion and which include a low corporate income tax rate, withholding tax applicable to interest and extensive targeted measures are simply not present in the German regime.

The Interest Limitation rule is considered to provide powerful protection against base erosion from excessive interest deductions – removing the requirement to rely on other protections.

In Germany, financing expense (in whatever form) is in principle a tax deductible expense where it meets a general test of being incurred for a business purpose. This prevents a company, for example, deducting a financing expense that relates to a private use. The deductible expense is typically recognised for tax purposes in accordance with the measure and timing of recognition of the expense under the accounting standards applicable to the taxpayer e.g. German GAAP.

Intra group loan arrangements are within the scope of transfer pricing provisions which apply an arm’s length standard in pricing the deductible expense. These provisions are broadly aligned with OECD transfer pricing guidelines.

The German corporate income tax rate at which a taxpayer obtains relief for financing expense is c. 30% (which is a combination of federal and trade tax rates).

Apart from the corporate income tax nominal tax rate (which is over twice the Irish rate of corporation tax), the German tax regime for financing expense has a similar starting point to the regime that applies to expenses incurred in earning profits from the conduct of a trade in Ireland.

7 Section 811C, TCA 1997.

Beyond this, Germany applies earnings stripping measures which are almost identical to the Interest Limitation rule under Article 4, ATAD1.

Finally, Germany has a general anti-abuse rule which could apply to deny a deduction for an expense which arises under artificial arrangements which have a tax avoidance motive and do not have a commercial purpose. As in the case of the Irish General Anti-Abuse Rule7 (GAAR), the German anti-abuse provisions rarely apply in practice but are available as an anti-avoidance measure of last resort.

That’s it.

Germany does NOT:

Apply withholding tax on interest payable on typical intra group borrowings. German

withholding tax on interest (which applies at a

basic rate of 25% plus a solidarity surcharge) is

confined to a narrow range of interest including

interest payable on borrowings secured on

German immovable property or on German

ships as well as interest on certain profit

participating loans. The lack of withholding tax

on intra group interest payments is one of the

main features of the German regime that raises

a risk of base erosion for intra group financing

payments. The rate of withholding tax on the

narrow range of interest within the scope of

withholding tax may be reduced under a double

tax treaty.

Automatically characterise interest paid to 75% non-resident group members as a non-

deductible distribution.

Deny a deduction on intra-group borrowings used to acquire assets already held by the group

(on the assumption that there is a commercial

purpose for the borrowing).

Deny a deduction for interest payable to group members resident in low taxed jurisdictions.


SECTION 1:


Germany has measures on its statute books

which could deny deductions for payments

made to entities resident in jurisdictions which

are described on a ‘blacklist’. As there is no such

‘blacklist’ in existence, these measures do not

have effect in practice8.

Deny a deduction for borrowings used to finance investments in shares which give rise to

an exempt participation gain on disposal. There

is no restriction of the interest expense by

reason of such a ‘capital recovery’ event (unlike

Ireland’s interest as a charge regime). If a

dividend is received on shares eligible for the

dividend participation exemption, the financing

expense remains deductible but there is a

deemed non-deductible expense which is equal

to 5% of the dividend amount. German groups

in practice can absorb financing expense

deductions up to the capacity of the group to

fund the borrowings from German taxable

profits.

Restrict deductible financing expense which remains deductible against all classes of income

(including interest income) and capital gains. In

computing the tax base for the purposes of

German trade tax which is a corporate income

tax that applies at the local or municipal level,

there is a mandatory addback or disallowance

equal to 25% of interest expense. The rate of

trade tax varies across municipalities but the

basis for computing taxable income is the same

across the municipalities and is also closely

aligned with the taxable measure of income that

applies for federal corporate income tax

purposes.

Having considered the impact of this balance of protections from base erosion, we have analysed how the mix of protections in the German regime might be used as a starting point template for the redesign of a

8 In like manner to other EU Member States, Germany may in future introduce counter measures which may include tax measures related to

payments of interest to persons resident in jurisdictions on the EU’s blacklist which is under development but there is currently no draft law in relation to such measures.

framework for Ireland’s corporation tax regime for interest and other financial payments.

We have summarised our analysis and suggested redesign in the table overleaf.

2.3 Suggested approach to Ireland’s corporation tax regime for interest and other financial payments

In the table that follows, we have summarised the main measures that currently apply under Ireland’s corporation tax regime that affect the tax treatment of interest, expenses (such as discount and premia) that are economically equivalent to interest as well as borrowing related costs. These are the categories of expense that are treated as ‘borrowing costs’ within the scope of the Interest Limitation rule under ATAD1.

The existing measures include a range of targeted and purpose-based tests that provide protections from base erosion principally by narrowing the base of deductible ‘borrowing costs’.

We have suggested changes to the scope of existing measures to rebalance the effect of protections afforded within the existing corporation tax regime to include those available under anti-hybrid rules, the Interest Limitation rule and potential future changes to Ireland’s transfer pricing regime.

