Foreign hybrid mismatches
In a further attack on the ‘big banks’, tax advantages from hybrid mismatches are being further restricted. The Government is targeting mismatched hybrid instruments issued by the offshore units of Australian banks and financial institutions. This foils the potential manipulation of Australia’s debt/equity rules, where instruments issued by an offshore unit pay interest, but will be treated as ‘Additional Tier 1’ capital under the banking regulatory requirements.
In the 2016/17 Budget, the Government committed to the OECD measures to neutralise hybrid mismatches. These measures aimed to deny benefits arising from taxpayers claiming a tax deduction in one jurisdiction where the amount is not income in another jurisdiction, or claiming a deduction in two tax jurisdictions.
The current amendment clarifies the position adopted by the ATO. In earlier private rulings issued by the ATO to specific taxpayers, the ATO confirmed these securities provided interest returns, meaning the distributions did not need to be franked for tax purposes. The mismatch arises as these securities should have paid a franked distribution if they were issued through the Australian based parent.
Under the changes, the returns on these securities will give rise to franking debits where the capital is not exclusively used in the foreign branch. These rules will apply to returns on investments paid after 1 January 2018, with some transitional arrangements for instruments currently on foot.
BDO welcomes the Government’s attempt to strengthen the hybrid mismatch rules and provide clarity to taxpayers operating in this market. However, financial institutions may fall foul of these provisions as they will apply to existing instruments, which are frequently issued for five to ten years. Banks require certainty in tax to offer long-term instruments to their investors. Ultimately, the potential loss of franking credits may result in unhappy shareholders in Australian banks.