Driven by motives to suppress the widespread use of hybrid mismatch structures and the subsequent erosion of the taxable bases of jurisdictions concerned, the Anti-Tax Avoidance Directive II (ATAD II) provides for common standards concerning hybrid mismatches with a view to coordinate the implementation of the OECD’s base erosion and profit shifting (BEPS) action points.
ATAD II in Malta
In December 2019, Malta transposed the provisions of the ATAD II concerning hybrid mismatches by means of Legal Notice 348 of 2019 (ATAD II implementation regulations). The ATAD II implementation regulations will apply as from January 1 2020, with the exception of reverse hybrid mismatches, the implementation of which shall enter into force on January 1 2022.
Moreover, the ATAD II implementation regulations apply to all companies including other entities, trusts and similar arrangements that are subject to tax in Malta in the same manner as companies and entities, which though not resident in Malta, have a permanent establishment in Malta.
What are hybrid mismatches?
Hybrid mismatches exploit the different tax treatment of an entity or instrument under the laws of two or more jurisdictions. The resulting effect is one of double non-taxation, whereby the taxpayer would have essentially not paid tax in each respective jurisdiction.
The following specific hybrid mismatches fall within the scope of the ATAD II implementing regulations:
Hybrid permanent establishments;
Payments made by/to hybrid mismatches;
Payments made under hybrid financial instruments; and
Three possible mismatch outcomes
The hybrid mismatch rules are aimed at neutralising specific mismatch outcomes which arise as a result of the above-mentioned hybrid mismatch arrangements:
Payments that give rise to a double deduction (DD) outcome, which includes payments that give rise to two deductions in respect of the same payments, one in the payer jurisdiction in which payment has its source and the other in the investor’s jurisdiction;
Payments that give rise to a deduction/no inclusion outcome (D/NI) outcome, which includes payments that are deductible under the rules of the payer jurisdiction and which are not included in the ordinary income of the payee;
Payments that give rise to an indirect deduction/no inclusion outcome, which includes payments that are deductible under the rules of the payer jurisdiction and that are set-off by the payee against a deduction under a hybrid mismatch arrangement.
The ATAD II implementation regulations introduce measures aimed at neutralising the mismatch outcomes which derive from the different types of hybrid mismatches. Such measures materialise through a primary rule/response and a secondary rule depending on the applicable circumstances.
The primary rule/response covers the instance whereby income is not taxed at the level of the recipient and hence the payer will be denied a deduction of the payment.
The OECD’s final report “Neutralising the Effects of Hybrid Mismatch Arrangements” highlights that the secondary rule, on the other hand, operates as a “defensive rule”, such essentially being a response in cases where there is “no mismatch rule in the other jurisdiction or the rule is not applied to the entity or arrangement.” By virtue of this rule, if the payment is deductible at the level of the payer, then the payment will be added to the taxable income of the recipient of such payment.
In the context of the above primary and secondary rules, where the hybrid mismatch results in DD outcome:
The primary rule requires that such deduction shall be denied, if Malta is the investor jurisdiction; and
The secondary rule provides that such deduction shall be denied if Malta is the payer jurisdiction.
Where the hybrid mismatch results in a D/NI outcome:
The primary rule requires that the deduction shall be denied if Malta is the payer jurisdiction; and
The secondary rule provides that Malta should include the income giving rise to the mismatch outcome to the taxable income of the recipient, but only if Malta is the payee jurisdiction and to the extent that the mismatch results either from an arrangement involving a payment under a financial instrument or alternatively, from a payment made by a hybrid entity where such payment would otherwise be disregarded under the laws of Malta.
ATAD’s impact on the Maltese tax framework
The Maltese tax landscape has experienced significant changes being introduced as a result of the transposition of the ATAD II regime in Malta. The introduction of complex and broad ranging rules has undoubtedly raised the bar for companies engaged in cross-border transactions both in terms of awareness of new underlying principles and even more in terms of adherence to ensure effective compliance with the new regime.
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