Finally, we have looked ahead to describe the main measures affecting the tax treatment of ‘borrowing costs’ and taxable ‘interest income’ in a corporation tax regime post-implementation of ATAD measures including anti-hybrid rules and the Interest Limitation rule.

Section references in the table overleaf are to sections in the Taxes Consolidation Act 1997.


SECTION 1:


Redesign of Ireland’s corporation tax regime for interest

Existing measures Change Corporation tax regime for deducting interest expense post-ATAD Implementation

‘Wholly and exclusively’ test for deduction of broad base of interest and expense economically equivalent to interest as well as borrowing costs (if revenue and not capital in character) under Section 81. Expense is generally deductible in accordance with the measure and timing of recognition of the expense in the income statement prepared in accordance with recognised accounting standards.

Broaden scope of eligible expense deductible against non-trading income using purpose-based test e.g. ‘wholly and exclusively’ to the extent incurred for the purposes of the business. Disapply revenue/capital distinction to permit deduction of borrowing costs even if capital in character. Follow accounts-based recognition of the expense. Remove section 76(5)(b) which generally prevents a deduction for yearly interest amounts.

Taxpayer is entitled to deduct interest, expense economically equivalent to interest and a broad range of borrowing costs in computing the taxable measure of both trading and non-trading income to the extent the expense has been incurred ‘wholly and exclusively’ for the purposes of the taxpayer’s business, following an accounts basis recognition of expense. It is assumed that the trading/non-trading income distinction is retained so that the expense is deductible separately against trading income and classes of non-trading income. This could include deductions of interest expense against non-trading interest income and foreign dividends.

Interest as a charge (Sections 243, 247, 249, et al.)

Remove the sections as no longer required where the expense meets the general deductible purpose test. As a transitional measure, preserve relief for unused carried forward interest as a charge as well as accruing but unpaid expense which would otherwise be deductible on a paid basis under section 247. Existing debt eligible for relief under the provisions presumed to meet the general deductible purpose test upon first application of the new regime. No clawback of past relief where ‘recovery of capital’ post implementation of new regime.

Section 130(2)(d)(iv) automatic treatment as a distribution for interest on debt without any ‘equity’ characteristics where it is payable to a non-resident 75% group member (disapplied for EU residents by section 130(2B)). Sections 452, 452A and 845A provide for elections to override this distribution treatment. Section 130 also characterises interest as a distribution where the terms of payment of the interest or the underlying debt have equity type characteristics.

Remove automatic treatment as a distribution for interest paid to a non-resident 75% group member which is not otherwise within the scope of section 130 measures targeted at interest on debt with equity characteristics. Remove sections 130(2B), 452, 452A and 845A as no longer relevant where distribution treatment no longer applies.

Interest on debt with ‘equity type’ characteristics may be recharacterised as a distribution for tax purposes.

Section 817B applies to ensure that interest income potentially taxable in 2 periods is taxable in the earlier period.

Section 817B applies to ensure that interest income potentially taxable in 2 periods is taxable in the earlier period.


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Section 840A narrows the scope for deduction of interest expense on group borrowings which are used to acquire certain types of assets already held by the group.

Remove section 840A as the Interest Limitation rule applies to both group and third party borrowings. Preserve relief for unused and carried forward expense offsettable under section 840A against profits from an acquired trade.

Section 291A caps current period relief for interest expense and capital allowances against 80% of the tax adjusted income from specified intangible assets.

Remove interest expense from scope of the 80% capping measures as subject to the 30% of EBITDA cap under the Interest Limitation rule. Preserve relief for excess and unrelieved carried forward interest under section 291A, treating it as interest expense deemed to be incurred in the period.

80% cap for current period deductions under section 291A confined to capital allowances on specified intangible assets.

Section 254 denies an interest deduction on a borrowing drawn down within 5 years if capital is withdrawn from a trade / business.

Remove for corporation tax purposes as broader scope of interest deductions would apply under the general purpose rule.

Section 817C denies deduction for accruing interest expense of borrower (until and if) taxed in hands of connected party lender.

Remove section as Interest Limitation rule provides for deferral of deduction of excess expense of the period. Preserve relief for previously denied expense, treat as expense subject to Interest Limitation rule in claim period.

Section 817A denies a deduction if a scheme or arrangement has been put in place and the sole or main benefit is to obtain a reduction in tax.

Section 817A denies a deduction if a scheme or arrangement has been put in place and the sole or main benefit is to obtain a reduction in tax.

Section 97 provides for deducting interest expense related to the purchase, repair or improvement of rental property. Accounts based recognition of the deductible expense already applies through the application of Case I principles.

Replace section 97(2)(e) with the general deductible purpose test. Existing debt eligible for relief under the provisions presumed to meet the general deductible purpose test upon first application of the new regime.

Interest, payments economically equivalent to interest, and a broad range of borrowing costs are deductible in taxing property rental income to the extent the related expense is incurred wholly and exclusively for the purposes of the property rental business activity.

Section 437 applies to limit deductible interest payable to directors/participators in closely held companies.

