Implementation of the OECD Hybrid Mismatch Rules – A Report to the Treasurer (31 March 2016)

[The Report]

Table of Contents




Background – 11

Review process – 12

Overview – 13

UK Hybrid Rules – 14

European Commission action on hybrids – 15


Background – 16


Date of commencement of the hybrid mismatch rules – 20

Grandfathering and Transitional arrangements – 22

De minimis threshold – 23

Purpose test – 24

Timing differences – 25

Adoption of OECD recommendation 2.1 – 28

Identifying dual inclusion income – 29

Imported mismatch rule – 31

Other exceptions – 34


Introduction – 35

General anti-avoidance regime (Part IVA) – 38

Definitions – 39


Background – 46


Legislative design – 53

Post-implementation review – 54






1.1 On 12 May 2015, the Board was asked to consult on the implementation of hybrid mismatch rules as developed by the OECD under Action 2 — Neutralising the Effects of Hybrid Mismatch Arrangements of the BEPS Action Plan.

1.2 Hybrid mismatch arrangements can result in double non-taxation, including long-term tax deferral. Such arrangements can reduce the collective tax base of countries around the world even though it may be difficult to determine which individual country has lost tax revenue. The OECD has developed recommendations regarding the design of hybrid mismatch rules to be implemented as part of domestic legislation under Action 2 of the BEPS Action Plan.

1.3 The terms of reference for this review were given to the Board on 14 July 2015 and are attached at Appendix C. The Action 2 Final Report (the Action 2 Report) was released by the OECD on 5 October 2015. The Board was asked to report on the Australian implementation considerations arising from the recommendations included in the Action 2 Report. The Board was asked in particular to identify an implementation strategy that has regard to:

  1. Delivering on the objectives of eliminating double non-taxation, including long term tax deferral;
  2. Economic costs for Australia;
  3. Compliance costs for taxpayers; and
  4. Interactions between Australia’s domestic legislation (for example, the debt-equity rules and regulated capital requirements for banks), international obligations (including tax treaties) and the new hybrid mismatch rules.

1.4 The Board’s review focused, at a high level, on identifying the major implementation considerations involved and making a recommendation as to the appropriate timing for implementation of these rules.


A summary of the Board’s key recommendations made in this report regarding implementation of Australia’s hybrid mismatch rules is set out as follows:

Recommendation 1 (adoption of Action Plan 2 Report recommendations):

The Board recommends that Australia should adopt the Action 2 Report recommendations (each an OECD recommendation), with some minor modifications as recommended throughout this report.

Recommendation 2 (date of commencement):

The Board recommends that the hybrid mismatch rules should commence in Australia for payments made on or after the later of 1 January 2018 or six months after the hybrid mismatch legislation receives Royal Assent.

Recommendation 3 (grandfathering and transitional arrangements):

The Board recommends that pre-existing arrangements should, as a general rule, not be grandfathered. However, as the legislation is developed, there may be certain categories of arrangements that may be appropriate for grandfathering (such as third party arrangements where there is significant detriment to investors arising from application of the hybrid mismatch rules).

The Board also considers that, as a general rule, transitional rules will not be required provided that sufficient notice is given to taxpayers on the proposed commencement date of the hybrid mismatch rules.

Recommendation 4 (de minimis threshold and purpose test):

The Board recommends that the hybrid mismatch rules do not include a:

  • de minimis test; or
  • purpose test.However, the Board notes as an observation that a de minimis threshold should be considered as an option for simplifying the application of the imported mismatch rule.

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Recommendation 5 (timing differences):

The Board recommends that:

  • OECD recommendation 1 should not apply to financial instruments with a term of three years or less, where the hybrid mismatch is merely one of timing; and
  • for financial instruments with a term longer than three years, the OECD recommendation 1 primary rule should apply to delay the ability of the Australian borrower to claim a deduction until the income is recognised for tax in the counterparty jurisdiction. Also, where the defensive rule is triggered in the case of an Australian lender, an amount would be included in the assessable income of the Australian payee each year an accruals deduction is claimed in the counterparty jurisdiction (with such assessable income being credited against any actual receipt, or the actual receipt being treated as non-assessable in the year of receipt).

This is a departure from the suggested approach in the Action 2 Report.

Recommendation 6 (adoption of OECD recommendation 2.1 and 2.2):

The Board recommends:

  • the adoption of the optional OECD recommendation 2.1; and
  • that the optional OECD recommendation 2.2 not be implemented immediately, but that it be left open to implement in the future if integrity concerns are identified.

