What is a legitimate hybrid?

The Beps project has produced two technical papers on the domestic and cross border issues about hybrids. Various advisors have commented publicly.

It seems to me that they start from the wrong place and protest too much – I won’t speculate on the second issue, but as I have said what is needed is a principled approach to hybrids not self interest masquerading as principle.

The fundamental issue which business has to address in terms of a review of hybrids is what is a legitimate hybrid for tax purposes using first principles? This isn’t about defending special interests, it’s about establishing the principles for the international tax system going forward (which is the over-riding challenge in Beps).

Historically my perspective was that hybrid tax treatments exist because of mismatches between tax systems. To benefit from them was a function of the dysfunctional nature of the international tax system. If a government chose to close down a hybrid, there was little intellectual basis in opposing this unless the hybrid treatment was intentional.

What we see now is something very different. If governments acting together seek to close down hybrid tax treatments, the response of business has to be very careful if it is to be principled.

Business needs to articulate where hybrid mismatches are in principle correct, and conversely it has to accept that where they are not, they are not defensible, in fact they are indefensible. I’m encouraged by a number of conversations in Paris this week where I’ve been encouraged to be forthright on this subject.

There was also discussion about regulatory hybrids which broadly mean those mismatches which are used to circumvent non tax regulation. The question is, can these be used for tax purposes? There appears to be an assumption that if the main purpose of the hybrid is regulatory then the incidental tax benefit is ok. I’m not sure this is tenable. I think the general rule is if the hybrid tax treatment is intended by all the tax authorities involved then it bona fide, if it’s not then I struggle with the logic in calling for its continuance if the tax authority challenges it.

A number of comments were made about the danger of double taxation if hybrids were removed. This does need to be taken seriously and addressed. It does emphasise though that if one advances the avoidance of double taxation as a key principle, then it is difficult to argue, in principle, against the removal of un intended double non taxation.

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