ATAD II: hybrid mismatches with third countries

EU Finance Ministers meeting in Brussels have reached agreement on the proposal for a Council Directive extending hybrid mismatch anti-avoidance provisions to third countries (ATAD II). Member States will generally have until 01 January 2020 to implement these provisions.

Background

The proposal for ATAD II was originally presented as part of the EU Commission’s corporate tax reform package in October 2016. In particular, the Commission proposed that the provisions of the Anti-Tax Avoidance Directive (ATAD) dealing with hybrid mismatches should be extended to hybrid mismatches with third countries by including rules to determine which of the two jurisdictions concerned should deny the deduction or (as appropriate) tax the corresponding income.

ATAD II

The compromise version of ATAD II now agreed by the Council will amend ATAD to add rules on mismatches with third countries that apply to taxpayers subject to corporate tax in one or more Member States, including permanent establishments (PEs) of non-EU entities. ATAD II will cover mismatches that arise between head office and PE, between PEs, between associated enterprises and those resulting from structured arrangements. Mismatches resulting from the existence of hybrid entities will only be covered where one of the associated enterprises has effective control over the other associated enterprises. Deduction without inclusion arising due to the tax-exempt status of a payee will not be treated as a hybrid mismatch.

The rules set out how hybrid mismatches are to be rectified in a range of situations, including double deductions, deductions without inclusion, imported mismatches, disregarded PE income and reverse hybrids.

In relation to banks, Member States will, for a limited time, be able to exclude from the scope of ATAD II intra-group regulatory capital that has been issued with the sole purpose of meeting the issuer’s loss-absorbing capacity requirements and not for the purposes of avoiding tax.

Implementation

Once formally adopted, Member States will need to legislate the provisions into domestic law and apply them with effect from 01 January 2020. However, one specific rule (the specific reverse hybrid entity rule requiring taxation of income to the extent not otherwise taxed) has a longer implementation timeframe, with an implementation date of 01 January 2022.