Remove as the Interest Limitation rule applies to limit interest deductions above the de minimis threshold. It is assumed the rule will not apply to standalone companies (but these exclude companies where an individual shareholder owns more than 25% of the company).

Smaller companies (many of which are closely held companies), in practice are expected not to be subject to the Interest Limitation rule where net interest expense does not exceed the de minimis threshold of €3 million per annum.


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Section 542 denies relief for interest expense in computing capital gains.

Preserve where the distinction in treatment between capital gains and income profits is retained.

Section 542 denies relief for interest expense in computing capital gains.

Bond washing provisions under Part 28 operate to deny deductions for certain ‘purchased interest’ expense where tax exempt income.

Preserve to retain protection from deductions related to such ‘purchased interest’ expense.

Bond washing provisions under Part 28 operate to deny deductions for certain purchased interest expense where tax exempt income arises on securities.

Bond washing provisions (section 812), anti-avoidance provisions related to securities transactions at section 813, 814 and 815 deem income to arise in circumstances where it might otherwise fall within the scope of capital gains tax provisions.

Preserve where the distinction in rate of tax remains between profits taxed as capital gains or income.

Bond washing provisions (section 812), anti-avoidance provisions related to securities’ transactions at section 813, 814 and 815 deem income to arise in circumstances where it might otherwise fall within the scope of capital gains tax provisions. Such income to be treated as ‘interest income’ under the Interest Limitation rule.

Anti-hybrid rule under ATAD1. Deduction denied for expense to counteract D/NI and D/D outcomes. Exclusions for bank loss-absorption instruments and certain ’on market’ transactions in securities by financial traders.

Transfer pricing provisions apply to adjust upward taxable profits to apply an arm’s length price to arrangements taxable under Case I including financing arrangements.

A consultation is expected in 2019 to consider aspects of Ireland’s future transfer pricing regime which might include broadening the scope of application of the regime to non-trading transactions.

Transfer pricing denies deductions for excessive ‘interest expense’ and reduces scope of interest expense subject to the Interest Limitation rule or recognises higher ‘interest income’ within scope of Interest Limitation rule, as appropriate.

Interest Limitation rule under ATAD1.

Apply a 30% of EBITDA limitation on net interest expense above a €3 million de minimis threshold, applied on a local group basis. Additional relief potentially available under a consolidated group ratio rule. Excess interest expense to be carried forward indefinitely with excess interest capacity carried forward for 5 years.

Section 811C general anti-abuse rule (GAAR) can apply to deny reliefs under a tax avoidance transaction where the transaction was arranged primarily to give rise to a tax advantage.

Section 811C general anti-abuse rule (GAAR) can apply to deny relief for interest expense under a tax avoidance transaction where the transaction was arranged primarily to give rise to a tax advantage.

Section 246 applies withholding tax at 20% to yearly interest paid by companies with relief available under section 246(3)(h) where the interest is payable in the ordinary course of the business of the company to another company resident in a EU/tax treaty jurisdiction that generally taxes foreign source interest.

Review broadening scope of exemption from withholding tax for interest payable by companies under section 246(3)(h) e.g. extend relief to non-resident counterparties resident or subject to tax in jurisdictions that meet international tax governance and transparency standards.

Withholding tax at 20% potentially applying to payments of interest subject to reliefs with broadened scope (e.g. under section 246, 246A, 64 and under tax treaty arrangements).


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The redesigned regime set out in the table above still includes an extensive range of protections from base erosion involving interest deductions and other financial payments. In the chart below, we have illustrated the order of priority in which these protections against base erosion would operate in the redesigned regime.

In Sections 2 and 3 of this submission, we have responded to the questions raised in the consultation on the implementation of anti-hybrid rules under ATAD2 and an Interest Limitation rule under ATAD1.

The outline redesign of Ireland’s corporation tax framework for deducting interest expense has taken into account our suggestions related to implementation of both the anti-hybrid rules and the Interest Limitation rule. Recognising the interlinked nature of these provisions, we have sought to make implementation recommendations that, if adopted, could work as part of a coherent and rebalanced, overall framework.


Section 2: Anti-hybrid rules

Background to the measures and consultation

Amending Directive ATAD2 sets out general provisions for implementing measures to counter hybrid mismatch arrangements. The Directive expressly advises Member States to “use the applicable explanations and examples in the OECD BEPS report on Action 29 as a source of illustration or interpretation to the extent that they are consistent with the provisions of this Directive and with Union law10.”

The November 2018 public consultation on ATAD Implementation focuses on Ireland’s implementation of ATAD measures to counter hybrid mismatch arrangements and to introduce an Interest Limitation rule. The consultation document suggests that implementation issues associated with the two sets of measures should be considered in tandem given that a number of Ireland’s interest limitation rules are hybrid or anti-hybrid in nature.

KPMG’s approach and response

In this Section of the submission, KPMG has responded in detail to all of the questions raised on implementing measures to counteract hybrid mismatches. In so doing, we have considered the interlinked nature of the hybrids and Interest Limitation rule provisions (which we have addressed in our responses set out in Section 3 of this submission). We have made suggestions related to implementation that contemplate the operation of the measures in a corporation tax regime that has both anti-hybrid rules and an Interest Limitation rule in effect.

