26 August 2016 OECD releases discussion draft on branch mismatch structures On August 22, 2016, the Organisation for Economic Co-operation and Development (OECD) released a discussion draft on branch mismatch structures (the Draft) as part of the follow-up work under Base Erosion and Profit Shifting (BEPS) Action 2 (Neutralizing the effects of hybrid mismatch arrangements). The OECD previously issued the BEPS Action 2 final report in October 2015 (Action 2 Report). The Draft identifies and analyzes the following five basic types of branch mismatch arrangements that may result in the certain outcomes namely, deduction/no inclusion (D/NI), double deduction (DD), and indirect deduction/no inclusion (Indirect D/NI): — Disregarded branch structures Moreover, the Draft describes preliminary recommendations for domestic rules that would neutralize the mismatches in tax outcomes arising from these structures, and asks a number of detailed questions regarding each for which comments are sought. According to the Draft, these preliminary recommendations do not necessarily reflect the consensus view of the Working Party 11 (WP11) or the Committee on Fiscal Affairs. All interested parties are invited to submit comments on the Draft and input on the consultation questions by September 19, 2016. The Draft identifies and analyzes mismatches that can arise through the use of branch structures and describes preliminary recommendations for domestic rules, based on the recommendations in the final Action 2 Report. Although the operation and scope of these branch mismatch rules follow the general approach in the final Action 2 Report, the trigger for the application of the rules differs because, rather than being attributable to differences between the legal characterization of instruments and entities, branch mismatches result from differences in the way the branch and head office account for a payment made under that structure. The Draft identifies five basic types of branch mismatch arrangements. The branch mismatch arrangement arises when the branch does not give rise to a permanent establishment (PE) or other taxable presence in the branch jurisdiction. In this fact pattern, the mismatch arises when a deductible payment received by a taxpayer is treated, under the laws of the residence jurisdiction, as being made to a foreign branch and therefore eligible for an exemption from income. At the same time, the branch jurisdiction does not recognize the existence of the branch and consequently does not subject the payment to tax. Thus, the result is a branch mismatch (a D/NI outcome). This branch mismatch arrangement arises when the branch jurisdiction recognizes the existence of the branch but a payment made to the branch is treated by the branch jurisdiction as attributable to the head office, while the residence jurisdiction exempts the payment from taxation on the grounds that the payment was made to the branch. In this fact pattern, the mismatch arises due to a difference between the laws of the residence and the branch jurisdiction in the attribution of payment to the branch. Therefore, the result is a branch mismatch (a D/NI outcome). The Draft explains that the simplest way to prevent a D/NI outcome from arising in these two types of branch mismatch arrangements is to improve the operation of the branch exemption rules in the residence country so that payments that are disregarded, exempt or excluded from taxation in the branch jurisdiction are treated as if they had been received directly by the head office (and thus outside the exemption for branch income). Therefore, as a specific recommendation on improvements to domestic law, countries should consider improvements to their branch exemption rules. Further, the Draft proposes a "branch payee mismatch rule" under which the deduction for a diverted branch payment or a payment to a disregarded branch would be denied if the branch structure gives rise to a mismatch in tax outcomes. The purpose of the branch mismatch rule is to neutralize mismatches caused by differences in the allocation of income between the branch and the head office under the respective laws of the two jurisdictions. The Draft proposes that this rule would apply only to payments made under a structured arrangement or between members of the same group. According to the Draft, the tests for structured arrangement and control group should be the same as those set out in the Action 2 Report. The Draft notes that the branch payee mismatch rule would not apply unless the payment actually gives rise to a D/NI outcome. Thus, the branch payee mismatch rule should only apply when there is a mismatch under the ordinary rules for allocating branch income. The Draft notes that the Action 2 Report states that a payment that has been fully attributed to the ultimate parent of the group under a controlled foreign company (CFC) regime and has been subject to tax at the full tax rate should be treated as having been included in ordinary income for purposes of the reverse hybrid rule. The Draft notes that WP11 will give further consideration to the need for any guidance on the potential effect of a CFC inclusion on the application of the branch payee mismatch rule. This branch mismatch arrangement arises when the branch is treated as making a notional payment to the head office that results in a mismatch in tax outcomes under the laws of the residence and branch jurisdictions. Under this fact pattern, the mismatch results from exploiting differences between the home country and the branch jurisdictions, where one jurisdiction recognizes a deemed payment between the branch and the head office and there is no corresponding adjustment to net income in the payee jurisdiction. Thus, the result is a branch mismatch (a D/NI outcome). The Draft proposes a "deemed branch payment rule" that would restrict the deduction for the deemed payment to the amount of dual inclusion income in the branch jurisdiction. If the branch jurisdiction does not include this rule, the defensive rule calls on the residence jurisdiction to include such payment as ordinary income to the extent necessary to eliminate the mismatch. To avoid double taxation, the income inclusion could be deferred until the resulting deduction is off-set against non-dual inclusion income. Deemed payment is defined in the Draft as "any payment that is treated, under the laws of the payer jurisdiction, as a purely notional payment to the same taxpayer in another jurisdiction. A deemed payment should not include any notional payment to the extent it represents or is calculated by reference to a third party expense of the taxpayer." Therefore, payments representing an allocation of third-party expenses should be treated as outside the scope of the deemed branch payment rule. This exclusion could, nevertheless, be subject to adjustments under the rules dealing with branch double-deduction payments (discussed later). The Draft further explains that deemed branch payments are unlikely to arise when there is a mechanism in place in either the branch or the residence state for ensuring that the total amount of net income subject to tax in both jurisdictions is no less than the total net income of the taxpayer as a whole. Thus, there should not be a mismatch if the deduction is set off against dual-inclusion income. This branch mismatch arrangement arises when the same item of expenditure gives rise to a deduction under the laws of both the residence and branch jurisdictions. The result is a branch mismatch (a DD outcome). The Draft recommends a "deductible hybrid payments rule" found in Recommendation 6 of Chapter 6 in the Action 2 Report. This rule is designed to neutralize the mismatch to the extent the payment gives rise to a double deduction outcome involving branch structures. The primary rule would deny the duplicative deduction in the residence jurisdiction. To avoid double taxation, the denied deduction could be carried forward to be set off against future dual-inclusion income. If the residence jurisdiction does not apply the primary rule, the defensive rule would be for the branch jurisdiction to deny the deduction. Interested parties are invited to comment on whether they agree that the branch mismatch should fall within the recommendation for deductible hybrid payments in the final Action 2 Report. The Draft indicates that WP11 could provide further commentary and guidance on the application of the recommendations in Chapter 6 of the Action 2 Report to DD branch outcomes. This branch mismatch arrangement arises when, for example, the payee offsets the income from a deductible payment against a deduction arising under a branch mismatch arrangement and imports that mismatch into a third jurisdiction. The result is a branch mismatch (an indirect D/NI outcome). The Draft recommends an "imported mismatch rule" that would deny the deduction for any payment that is directly or indirectly set off against any type of branch mismatch payment. The imported mismatch rule would only apply to payments made under a structured arrangement or between members of the same group. Thus, WP11 recommends rules designed to bring the treatment of branch mismatches into line with the recommendations in the Action 2 Report. As a result, the principles applying to imported mismatches set out in Chapter 8 of the Action 2 Report could also be extended to cover branch mismatch structures. Interested parties are invited to comment on whether the scope of the preliminary recommendation should be modified or clarified. Interested parties should consider the preliminary recommendations discussed in the Draft and decide whether to submit comments. Comments must be submitted by no later than September 19, 2016.
Document ID: 2016-1458 | |||||||||||||
