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December 17, 2021
2021-2262

Australian Taxation Office releases final guidance on imported hybrid mismatch rule

On 16 December 2021, the Australian Taxation Office (ATO) released in final Practical Compliance Guideline PCG 2021/5 Imported hybrid mismatch rule – ATO's compliance approach (PCG 2021/5). PCG 2021/5 provides long-awaited final guidance on the imported mismatch rule, replacing the Draft Practical Compliance Guideline (Draft PCG).

Broadly the imported hybrid mismatch rule operates to disallow a deduction for a payment if the income from such payment is set-off, directly or indirectly, against a deduction that arises under a hybrid mismatch arrangement in an offshore jurisdiction, referred to as an "offshore hybrid mismatch." PCG 2021/5 provides a framework of seven color-coded risk zones ranging from white zone (where the ATO has provided clearance to the taxpayer), through green (low risk) to very high risk (red). Taxpayers may be required to self-assess the risk of the imported hybrid mismatch rule within Australia's hybrid mismatch rules applying to their related-party arrangements where a Reportable Tax Position (RTP) Schedule is required to be prepared. Where a taxpayer's risk rating is outside of the white zone or blue (low risk) rating, there is no presumption that the arrangements do not comply with Australian tax law, but the ATO is more likely to conduct some form of engagement and assurance activity to further test the taxation outcomes of the arrangements.

While there are minor changes from the draft PCG, including changes to the definition of the risk zones and additional flexibility in how taxpayers can gather information demonstrating reasonable care in complying with the imported hybrid mismatch rule, the core content of the PCG is unchanged. In particular, Australian taxpayers continue to have a substantial burden of proof to demonstrate sufficient inquiry has been made by the Australian organization of personnel with knowledge of taxation treatment of the global group to support income tax deductions for payments to international related parties. This burden of proof includes a requirement to maintain written records of the inquiries. We have seen the ATO request evidence of the inquiries undertaken as part of Combined Assurance Reviews.

The key observations from PCG 2021/5 are:

  • The ATO allows taxpayers to adopt a combination of the "Top-down" and "Bottom-up" approaches to determine if an imported hybrid mismatch exists.
  • For non-structured arrangements, the ATO provides some flexibility in the methods prescribed to perform the imported hybrid mismatch analysis while still demonstrating reasonable care if the outcome of the taxpayer's inquiries provides sufficient evidence to show compliance with the imported hybrid mismatch rule.
  • Taxpayers filing a tax return from the date of publication who are required to file an RTP schedule must make a disclosure if the taxpayer falls within the high-risk zone of PCG 2021/5 (i.e., Amber Zone and Red Zones 1 and 2) or if taxpayers have not applied PCG 2021/5. This is particularly relevant for taxpayers with income years ending 30 June 2021 that are yet to file.
  • It is anticipated that the revised RTP schedule instructions will include a specific question requiring disclosure of the risk zone under PCG 2021/5.

The key observations regarding the risk zone framework are:

  • The risk zone framework has changed from eight to seven colored risk zones.
  • Amber risk zone is now a high risk (previously moderate).
  • Red 1 to 3 high-risk zones have been collapsed into Red 1 and Red 2, both being very high-risk zones.
  • Lower risk zone categories (i.e., blue, green, and yellow) have been redefined.
  • The yellow risk zone definition now introduces a safe harbor for groups having in place a global hybrid arrangement risk policy that is wholly consistent with Organisation for Economic Co-operation and Development Action 2 report where the Australian group has turnover (revenue) of less than AU$250m.
  • Provided there have been no material changes to the Division 832 control group, the risk zone assessment may generally be relied on by taxpayers for the next two income years.
  • Taxpayers have been provided with clear guidance of expected ATO compliance actions based on their risk zone with the inclusion of the table "What you can expect given your risk zone."
  • For a period of 18 months from the date of publication, the ATO will consider reducing penalties where taxpayers voluntarily disclose their arrangements for prior income years.

As expected, the compliance approach outlined by the ATO continues to be very detailed requiring extensive analysis and information gathering, and will be onerous for large global groups.

The final guidance will apply before and after its issuance such that the guidance practically applies from 1 January 2019, the date of commencement of the hybrid mismatch rules.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young (Australia), International Tax and Transaction Services, Perth

Ernst & Young LLP (United States), Australian Tax Desk, New York

Ernst & Young LLP (United Kingdom), Australian Tax Desk, London

 

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