In framing our responses, we have also reviewed in detail the operation of the measures in the wider context of Ireland’s corporation tax regime for interest deductions and other financial payments. Our findings and recommendations for policy choices arising from this wider review are set out in Section 1.

In responding to the consultation questions on implementing anti-hybrid measures, as set out in ATAD2, we have looked to the OECD final reports under Action 2 of its BEPS Plan for additional insights on points of interpretation. In preparing our response, KPMG has reviewed hybrid mismatch measures which have been enacted in the United Kingdom (UK), Australia, New Zealand and proposed regulations on hybrid measures in the United States of America (US).

We have chosen these jurisdictions for a number of reasons. The legislative measures and related guidance are published in English. The measures draw on a

9 Action 2 report, October 2015 on Neutralising the Effects of Hybrid Mismatch Arrangements. 10 Recital 28, ATAD2.

common law legal framework that has many similarities with Ireland’s legal system. The measures have been implemented at different times - the first being those enacted by the UK, then Australia and, most recently, New Zealand and the US.

All four jurisdictions are at an early stage of implementation, post enactment. We have had the opportunity to take soundings both from individuals who were involved in the design policy choices made by those jurisdictions when implementing their measures as well as practitioners who have experience in advising clients on the practical implications arising post adoption of the measures.

We acknowledge that the corporate income tax regimes into which these anti-hybrid measures are designed to fit differ in many respects from Ireland’s corporation tax regime. However, notwithstanding these differences, all of these jurisdictions were attempting to implement anti-hybrid rules that follow (to differing extents) the framework of recommendations set out in the OECD’s final report on Action 2. In assessing the manner of adoption of their policy choices and how it fits into their regime, we have considered whether those choices and the experience of practitioners in implementing the measures offer insights for Ireland as its looks to adopt the anti-hybrid rules into its corporation tax regime.

In our responses below, we have sought to make suggestions that could support a regime which is both principles based in achieving the high level framework objective set out under ATAD2 coupled with more precise drafting for areas of the rules which require clear boundaries to provide certainty for business in their application.

We have assumed that Ireland’s policy intent is to enact measures that are aligned with the OECD’s recommendations in its final reports on hybrid mismatch and branch mismatch arrangements under Action 2 of its BEPS Plan but which do not go beyond the OECD framework.

In assessing how measures might be implemented with the greatest certainty for business, we have drawn upon insights from the practical challenges faced by taxpayers in implementing equivalent

measures in other jurisdictions.


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| Anti-hybrid rules |

We have set out a summary below of our responses and then the detailed analysis that underpins our responses.

Answer 1

We have separately made comments on Collective Investment Vehicles in our response to Question 30 below.

We suggest that:

the scope of adjustments to taxable profits under the anti-hybrid rules should be limited to companies within the charge to Irish corporation tax,

companies whose profits are exempt from tax by reason of their status e.g. companies eligible for charitable status, should be expressly excluded from the measures,

where a deduction is to be denied or an amount of income is assessable under the anti-hybrid rules and such expense or income adjustment is reflected in profits attributable to a partnership, the amount should be assessable on corporate partners within the scope of corporation tax in proportion to their respective entitlement to the profits of the partnership.

Partners, taken together with associated enterprises, whose interests in the partnership are less than 25% should be excluded from the scope of adjustments under the anti-hybrid rules.

Answer 2

We recommend that the definition of foreign taxes equivalent to Irish tax should include tax:

paid by, paid on behalf of or borne by the taxpayer,

equivalent to Irish corporation tax, income tax, or capital gains tax,

of an equivalent nature payable at a sub-national level e.g. a canton or municipality, where there is no equivalent tax payable at a higher level such as a national / federal level,

payable under a separate regime such as a Controlled Foreign Company or Diverted Profits Tax regime on an attribution of profits, and

Question 1: Entities

What entities should be within scope of Ireland’s anti-hybrid regime?

Question 2: Foreign / Local Taxes

What foreign taxes should be considered as equivalent to Irish taxes for the purposes of establishing whether or not a mismatch outcome arises? For example how should municipal taxes, local taxes, taxes on profits under CFC regimes etc. be treated?


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when seeking to exclude outcomes which have already been subject to counteracting measures, tax payable under an anti-hybrid regime where this is a separate tax regime.