Recommendation 7 (identifying dual inclusion income):

The Board recommends that a simple dual inclusion income approach be taken to avoid unnecessary complexity and minimise compliance costs for taxpayers. Excess amounts disallowed should be able to be carried forward to set off against dual inclusion income in another period.

Recommendation 8 (imported mismatch rule):

The Board recommends that consideration be given to possible mechanisms to reduce uncertainty and the potential compliance burden in applying the imported mismatch rule, whilst still ensuring an appropriate level of integrity.

The Board also strongly recommends that careful consideration be given during the legislative design process to ensure the interpretation and compliance issues identified with section 974-80 are not replicated in the imported mismatch rule. The Board also recommends that the Commissioner provide contemporaneous administrative guidance to assist both taxpayers and the ATO in applying the rule.

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Observation 1

As an observation, the Board notes that consideration should be given towards either a de minimis test or other safe harbour test for the imported mismatch rule to minimise compliance and uncertainty (even if on a transitional basis until sufficient countries implement their own hybrid mismatch rules).

Recommendation 9 (exceptions):

The Board recommends that further consideration be given during the legislative design process to specific exceptions from the hybrid mismatch rules including, but not limited to:

  • the exceptions recommended in the Action 2 Report, consistent with the approach taken under recommendation 1.5 in respect to special investment vehicles, including for securitisation vehicles;
  • financial traders — repurchase agreements and securities lending agreements; and
  • managed investment trusts (widely held).
    Recommendation 10 (thin capitalisation):
    The Board recommends that further consideration should also be given to:
  • whether, in circumstances where a debt deduction is denied by operation of the hybrid mismatch rules, the hybrid debt to which the deduction relates should be excluded from the adjusted average debt calculation in all cases; and
  • whether any other consequential changes are required to be made to the thin capitalisation rules as a result of the operation of the hybrid mismatch rules.Recommendation 11 (interest withholding tax):The Board recommends that interest withholding tax should continue to apply to interest payments on hybrid debt financing, unless it falls within an existing interest withholding tax exemption.Recommendation 12 (general anti-avoidance regime):The Board recommends that administrative guidance be provided by the Commissioner on whether, and under what circumstances, the general anti-avoidance rule in Part IVA will be applied to restructures undertaken by taxpayers to avoid the application of the hybrid mismatch rules.

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Recommendation 13 (definitions):

Recommendation 13.1 (Financial Instrument)

The Board recommends that to maximise international harmonisation, the OECD’s definition of ‘financial instrument’ in the Action 2 Report should be used in Australia’s hybrid mismatch rules.

However, the Board recommends that the definition be clarified to note that for the purposes of the hybrid mismatch rules, the scope of the definition should be limited to where the instrument is also a ‘financial instrument’ for the purposes of Australian accounting standards and accounting principles.

The Board recommends that leases be specifically carved out of the ‘financial instrument’ definition. Other carve outs may also be appropriate and should be considered during the legislative design process.

Recommendation 13.2 (Structured Arrangement)

The Board recommends that the concept of structured arrangement be clearly defined in its scope and be well supported by guidance material to ensure taxpayers are able to easily assess whether their arrangements would be caught by the hybrid mismatch rules.

Although the Board does not recommend a specific ‘widely held’ or ‘marketable securities’ carve out, the Board notes that care should be taken in the development of legislation and ATO administrative guidance to clarify that, in general, such arrangements should not be captured by the definition of structured arrangement.

Recommendation 14 (OECD recommendation 5):

The Board recommends that OECD recommendation 5 not be implemented immediately, but that it be left open to implement in the future if integrity concerns arise and after the merits have been given further analysis.

Recommendation 15 (hybrid regulatory capital):

Deductible/frankable regulatory capital issuances can advantage banks and insurers with sufficient offshore operations and franking credit balances.

The Board considers that an appropriate policy response is one that provides, to the greatest extent possible, a level playing field between all regulated entities, allows for Australian regulated entities to diversify their sources of funding and minimises complexity, compliance and disruption to markets.

The application of the hybrid mismatch rules to regulatory capital would partially assist in achieving a more level playing field between all regulated entities. However, it

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may be possible to neutralise the hybrid mismatch outcomes of such arrangements in a manner which better facilitates a level playing field and goes further in achieving the other aims of diversification and minimising complexity, compliance and disruption. This would require a holistic review of Australia’s tax treatment of regulatory capital, encompassing potential changes to section 215-10 and the franking streaming rules.

