Section
267A, added December 2017, denies a deduction to a US-situated payer of
interest or a royalty to a related non-US hybrid party or as part of a hybrid
transaction. This hybrid mismatch provision was likely influenced by Action
2 – OECD Base Erosion and Profit Shifting Report, which was
finalized in 2015.
Section
267A originated in the US
Senate Committee on Finance International Tax Reform Staff Discussion Draft,
released November 19, 2013. Proposed section 267A prevented related-party
payments in a base erosion arrangement, defined as a transaction, series
thereof, or other arrangement that (1) reduces foreign income tax paid or
accrued and (2) involves a hybrid transaction or instrument, a hybrid entity,
an exemption arrangement, or a conduit financing arrangement. The proposal was
clearly influenced by the said OECD report, but Congress did not entirely follow
the report: final section 267A addresses only a hybrid transaction and a hybrid
entity.
A
US payer of interest or a royalty is denied a related-party deduction if the amount
is not included in or is deductible from the related party’s income. That
latter concern was raised in the 2016
Treasury Green Book, released February 2015 (the year the OECD
Action 2- BEPS report was released). Treasury expressed concern that “there has
been a proliferation of tax avoidance techniques involving a variety of
cross-border hybrid arrangements, such as hybrid entities, hybrid instruments,
and hybrid transfers” such as sale-repurchase transaction:
"In one such hybrid arrangement, a U.S.
person holds an interest in a reverse hybrid, which is an entity that is a
corporation for U.S. purposes but is a fiscally transparent entity (such as a
partnership) or a branch under the laws of a foreign jurisdiction. Because the
United States treats the reverse hybrid as a corporation, income earned by the
reverse hybrid generally will not be subject to current U.S. tax. Moreover,
even if the reverse hybrid is treated as a CFC, interest and royalty income
earned by the reverse hybrid from certain foreign related persons (which
otherwise would qualify as subpart F income) may nonetheless not be subject to
U.S. taxation as a result of either section 954(c)(3) or section 954(c)(6).
Payments to the reverse hybrid, however, generally are also not subject to tax
in the foreign jurisdiction in which it is established or organized, because
the foreign jurisdiction views reverse hybrid as a fiscally transparent entity
and therefore treats that entity’s income as derived by its owners, including
its U.S. owners. As a result of this hybrid treatment, income earned by the
reverse hybrid generally would not be subject to tax currently in the United
States or the foreign jurisdiction".
The
2017 Green Book expresses the ongoing Treasury concern with hybrid entities and
transactions.
Section
267A refers to section 954(d)(3) for guidance on the meaning of “related party”:
a related person that
Is an individual, corporation, partnership,
trust, or estate which controls, or is controlled by the person making the payment
from the United States or
Is a corporation, partnership, trust or
estate which is controlled by the same person or persons which control the
payor.
Section
954(d)(3) defines “control” as the ownership, directly or indirectly, of (1) corporate
stock that has more than 50 percent of the total voting power of all classes of
stock entitled to vote, or (2) more than 50 percent (by value) of the
beneficial interests in a partnership, trust, or estate. Rules similar to those
in section 958 also apply.
A
US payer of interest or a royalty must determine whether it is related to a
non-resident payee; a US fund must ensure that no single non-resident investor may
hold 50 percent of the fund’s value. The US payer must also determine whether
the payee is a hybrid and whether the payment is taxed where the hybrid entity
resides for tax purposes (section 267A)(d)). A “hybrid transaction” means any
transaction, series thereof, agreement, or instrument under which one or more
payments are treated as interest or royalties and “are not treated for purposes
of the tax law of the foreign country of which the recipient of such payment is
resident for tax purposes or is subject to tax.”
Needless
to say, a Canadian financing structure that uses a hybrid through a jurisdiction
such as the Cayman Islands (which hybrid has checked the box and is thus a
flowthrough for US purposes) must review its current structure. Also, a US
entity with non-resident investors must take a closer look at the recipient of an
interest and royalty payment and determine whether at time of payment a
non-resident payee might be deemed related and a hybrid.
Given
the sparse definition of “a hybrid” or “a hybrid transaction” under section 267A,
practitioners await further guidance from section 267A regulations yet to be
released.
Sunita
Doobay
TaxChambers
LLP, Toronto
*First published in the June edition of the Canadian Tax Highlights, a Canadian Tax Foundation newsletter