Answer 3

In summary, in relation to the question of defining ‘included in income’ or ‘subject to tax’, we suggest:

given the complexity associated with identifying hybrid mismatch outcomes and the interpretation and application of anti-hybrid rules, it would be worthwhile considering supplementary points of clarification in law as to what is meant by subject to tax in the context of the anti-hybrid rules,

payments should still be regarded as ‘included in income’ and ‘subject to tax’ where they are received by taxpayers subject to tax in a jurisdiction which has a nil tax regime or a purely territorial regime; tax exempt taxpayers; and (with the exception of measures to counteract mismatch outcomes from tax deductible ‘dividends’) where the receipt is generally exempt from tax under the foreign jurisdiction’s regime,

a general principle should apply that differences in the taxable measure of payments should not be taken into account if those differences do not arise as a result of differences in the character of the instrument or entity,

if Ireland moves to adopt a more territorial regime, the conditions for a foreign branch profits or foreign dividend exemption regime can be framed in a manner that reduces the risk of hybrid mismatch outcomes,

legislation should expressly provide that a hybrid mismatch adjustment should not arise as a result of foreign currency exchange movements - but leave it to taxpayers to seek to identify, on a reasonable and consistent basis, what such movements are in relation to each potential hybrid mismatch,

it should also be clear that transfer pricing adjustments should not be subject to a hybrid mismatch counteraction. Such differences in the taxable measure of arrangements should be dealt with by means of transfer pricing adjustments to profits taxed in the jurisdictions in question,

notional income or notional expense deductions should not be within the scope of the hybrid mismatch measures on financial instruments. A formula of wording has been used in other

Question 3: Subject to tax

Taking account of the foreign taxes to be included, what outcomes should be included within the concept of “inclusion”? What timings should apply to that test?


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jurisdictions to describe such arrangements which might be appropriate to consider in an Irish context. These are mismatches related to the financial instrument that “do not arise as a result of economic rights created between the counterparties”,

given the expected complexity faced by taxpayers implementing anti-hybrid rules, it is essential that implementation is supported by guidance including a range of illustrative examples.

Answer 4

In summary, in relation to the question of defining included in income or subject to tax in the context of timing mismatches, we suggest:

to promote certainty, it would be useful to have a bright line test in relation to the timing of recognition of items that are considered to be ‘included in income’ or ‘subject to tax’. This might be, for example, a test which treats a payment as included in a foreign tax period which commences within 12 months of the end of the tax accounting period in which a deduction arises for the Irish taxpayer,

in the case of financial instruments, taxpayers should be given the opportunity to treat a longer deferral period as meeting the standard of the income being included within a reasonable period of time, where this can be supported by them as being on terms that are comparable to those that would be expected to be agreed between independent enterprises,

where there is a mismatch due solely to timing, the taxpayer should deny the deduction in the current period and be given the opportunity to track the mismatch and claim a deduction in a future period where the income is eventually subject to tax,

in the case of financial instruments, we consider it worthwhile having a general rule that would exclude timing differences where the financial instrument is for a period of, say, three years or less, where the potential for the hybrid mismatch arises solely due to that timing difference. This would be attractive in removing from the potential scope a large number of intra-group debt relationships that arise from intra-group trading transactions which may settle periodically,

Question 4: Timing of inclusion

There are a number of ways that timing mismatches can be dealt with on the implementation of ATAD2. Different methods may be more appropriate for different hybrid mismatches. What issues should be considered when deciding how to treat timing mismatches?


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even in circumstances where a timing difference is not considered to be a hybrid outcome under Ireland’s measures, Irish taxpayers are given the flexibility to elect to accelerate the taxation of the corresponding receipt in Ireland to match the timing of deduction of the payment, so as to prevent a potential hybrid mismatch outcome arising,

the concept of ‘subject to tax’ and the related issue of timing of recognition should be sufficiently wide to treat deductible amounts as subject to tax where they are included in income, not of the recipient entity, but of its members,

a similar concept should apply to treat as ‘subject to tax’ deductible amounts that are included in profits which are subject to tax as part of a Controlled Foreign Company regime in the parent jurisdiction, a Diverted Profits Tax regime or, in certain contexts, included in taxable income under a tax that counteracts hybrid mismatch outcomes,

as part of implementation, it would be worthwhile testing the application of ‘subject to tax’ concepts under Irish legislation using examples which include a wide range of outcomes related to disregarded entities and payments that can arise by reason of the operation of international measures such as the US ‘check-the-box’ provisions. This is in order to assess whether the deductible amount can be said to be ‘included in income’ and to reduce the risk of double taxation outcomes potentially arising upon implementation of the measures.

Answer 5

We suggest that Ireland could move to offer a foreign branch profits exemption regime available at the election of taxpayers which has conditions which reduce the likelihood of a hybrid mismatch occurring due to a branch related mismatch. These are outlined in the detailed response to this question later in this Section.

Similarly, we have suggested an outline design for a foreign dividend exemption regime that prevents a deduction/no inclusion outcome arising as a result of an exemption applying to a dividend that is deductible by the payor.

Question 5: Disregarded PEs

As set out in Ireland’s Corporation Tax Roadmap, a public consultation on moving to a territorial regime is to be held in early 2019. If Ireland were to move to a territorial regime what are the relevant considerations to implementing a disregarded PE rule?