The Board recommends that further time be granted to consider the appropriate policy response to this matter given:

  • the complexities and interactions involved;
  • the limited time period in which this review was able to be undertaken, and
  • the need to undertake a holistic review to assess and ensure unintended consequences do not arise.

The Board proposes to work with Treasury, the ATO and stakeholders to identify a workable solution. This further work will be undertaken as a matter of priority so that any commencement may align with the commencement date of the hybrid mismatch rules.

The Board notes that there are some strong arguments in favour of grandfathering or including transitional arrangements for existing deductible/frankable AT1 issuances for any changes ultimately recommended under this further review, to minimise market disruption and the impact on third party investors. Accordingly, the Board recommends appropriate grandfathering or transitional arrangements also be considered as part of the further review. Any cut off date for grandfathering or transitional arrangements should be clearly defined to minimise any disruption for future AT1 issuances, including issuances that may be made during the further review period.

Recommendation 16 (legislative and administrative issues):

The Board recommends:

  • the hybrid mismatch rules be drafted as a separate regime in Australia’s tax law;
  • a balance of principles-based drafting setting out the high-level policy underpinning the hybrid mismatch rules, coupled with more precise drafting for areas of the rules which require clear boundaries to provide certainty in their application;
  • the hybrid mismatch rules apply in priority to all other parts of Australia’s tax law; and

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  • the Commissioner provide detailed administrative guidance contemporaneously with the introduction of the hybrid mismatch legislation.

Recommendation 17 (post-implementation review):

Acknowledging that there is a possibility that Australia will be one of the first countries to implement the hybrid mismatch rules, the Board recommends that a post-implementation review of Australia’s hybrid mismatch legislation be undertaken, preferably after a number of other jurisdictions have implemented hybrid mismatch rules and in light of any further recommendations made or best practice approaches suggested by OECD Working Party 11 in relation to the implementation of the Action 2 Report.



The table below provides a summary of the hybrid mismatch rules which include a recommendation to neutralise hybrid mismatches.


Neutralising recommendation


Deduction/No Inclusion (D/NI) outcomes

1. Hybrid financial instrument

Primary rule — Deny payer deduction to the extent of the D/NI outcome

Defensive rule — Include in payee ordinary income to the extent of the D/NI outcome

Related persons and structured arrangements

2. Specific Hybrid financial instrument rule

Deny dividend exemption for deductible payments

Limits withholding tax relief for hybrid transfer instruments

No scope limitation

3. Disregarded Hybrid Payments Rule

Primary rule — Deny payer deduction37
Defensive rule — Include in payee ordinary income

Same control group and structured arrangements

4. Reverse Hybrid Rule

Primary rule — Deny payer deduction.

Same control group and structured arrangements

5. Specific Reverse Hybrid Rule

Specific recommendations to:
– Improve CFC rules/offshore investment regimes
– Limit tax transparency for non-resident investors
– Introduce information reporting for intermediaries

No scope limitation

Deduction/Deduction (or Double Deduction DD) outcomes

6. Deductible Hybrid Payment Rule

Primary rule — deny parent entity deduction Defensive rule — deny payer deduction

Defensive rule applies to same control group and structured arrangements

7. Dual Resident Payer Rule

Primary rule — deny parent entity deduction There is no defensive rule

No scope limitation

Indirect Deduction/No Inclusion D/NI outcomes

8. Imported Mismatch rule

Primary rule — Deny payer deduction

Same control group and structured arrangements

37 To the extent it exceeds dual inclusion income (where the income is recognised in more than one jurisdiction — may include CFC income).

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OECD recommendation 1 is intended to prevent taxpayers from entering into arrangements that exploit differences in the tax treatment of a financial instrument to produce a hybrid mismatch. A mismatch under a financial instrument arises when the payment made under a financial instrument is deductible under the laws of one jurisdiction (the payer jurisdiction) and not included in ordinary income by a taxpayer under the laws of another jurisdiction where the payment is received (payee jurisdiction).

OECD recommendation 1 applies to three different types of financing arrangements that give rise to a hybrid mismatch:

  1. 1  Financial instruments — this covers arrangements that are treated as debt, equity or derivative contracts. An example is a redeemable preference share issued by an Australian company which is treated as debt for Australian tax purposes and equity in the jurisdiction of the holder.
  2. 2  Hybrid transfers — this applies where entities in different jurisdictions are treated as the owner of the same asset for tax purposes. An example could be a securities lending arrangement where one jurisdiction treats the legal owner as the holder of the securities and another jurisdiction treats the economic owner as the holder of the securities.
  3. 3  Substitute payments — this covers where a payment is made in substitution for the financing or equity return on a transferred asset where the tax outcome undermines the integrity of the hybrid financial instrument rule.

