Technical Update:

Australia’s hybrid mismatch rules – time to act

01 April 2018

Revised draft legislation to implement hybrid mismatch rules in Australia has been released for public comment by 4 April. Australian taxpayers need to be aware of the new integrity measures and key changes to the exposure draft from 2017 and act soon.

Revised Exposure Draft

On 7 March 2018 the Australian Government released revised exposure draft (ED) legislation to implement hybrid mismatch rules further to its initial ED on 24 November 2017 in response to recommendations by the Organisation for Economic Co-operation and Development (OECD) in 2015. Refer to BDO’s Technical Update from 2017 for analysis of the initial ED.

Hybrid mismatches arise where there are differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions. If a mismatch arises, it is neutralised by disallowing a deduction or including an amount in assessable income (hopefully only in one jurisdiction).  

What’s changed

The revised ED updates the ED from 2017 with new integrity measures to discourage foreign interposed zero or low tax rate entities lending to Australia and address branch mismatch arrangements. The revised ED also introduces a number of new concepts and gives rise to a number of unanswered questions, particularly in relation to the interaction of the new hybrid mismatch rules with Australia’s existing international tax rules and how they might apply in conjunction with similar rules implemented by other jurisdiction.

The structure of the ED has also been significantly amended, including restructuring to move the relevant operative provisions and definitions to the subdivisions relating to the specific classes of mismatch arrangements.

Integrity measures

Financing integrity measure

A targeted financing integrity measure has been introduced in Subdivision 832-J to prevent multinational groups from being able to enter into arrangements designed to circumvent the hybrid mismatch rules using interposed conduit type entities that pay effectively no tax to invest into Australia, as an alternative to investing directly into Australia via traditional hybrid instruments or entities. This measure will operate to disallow an Australian deduction of an entity (the paying entity) for a payment of interest (or a payment of a similar character) to a foreign entity (the interposed foreign entity) where pursuant to s832-795 ITAA 1997 the:

  • Paying entity, interposed foreign entity and the ultimate parent entity are in the same “Division 832 control group”; and
  • Interposed foreign entity and the ultimate parent entity are not residents of the same foreign country; and
  • Rate of foreign income tax rate of the country of residence of the interposed foreign entity is 10% or less.

Branch hybrid mismatch and limited scope response integrity measure

Subdivision 832-F implements recommendations from the 2017-18 Mid-Year Economic and Fiscal Outlook when the Government announced it would implement recommendations in the OECD’s report on neutralising the tax effects of branch mismatch arrangements from 27 July 2017 to deny the application of Australia’s foreign branch exemption to branch income that not subject to tax in the foreign jurisdiction, and deductions for deemed intra-branch payments from the Australian branch of a foreign bank where there is no corresponding income pick in the other jurisdiction.

The revised ED proposes further rules which will:

  • Limit the scope of the exemption for foreign branch income by amending section 23AH of the Income Tax Assessment Act 1936 where a branch hybrid mismatch arises (where the residence country provides a branch exemption, but the branch country does not tax the payment because the payment is treated as not derived in carrying on business through a permanent establishment);
  • Disallow a tax deduction for payments that give rise to a branch hybrid mismatch for the payee; and
  • Prevent a deduction from arising for notional payments made by an Australian branch of a foreign bank to its head office in some circumstances.

Other changes

Dual inclusion income

The dual inclusion income rule has been expanded and clarified in Subdivision 832-I of the revised ED and is important because no adjustment might be required despite the existence of hybridity to the extent dual inclusion income exists. Specific legislative guidance has also been provided on when an entity is eligible to apply the dual inclusion income.

Interaction with TOFA

There has also been clarification in relation to the interaction of the hybrid mismatch rules with taxation of financial arrangement (TOFA) rules in Division 230. Subdivision 832-K specifies what elements of Division 230 gains or losses are captured by the hybrid mismatch rules. Very broadly, to the extent which the gain or loss represents a currency exchange rate effect, it is treated as a separate gain or loss and the hybrid mismatches rules should not apply to it. Further, the amount of a Division 230 gain or loss is adjusted where the hybrid mismatch rules have the effect of adjusting the amount of that gain or loss.


With the deadline for comments on the current ED law not due until 4 April 2018, it the measures will not be able to be introduced into Federal Parliament in the current Autumn sitting scheduled to conclude on 28 March 2018.  Since both Houses of Parliament will not then next sit until the week commencing 8 May 2018, it is reasonable to expect that the new law could not apply to any payments made before 8 November 2018. It is therefore anticipated that the broader substantive measures will most likely take effect from 1 January 2019.

It is interesting that the new law seems to apply to payments made six months after the relevant amending Bill is enacted pursuant to para 1.324 of the EM, which is inconsistent with recommendation 9.2 from OECD’s final report on Hybrid Mismatch Arrangements from 5 October 2015, that “... to avoid unnecessary complication and the risk of double taxation, the rules should generally take effect from the beginning of a taxpayer’s accounting period”.

This also does not leave much time to consider the application of these rules to existing and proposed arrangements, which in some cases may need to be unwound. Taxpayers participating in cross-border transactions after the Bill’s commencement date will need to consider whether the proposed rules including the new integrity measures apply to their arrangements. The lack of ‘grandfathering’ relief means that existing arrangements should also be evaluated and, if appropriate, restructured.

BDO Comment

Australian taxpayers with cross-border transactions should contact BDO for assistance with:

  • Reviewing application of the hybrid mismatch rules to structures including implementation of strategies to either restructure (which will require careful consideration of legal, accounting, treasury and foreign tax issue) or unwind impacted hybrid structures
  • Restructuring out of hybrid arrangements and entering into alternative arrangements that do not attract the operation of hybrid mismatch rules which is not simple and requires careful consideration of legal, accounting, treasury and foreign tax issues, and timing will be tight given the wide range of complexities involved including Foreign Investment Review Board considerations, tax issues including foreign currency tax implications, stamp duty and accounting issues
  • Managing these issues which may involve significant lead times if tax, legal and accounting are not aligned as timing will be tight given the wide range of complexities involved and potential start date of 1 January 2019.