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Answer 6

We suggest that Ireland should include defensive measures in relation to disregarded Permanent Establishments (PEs). Under these measures, Ireland could subject to corporation tax profits of a non-resident company from an otherwise disregarded branch or agency presence in Ireland:

provided that such measures continue to respect Ireland’s obligations under double tax treaties and related allocation of taxing rights. For example, if the PE’s activities fall below a threshold to be taxable as a PE and the head office jurisdiction is allocated taxing rights in respect of those profits under the terms of a double tax treaty, they should not be subject to branch mismatch counter measures in Ireland,

unless Ireland has chosen to unilaterally give up its taxing rights, for example, in the circumstances of an agency relationship within the scope of the PE exemption measures under section 1035A, TCA 1997. Reliefs afforded under such provisions should not be affected by branch mismatch counter measures as Ireland has already set the conditions under which it is willing, unilaterally, not to tax such persons under a PE standard,

but not where the profits of the PE are subject to tax in the head office jurisdiction or are subject to tax in another jurisdiction, e.g. because the profits are considered to be allocable to a taxable presence of the entity elsewhere or are subject to tax under, for example, a Diverted Profits Tax regime, a Controlled Foreign Company regime, or something which is substantially similar such as a branch switchover regime.

Answer 7

We suggest that Ireland should adopt a transfer pricing basis which follows the Authorised OECD Approach (AOA) for the attribution of profits to branches (both in the case of Irish branches and for foreign branches of Irish resident companies). In so doing, this should reduce the possibilities of mismatches arising due to differences in the allocation of profits between an Irish taxable presence and a presence that is recognised in another jurisdiction.

Question 6: Disregarded PEs

Where the profits of an otherwise disregarded PE are subject to tax, e.g. under a switchover rule or a CFC charge, is that sufficient for them to then be treated as a PE, rather than a disregarded PE? What are the relevant considerations to deciding whether or not Ireland should implement the defensive rules on disregarded PEs?

Question 7: Other defensive rules

What are the relevant considerations to deciding whether or not Ireland should implement the defensive rules in the context of these hybrid mismatches?


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Answer 8

Where the outcome of applying the anti-hybrid rule is the denial of a deduction, the consequence for the Irish taxpayer should simply be that the measure of taxable income against which the deduction would otherwise have been offset is increased.

Where the outcome of applying a secondary or defensive measure is to tax income, we suggest that the measure and classification of the income falls under general taxing principles i.e. if it could be said to arise in the course of a trade, that such income is included as part of the receipts of the trade taxable in the period in which it has arisen. If it falls to be taxed as non-trading income, the adjustment should be assessable to corporation tax under Schedule D, Case IV.

Where such income arises on a financial instrument, we suggest that it should be included as an ‘interest income’ amount when applying interest deduction restrictions under the Interest Limitation rule, but not for any other purpose, i.e. not for the purposes of extending the scope of withholding tax.

Answer 9

We consider that the greatest practical challenge for taxpayers in implementing imported mismatch provisions is having sufficient insight to know whether, in fact, an imported mismatch has arisen.

We consider that adoption of a standard that the taxpayer is “in possession of, or aware, of information” [that a hybrid mismatch has arisen] which is supported by implementing guidance, is perhaps the best that can be achieved in this context.

In accordance with the stated policy intent of enacting measures in line with ATAD2, the scope of imported mismatch arrangements should only apply and not go beyond circumstances where “such payment directly or indirectly funds deductible expenditure giving rise to a hybrid mismatch”. In order to provide the greatest certainty upon implementation, guidance should be provided on the scope of transactions that can be said to “fund deductible expenditure”.

In circumstances where there is an EU counterparty, it should be reasonable for the Irish taxpayer to assume that the EU Member State has adopted appropriate anti-hybrid mismatch measures in line with ATAD2.

Question 8: Charge to tax

How should these amounts of income be taxed? A number of options exist, such as including them as a Case IV amount chargeable to corporation tax, charging them to income tax, or having different treatment for different anti-hybrid rules.

Question 9: Imported mismatches

What factors should be considered in relation to the implementation of the rules to prevent imported mismatches, specifically in relation to their application where the Irish taxpayer is transacting with a person in an EU country which has implemented ATAD2?


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Answer 10

We suggest that:

it would be appropriate to include a concept of dual inclusion income in respect of financial instruments just as in respect of any other potential hybrid mismatch,

the concept of dual inclusion income should take into account the position of branches of financial institutions (whether banks or insurance companies) which can include deductions which cannot be traced to individual payments,

as part of implementation, it would be worthwhile testing the application of dual inclusion income concepts under Irish legislation using examples which include a wide range of outcomes related to disregarded entities and payments that can arise by reason of the operation of international measures such as the US ‘check-the-box’ provisions. This is in order to assess whether there is dual inclusion income and to reduce the risk of double taxation outcomes potentially arising upon implementation of the measures,

the concept of dual inclusion income should also take into account the effect of measures which are similar to anti-hybrid mismatch measures such as dual consolidated loss rules which serve to deny or protect from double deductions losses arising from transactions including financial instruments.

Answer 11

Where a deduction has been disallowed which is included in income in a later period, we suggest that the taxpayer should be entitled to track and carry forward the disallowed amount for ‘reactivation’ as a deductible expense in a future period where it is included in income in that period.

There is a similar mechanism to achieve this type of relief under section 817C, TCA 1997 where interest expense which would otherwise be deductible as a trading expense is not deductible by the company until the period that it is taxable upon the relevant connected person.

