On 21 April 2021, the ATO released a draft Practical Compliance Guideline PCG 2021/D3 Imported hybrid mismatch rules – ATO’s compliance approach that describes its compliance approach to the assessment of relative levels of tax compliance risk associated with imported hybrid mismatches addressed by Subdivision 832-H of the Income Tax Assessment Act 1997 (ITAA 1997).
An imported hybrid mismatch applies where interposed entities are placed between the Australian entity that is making the payment and the foreign parent where the secondary tax benefit is created. An imported hybrid mismatch arises where:
- An Australian entity makes a deductible payment to a foreign entity (either directly or via another interposed entity);
- The payment is made within members of the same control group or under a structured arrangement that gave rise to the hybrid mismatch; and
- The foreign entity is a party to an offshore hybrid mismatch.
An offshore hybrid mismatch arises where:
- A hybrid mismatch arises outside Australia;
- The Australian taxpayer is not a party to the offshore hybrid mismatch;
- The Australian hybrid mismatch rules in earlier subdivisions do not apply to the arrangement; and
- There are no hybrid mismatch rules in the foreign countries, or the rules do not prevent this arrangement.
Broadly, this type of mismatch requires an Australian taxpayer to make a payment which gives rise to an Australian income tax deduction. The recipient of the payment is resident in a foreign country. The recipient will generally be assessable on the amount of the payment, and they then make an equivalent payment to another taxpayer who is resident of another country. That payment is deductible in the foreign country of payment. However, that payment, when it is received in the final country, is not subject to tax in that country.
PCG 2021/D3 outlines the compliance obligations and expected level of enquiry undertaken by taxpayers and their controllers in order to identify and assess the expected tax treatment of instruments or entities in foreign counterparty jurisdictions (limited to members of the same Division 832 control group or payments made under a structured arrangement). There is still the ability for taxpayers to mitigate the cost of compliance by endeavouring to eliminate hybrid mismatch arrangements in line with the Commissioner’s compliance approach outlined in PCG 2018/7 Part IVA of the Income Tax Assessment Act 1936 and restructures of hybrid mismatch arrangements.
PCG 2021/D3 contains a framework of eight colour coded risk zones ranging from the white zone (ATO clearance provided – i.e. no risk) through to red (high risk). Self-assessment will be required where a Reportable Tax Position (RTP) schedule is required to be prepared (this generally applies to companies with a stand-alone turnover of greater than $25 million who are also part of an economic group with business turnover greater than $250 million as reported in the Australian entities’ income tax returns). Where a taxpayer’s risk rating is outside of the white zone or blue (low risk) rating, the ATO will be more likely to conduct some form of activity to further test the taxation outcomes of the arrangements.
The guidance provided in the PCG makes it clear that there is an expectation that an Australian taxpayer should be in a position to obtain information in relation to any payments resulting in imported hybrid mismatches. Accordingly, the taxpayer will need to undertake an analysis of payments made to international related parties to ascertain if they have been made under a structured arrangement.
Division 832 control groups
The compliance approach expected by the ATO will require extensive analysis and information requests to tax qualified professionals working for/at each entity in every jurisdiction involved in the chain of payments, which may be particularly burdensome for large global groups (e.g. groups with turnover greater than $250 million). As extensive evidence gathering is required, formal documented requests for information from the Global Head of Tax or other qualified personnel will need to be obtained, including but not limited to the details of any foreign hybrid mismatch calculations. The PCG contains very detailed lists of exactly what is expected to be obtained under each risk zone category.
There are two recommended approaches:
- Top-down approach: The Division 832 control group should identify if there are any offshore hybrid mismatch outcomes in the group and if the offshore hybrid mismatches are imported into Australia.
- Bottom-up approach: The Australian taxpayer should determine if a cross border payment to an international member of the control group is importing (directly or indirectly) an offshore hybrid mismatch.
Now that the draft guidance has been issued, taxpayers can reassess their international payments and collate relevant evidence e.g. loan agreements, group treasury policies, etc., to establish their risk rating under the PCG.
Three important takeaways from the draft guidance:
- In line with the recent general trend of ATO guidance placing the burden of collecting information from international related parties, the onus is on the Australian taxpayer to request and indeed obtain information from international related parties pertaining to payments (paid or received) that may result in a hybrid mismatch in Australia.
- The information must be obtained from ‘appropriately qualified responsible’ individuals or suitably qualified representatives in the applicable foreign jurisdictions (e.g. The Global Head of Tax).
- Notwithstanding the PCG emphasises the compliance of entities required to lodge an RTP, the ATO have other compliance programs where this assessment could be requested such as through the Top 1000 taxpayer program. There is also no de-minimus threshold for these rules to apply and accordingly, all Australian taxpayers involved in cross border transactions should undertake the recommended level of analysis prior to lodging their income tax returns.
Furthermore, now that the ATO has published its views in respect of the expectations to ascertain whether a taxpayer has an imported hybrid mismatch, any existing arrangements that do not fall within the lower risk zone(s) per the analysis should be revisited as a matter of urgency as they present a high risk from both a tax and transfer pricing perspective.
Submissions in relation to PCG 2021/D3 are due by 21 May 2021. The final guidance will apply before and after its issue such that the guidance practically may apply from 1 January 2019.