ATO provides guidance on hybrid mismatch rules

The Australian Taxation Office (ATO) has  recently published Taxation Determination TD 2022/9 regarding the hybrid mismatch rules.

TD 2022/9 has affirmed and finalised the position previously espoused in Draft Taxation Determination TD 2019/D12, that the United States’ Global Intangible Low-Tax Income (GILTI) rules do not correspond to the assessing provisions of Australia’s controlled foreign company (CFC) regime for the purposes of its hybrid mismatch rules.

The reason this is relevant is that many groups had put forward views that the GILTI provisions did correspond sufficiently to Australia’s CFC rules – which could invoke certain “anti-overlap” rules within Australia’s hybrid mismatch rules where Australian income is “subject to foreign tax” under rules equivalent to Australia’s CFC rules. The ATO’s position seeks to close this argument, thereby expanding the ambit of the hybrid mismatch rules to impose tax.

Double Taxation

The most pronounced implication of the ATO’s position is the significant risk of double taxation for Australian taxpayers with a US connection.

Specifically, any tax paid under the United States’ (US) GILTI rules will be disregarded for the purposes of determining the existence and calculation of a deduction/non-inclusion (DNI) mismatch, meaning an income tax deduction will be denied in Australia for the entire amount of relevant payments, and not merely the difference between the tax paid in the US and the value of the associated income tax deduction in Australia.

Background

Australia’s hybrid mismatch rules, contained in Division 832 of the Income Tax Assessment Act 1997 (ITAA 1997), implemented the Organisation for Economic Co-operation and Development’s (OECD) Action 2 recommendations, and were initially introduced to cover income years starting on or after 1 January 2019 with the objective of “preventing entities that are liable to income tax in Australia from being able to avoid income taxation, or obtain a double non-taxation benefit, by exploiting differences between the tax treatment of entities and instruments across different countries”[1].

Broadly, Australia’s hybrid mismatch rules achieve this objective by either disallowing income tax deductions or including amounts in assessable income, depending on whether there is a DNI or deduction-deduction (DD) mismatch.

Paragraph 832-105(1)(b) provides that a DNI mismatch will arise to the extent an income tax deduction exceeds the portion of a payment that is either "subject to Australian income tax" or "subject to foreign income tax". Whereas, subsection 832-130(5) provides that an amount will be regarded as “subject to foreign income tax” in a CFC setting where the amount is “included in working out the tax base of another entity under a provision of a law of a foreign country that corresponds to sections 456 or 457 of the Income Tax Assessment Act 1936”.

What this practically means is that tax paid under a foreign CFC regime will only be recognised for the purposes of determining the existence and calculation of a DNI mismatch where the assessing provisions of the foreign CFC regime are regarded as “corresponding to” the assessing provisions of Australia’s CFC regime. In the absence of such correspondence, a DNI mismatch will arise to the extent of the entire payment for which an income tax deduction is sought.

TD 2022/9

Although Appendix 1 to TD 2022/9 differs from Appendix 1 to TD 2019/D12 in the sense that the former focusses less on the regimes’ respective mechanics and more on their ‘gist’, the conclusion is the same: 

The US’ GILTI rules do not ‘correspond’ to sections 456 and 457 of the Income Tax Assessment Act 1936 (ITAA 1936) and therefore amounts subject to tax under the former will not be regarded as ‘subject to foreign income tax’ under subsection 832-130(5) of the ITAA 1997.

The Commissioner’s position is informed by the Explanatory Memorandum to the Bill that introduced Australia’s hybrid mismatch rules (the EM), as well as commentary from Chevron Australia Holdings Pty Ltd v Commissioner of Taxation (No 4) [2015] FCA 1092 and Winter v Ministry of Transport [1972] NZLR 539 which equated correspondence to the ‘effect’ or ‘gist’ of two things.

In other words, correspondence does not simply focus on detail or the mere mechanics of the law, but on whether or not two particular laws have the same statutory objectives or purposes.  The implication being, that the mechanics of two laws could arrive at the same mechanical outcome but not “correspond” to each other.

In this regard, the Commissioner is of the view that the US’ GILTI rules and Australia’s CFC rules serve different purposes (i.e., the former seeks to impose a global minimum tax regime, whereas the latter constitutes an anti-deferral regime) and operate on different bases (e.g., aggregated versus disaggregated) and that, having regard to the aforementioned authorities, they cannot be considered to correspond.

Discussion

The Commissioner’s position is arguably consistent with paragraphs 37 and 38 of the OECD’s Action 2 Final Report to which the EM refers and the conclusion reached on this particular issue is one which a reasonable person could readily come to.

The key concern facing many groups is the significant complexity that the hybrid mismatch rules entail, particularly in the context of the imported mismatches. Although the overall intent/objectives of Australia’s hybrid mismatch rules are ones which most groups can understand, their specific application in many cases can go beyond mitigating double-deduction and deduction/non-inclusion outcomes, with a resulting outcome that in fact double taxation can easily arise.

Although the genesis for the OECD’s hybrid mismatch rules is readily understandable and collective action on tax avoidance is to be welcome, the reality is that there is divergence between different jurisdictions as to how they have gone about counteracting hybrid mismatches. Inevitably, questions will remain as to whether particular measures in one jurisdiction equate to the ‘effect’ or ‘gist’ of arguably similar provisions in another.

Another residual example of this is the US’ ‘dual consolidated loss’ rules, as well as certain other anti-hybrid measures within the US tax code, which in many cases are intended to counteract particular double-deduction or deduction/non-inclusion outcomes, but where there is uncertainty as to whether they equate to the ‘effect’ or ‘gist’ of Australia’s hybrid mismatch rules as relevant to particular facts.

There are many areas where – despite one round of amendment legislation and a plethora of ATO guidance – Australia’s hybrid mismatch rules can still lead to incongruous outcomes (including double taxation) at worst, and significant unresolved complexity at best. This highlights the significant challenges associated with balancing the need to counteract the obvious potential for mischief in this area, whilst providing adequate safeguards against the incidence of double taxation.

Key Implications

Key implications of TD 2022/9 for taxpayers include the need to:

• Understand the significant complexity underpinning the application of Australia’s hybrid mismatch rules, and ensure they have a clear understanding of what their filing position is, and any risk areas;
• In particular, to the extent that taxpayers were relying on the GILTI rules being equivalent to Australia’s CFC rules to argue against the hybrid mismatch rules having an adverse impact, reassess the risk of such a position in light of TD 2022/9; and
• Consider the merit of other positions that can be taken, particularly in relation to the equivalence of other provisions, as outlined above.

Having a documented position on the application of the hybrid mismatch rules is very important for several reasons, including the need to:

• Correctly answer the detailed questions within the International Dealings Schedule;
• Be able to respond to any request for information from the ATO, which is almost inevitable in the event of a review;
• Demonstrate to statutory auditors that sufficient diligence has been performed;
• Demonstrate to any prospective purchaser that there are no unascertained exposures.
  

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  HOW CAN RSM HELP?

  If you have any questions regarding the Hybrid Mismatch rules, please contact your local RSM tax advisor.