Question 10: Dual inclusion income and financial instruments

What factors should be considered in relation to the concept of dual inclusion income being incorporated into the application of the financial instrument anti-hybrid rules to avoid those rules resulting in double taxation of the same income?

Question 11: Dual inclusion income and deferrals

While there is a symmetry in allowing the deferral of an adjustment, the practicalities of tracking deferred adjustments must be considered. How could such timing differences be dealt with, from a practical perspective, in the implementation of the anti-hybrid rules? This question is linked to the question on timing issues in ‘subject to tax’ above.


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Where income is taxed in Ireland as a defensive measure in response to the non inclusion of income due to timing differences, we suggest that this income should be expressly carved out from taxable receipts in future.

There is a similar mechanism to achieve this type of relief from potential double taxation under section 817B, TCA 1997 which taxes prepaid interest receipts in the period of receipt but then excludes such income from taxation in future periods when it would otherwise be recognised as taxable income in that period.

As noted in our response to Question 4 on timing differences, even in circumstances where a timing difference is not considered to be a hybrid outcome under Ireland’s measures, we suggest that Irish taxpayers are given the flexibility to elect to accelerate the taxation of the corresponding receipt in Ireland to match the timing of deduction of the payment, so as to prevent a potential hybrid mismatch outcome arising due to the non inclusion of income.

Answer 12

We suggest that, in consultation with the banking sector, Ireland should implement the Member State choice afforded under Article 9(4) and exclude from scope of the anti-hybrid rules certain financial instruments which have loss-absorption features.

We suggest that Ireland adopts the Member State choice which is afforded under ATAD and excludes ‘on market’ transactions in hybrid transfer instruments by participants in those markets.

We suggest that this could be done by excluding transactions where the results are taken into account in the measurement of activities under Case I principles which apply to measuring the results of trading activities.

Question 12: Financial trader exemption

What factors should Ireland consider when determining, as permitted, whether or not to apply the deduction without inclusion rules to such trades by financial traders?


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Answer 13

On balance, having reviewed a range of possible approaches, we suggest that the definition of associated enterprise for the purposes of the anti-hybrid rules could draw upon Companies Act 2014 definitions.

Answer 14

Legislative work to define when entities are transparent or otherwise for tax purposes would be welcome. In addition to providing greater certainty for taxpayers in implementing the anti-hybrid measures, we consider that it would be useful, more generally, in providing greater certainty of the tax treatment of receipts from, or payments to, foreign entities. Where it is being implemented for a wider purpose than the anti-hybrid rules, we suggest that it should be subject to technical soundings taken from a broad range of businesses operating internationally.

We suggest that a legislative basis for classifying foreign entities as transparent or opaque for tax purposes should adopt a multi-factorial test that is aligned as closely as possible with the factors that case law has suggested are relevant to determining whether or not an entity is transparent for tax purposes. We recommend that this looks primarily to the legal characteristics of the entity and then to the manner in which the profits are ultimately taxed.

In the context of hybrid entity rules, it is important to take into account in designing the rules that foreign partnerships can be legal entities of themselves, but that the profits can be assessable directly on partners.

Question 13: GAAP

What factors should be considered when implementing the concept of consolidated accounting groups in hybrid mismatch measures?

Should a version of section 432 Taxes Consolidation Act 1997 (“TCA”) be used to define associated enterprises? Or, rather than referring to section 432 or relevant accounting standards, should the concepts of a group under accounting principles be imported into domestic tax legislation using, for example, section 7 Companies Act 2014 as a template?

Question 14: Hybrid entities

Is the current case law clear enough to give taxpayers certainty on the treatment of an entity, when it comes to applying the anti-hybrid rules?


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Answer 15

We recommend that that a single concept be used to encompass both investor and payee when determining if a payment has been deducted and included in income.

Although it may be attractive to consider a principles based approach that would seek to encompass all hybrid mismatch outcomes, we consider that, in practice, the rules would be easier to implement where taxpayers can look separately at measures that address financial instruments and hybrid transfers, hybrid entity and branch mismatch outcomes.

Answer 16

To provide the greatest certainty for taxpayers in identifying the scope of deductions that are subject to the anti-hybrid rules in addition to those arising from payments, we suggest that such additional deductions are expressly listed in the legislative provisions.

This could include, for example, an impairment loss in the fair value of an asset as well as payments (which are otherwise ignored) between partners and a partnership.

In our responses to Questions 4 and 11 on dealing with timing mismatches in deduction / no inclusion outcomes for payments, we have suggested that the rules should provide for adjustments in later periods in order to take into account payments which have been denied deductions but the related income is taxed in a later period. Similar adjustments should be permitted to reflect, for example, the inclusion in income of amounts which are released where a deduction has been denied for the corresponding provision or impairment amount.

Question 15: Investor / payee jurisdiction

Should a single concept be used to encompass both investor and payee when determining both if a payment has been deducted and included in income?