A hybrid mismatch will only arise where the mismatch can be attributed to the terms of the financial instrument. OECD recommendation 1 is not intended to apply to mismatches:

Implementation of the OECD hybrid mismatch rules


  • that are solely attributable to the status of the taxpayer e.g. tax exempt pension funds;
  • that arise in respect of a payment made to a taxpayer in a purely territorial regime (A jurisdiction that excludes or exempts all foreign source income); and
  • that arise in respect of the circumstances in which the instrument is held.

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OECD recommendation 2 provides the following two specific recommendations which are optional for countries to adopt:

  • OECD recommendation 2.1— Deny a dividend exemption or equivalent tax relief39 for payments that are treated as deductible by the payer.
  • OECD recommendation 2.2— Limit the ability of a taxpayer to claim relief from foreign withholding tax on instruments that are held subject to a hybrid transfer.

There is no limitation on the scope of the recommendation 2. It can apply to any arrangement and not just structured arrangements or arrangements entered into between related parties.

Denial of dividend exemption for deductible payments

OECD recommendation 2.1 applies to deny the payee a dividend exemption or equivalent tax relief to the extent the payment is deductible to the payer. Where recommendation 2.1 is adopted by the payee jurisdiction (such that the payee is denied a dividend exemption), it should not be necessary for the payer jurisdiction to then apply recommendation 1 to deny a deduction, as any mismatch will have already been eliminated.

Australia currently provides a dividend exemption in Subdivision 768-A which may be impacted by the operation of recommendation 2.1. A number of countries including the UK, Japan, and the Netherlands have, or have announced, domestic rules which remove their dividend exemption for deductible payments. The EU have also issued a Directive to EU members stating that the tax exemption applied to distributed profits should be disallowed to the extent those profits are deductible by the subsidiary of the parent company.

Restriction of foreign tax credits under a hybrid transfer

OECD recommendation 2.2 sets out a rule to restrict foreign tax credits under a hybrid transfer, to align the availability of withholding tax relief with the economic benefit of the payment. This could arise under a securities lending arrangement where both the borrower and lender are treated as deriving the dividend income under their respective jurisdictions and both parties seek to claim withholding tax relief.

The rule would operate to restrict the amount of credit in proportion to the net taxable income of the payer under the arrangement.

39 Equivalent tax relief may include domestic tax credits, foreign tax credits or dividends taxed at a reduced rate.

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OECD recommendation 3 focuses on payments made by a hybrid payer. OECD ecommendation 3 requires the denial of a deduction to the payer.

A hybrid payer is any entity which makes a payment where the tax treatment under the laws of the payee jurisdiction causes the deductible payment40 to be a disregarded payment. Payments which are disregarded only give rise to a hybrid-mismatch where they are available to set off an amount of income that is not recognised in both the payer and payee jurisdiction. There is no hybrid mismatch where the deduction offsets dual inclusion income — that is, income included in the income in both the payer and payee jurisdiction.

Any amount disallowed can be carried forward to be set off against dual inclusion income in another period.


Under OECD recommendation 4, a deductible payment made to a reverse hybrid may give rise to a mismatch in tax outcomes where that payment41 is not included in ordinary income in the jurisdiction where the payee is established or in the jurisdiction of any investor in that payee. OECD recommendation 4 requires the denial of a deduction to the payer.

A reverse hybrid is any entity that is treated as transparent in the jurisdiction in which it is established, but treated as a separate opaque (taxable entity) by the investor jurisdiction. This type of entity is referred to as a reverse hybrid as it is the reverse of the more usual type of hybrid (where the establishment jurisdiction treats the entity as opaque and the investor jurisdiction treats the entity as transparent).

OECD recommendation 4 does not apply where a mismatch would not have arisen had the income been paid directly to the investor. Inclusion of a payment under a CFC regime will be treated as having been included in ordinary income for the purposes of the reverse hybrid rule.

OECD recommendation 4 will also not apply if inclusion of the payment is brought under OECD recommendation 5 to neutralise the mismatch.

  1. 40  Deductible payments are not limited to interest payments and may include items such as rent, royalties and services payments.
  2. 41  Like the disregarded hybrid payments rule, the reverse hybrid rule applies to a broad range of deductible payments (but does not include capital allowances) — see footnote 12.

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Recommendation 5 sets out improvements to domestic laws that could be made to reduce the incidence of reverse hybrids, namely:

  1. (a)  Recommendation 5.1 – amend the offshore investment (CFC) rules to ensure attribution of any ordinary income allocated to the taxpayer by a reverse hybrid (to eliminate any NI outcome). Australia will need to determine whether and how its CFC rules should be amended to reflect this recommendation;
  2. (b)  Recommendation 5.2 – ‘switch off’ tax transparent treatment in the establishment jurisdiction (by treating the tax transparent vehicle as a resident taxpayer) where a tax transparent vehicle is controlled by a non-resident investor who will not be subject to tax on income allocated to that investor by the tax transparent vehicle (because it is not transparent in the investor’s jurisdiction); and
  3. (c)  Recommendation 5.3 – introduce tax filing and information reporting to encourage appropriate and accurate records for tax transparent entities — that is, who their investors are, the size of each investor’s investment and the amount of income and expenditure allocated to each investor.


DD outcomes may be triggered where a taxpayer makes a payment through a cross-border structure, such as a dual resident, a foreign branch or a hybrid person, and a deduction can be claimed for that expenditure in more than one jurisdiction. Recommendation 6 will only apply where there is a hybrid mismatch, so will not apply where there is also dual inclusion income offsetting the DD (income included as assessable in more than one jurisdiction).

An example is a US general partnership (GP) with Australian partners that is treated as opaque in the US (under the ‘check the box’ regime) and treated as transparent in Australia. The US GP is the top company of a US tax consolidated group and borrows funds from a third party lender and claims a deduction for the interest both in the US at the GP level and again at the Australian partner level.

The OECD acknowledges that determining which payments give rise to a DD and which items are dual inclusion income requires a comparison between the domestic tax treatment of these items and their treatment under the laws of the other jurisdiction. The Action 2 Report notes countries should decide whether they extend recommendations 6 and 7 (see below) to all deductible items regardless of whether they are attributable to a payment (for example, double tax depreciation claims).

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OECD recommendation 7 applies to DD outcomes that arise because a dual resident entity is able to claim a deduction for a single economic expense in more than one jurisdiction. There is no mismatch to the extent the deduction is set-off against income that is included as income in both jurisdictions (dual inclusion income).

The rule recommends that both jurisdictions should apply the primary rule to restrict the deduction to dual inclusion income. Any excess can be carried forward to set-off dual inclusion income in another period.


The imported mismatch rule in OECD recommendation 8 is designed to prevent taxpayers from entering into structured arrangements or arrangements with group members in jurisdictions that have not introduced hybrid mismatch rules, to indirectly shift the tax advantage from the hybrid mismatch to a jurisdiction that has not applied the rules. This may be through the use of a non-hybrid instrument such as an ordinary loan.

The primary rule is that the payer jurisdiction should deny the deduction for any imported mismatch payment to the extent the payee treats the payment as set-off against a hybrid deduction in the payee jurisdiction.

Tracing and priority rules will need to apply to determine the extent to which a payment should be treated as set-off against a deduction under an imported mismatch arrangement. [Paragraph 246 of the final Action 2 Report sets out the suggested priority rules ((1) structured imported mismatches, (2) direct imported mismatches, and (3) indirect imported mismatches).]


OECD recommendations 10, 11 and 12 provide definitions for jurisdictions to adopt for the purposes of applying the OECD recommendations in the Action 2 Report.

OECD recommendation 10 defines structured arrangement as ‘any arrangement where the hybrid mismatch is priced into the terms of the arrangement or the facts and circumstances (including the terms) of the arrangement indicate that it has been designed to produce a hybrid mismatch’.

OECD recommendation 11 provides that ‘two persons are related if they are in the same control group or if one person has a 25 per cent investment in the other person or a third person holds a 25 per cent or greater investment in both.’ The test measures

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both direct and indirect investment, which includes voting rights and the value of any equity interests. If two or more people act together in respect of the ownership or control of an investment, they are required to aggregate their ownership interests for purposes of the related party test.

OECD recommendation 11 further provides that two persons are in the same control group if they form part of the same consolidated group for accounting purposes, if they are treated as associated enterprises under Article 9 of the OECD Model Tax Convention 2014, if one person has a 50 per cent investment in the other or someone has a 50 per cent investment in both or if there is effective control (whether directly or indirectly).

OECD recommendation 12 of the Action 2 Report provides a suite of other definitions for jurisdictions to adopt as part of their hybrid mismatch rules.


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