Question 16: Payment / deemed payment

The Irish tax regime does not have deemed payments, as such, but under the accruals basis can there be events (e.g. forgiveness of debt) which could come within the scope of these provisions?


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Answer 17

We suggest that the anti-hybrid rules adopted in Ireland should simply refer to debt, equity or derivatives.

Irish taxpayers are used to applying measures related to debt, derivatives and equity based on the legal characterisation of those instruments. If we apply a principle of seeking to find the greatest degree of certainty for taxpayers in Ireland in implementing the measures, we suggest that the terms as applied under the anti-hybrid rules should retain their usual meaning under law.

Answer 18

We acknowledge that there is a challenge in implementing measures targeted at structured arrangements in a proportionate manner. We suggest:

adoption of a standard that the taxpayer has knowledge there is an arrangement in place which could reasonably be taken to indicate that the arrangement is in scope of the anti-hybrid rules,

it is not proportionate to place a burden of additional due diligence on the taxpayer – compliance with such measures can only be based on knowledge in possession of the taxpayer,

the measures only apply where one of the main purposes of the arrangement is to achieve a hybrid mismatch outcome and that it is reasonable to believe that the arrangement would not have been put in place but for the benefits of the hybrid mismatch outcome,

that certainty and consistency in implementation is supported by guidance which illustrates the application and non-application of the structured arrangement measures to a range of scenarios.

Question 17: Financial instruments

What rules could be described as Ireland’s rules for taxing debt, equity or derivative returns? Is it sufficient to describe them as debt, equity or derivative instruments? There are a number of definitions of “financial assets” in the TCA: should they be used as a basis for this definition? Alternatively, could financial instruments be defined in line with IAS39?

Question 18: Structured arrangements

Recital (12) recognises that to ensure proportionality, ATAD2 should only apply to cases where there is a substantial risk of avoiding taxation through the use of hybrid mismatches. What factors should be considered in implementing the awareness test and the value test?

What practical difficulties may be encountered in establishing whether or not a structured arrangement exists?


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Answer 19

We agree that provisions should only apply where it would be reasonable to consider that the Irish taxpayer was aware it was a party to a hybrid transaction. This appears to be proportionate in light of:

the manner of operation of capital markets which affords protections against planning to achieve hybrid mismatch outcomes for non-controlled parties, and

the potentially significant downside, in the form of a disruption to the efficient operation of such markets, where a proportionate balance is not achieved in implementing the measures.

Answer 20

In determining whether there is a hybrid mismatch outcome, we suggest that the main test should apply by reference to the tax regime in the jurisdiction itself.

We suggest that this is supplemented by tests that are applicable to specific types of hybrid transaction, e.g. a hybrid rule that encompasses financial instruments expressly includes only those mismatches that arise due to differences in the characterisation of the instrument or the payment made under it.

Question 19: Capital market transactions

Taking account of recital (12), should provision be made such that the anti-hybrid rules only apply where it would be reasonable to consider that the Irish taxpayer was aware it was party to a hybrid transaction? What are the relevant considerations?

Question 20: What is tested for hybridity?

Should regard be had to the transaction, to the actual circumstances of the taxpayer or to the laws of the foreign jurisdiction? Should this vary depending on the type of hybridity being neutralised?


SECTION 2:


Answer 21

We have suggested that the parts of the section 130 provisions that recharacterise interest as a distribution should continue to apply in relation to debt which has equity characteristics. We suggest that these measures would apply in priority to the anti-hybrid rules.

We have also identified a range of anti-avoidance provisions related to transactions in securities which operate to treat part of disposal proceeds as income, to deem income to arise which is assessable to corporation tax under Case IV or to deny deductions for certain ‘purchased interest’ costs. We have suggested that such provisions should continue to apply. Where income is recognised, we have suggested that such income should be regarded as ‘interest income’ for the purposes of application of the limits on interest deductions under the Interest Limitation rule.

In our response to Question 44, we have set out a high level overview of the suggested operation of the order of priority of various protections against base erosion under Ireland’s corporation tax regime for interest and other financial payments (on the assumption that suggested changes are made in the overall design of Ireland’s regime).

Answer 22

As discussed in our response to Question 21, we suggest that other provisions which operate to deny hybrid mismatches on a domestic basis remain unchanged. In this way, the analysis of protections against domestic mismatches under the wider framework of Ireland’s tax regime can be evaluated independently of the impact of cross border mismatches which are focused on hybrid outcomes under the framework of corporate income tax regimes.

Question 21: Existing domestic provisions

Bearing in mind both the interest limitation and anti-hybrid requirements of ATAD, what amendments, if any, should be made to these domestic provisions? (see also, Question 44)

Question 22: Existing domestic anti-hybrid provisions

Should the domestic anti-hybrid rules be maintained in their current form or should they be amended and replaced with a single anti-hybrid rule which applies to both cross border and domestic transactions?


SECTION 2:


Answer 23

We suggest that adjustments under the anti-hybrid rules should simply be treated as non-deductible

Hybrids and Interest Limitation Consultation · 2019. 4. 4. · KPMG Telephone 1 Stokes Place Fax...

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