beps action 2: neutralise the effects of hybrid mismatch arrangements

463 Pages·2014·13.13 MB·English

by  Aisling Nolan

Comments received on Public
Discussion drafts

BEPS ACTION 2:
NEUTRALISE THE
EFFECTS OF HYBRID
MISMATCH
ARRANGEMENTS
7 May 2014
TABLE OF CONTENTS
Alternative Investment Management Association (AIMA) 3
Association for Financial Markets in Europe (AFME) - British Bankers Association (BBA) 5
Association of British Insurers (ABI) 12
AstraZeneca 39
Australian Bankers Association (ABA) 43
Banking Working Group 49
BASF The Chemical Company 60
BDI Federation of German Industries 64
BEPS Monitoring Group (BMG) 68
BIAC 76
British Private Equity and Venture Capital Association (BVCA) 94
British Property Federation - Domestic Laws 104
British Property Federation - Tax Treaties 105
Bundessteuerberaterkammer - KdöR 106
BUSINESSEUROPE 111
CBI - 100Group 115
CIOT - Domestic Laws 117
CIOT - Tax Treaties 125
Confédération Fiscale Européenne (CFE) 129
Confederation of Indian Industry 133
Confederation of Netherlands Industry and Employers (VNO-NCW) 140
Confederation of Swedish Enterprise 144
Crowe Horwath Italy 148
Danon Robert University of Lausanne 151
Deloitte UK - Domestic Laws 159
Deloitte UK - Tax Treaties 169
Deloitte USA 172
Dutch Association of Tax Advisers NOB 180
Ernst & Young LLP 182
European Banking Association (EBF) 188
European Business Initiative on Taxation (EBIT) 191
European Private Equity & Venture Capital Association EVCA 195
FIDAL 212
Freshfields Bruckhaus Deringer 215
Harris Consulting & Tax Ltd (HCAT) 220
Ibec 222
IBFed – Submitted after deadline 227
IFA Mexico 230
Institute of Chartered Accountants in England & Wales (ICAEW) 236
Insurance Europe 240
Insurance Working Group - Domestic Law 247
International Alliance for Principled Taxation (IAPT) - Domestic Law 261
International Alliance for Principled Taxation (IAPT) - Tax Treaties 277
International Bar Association Tax Committee 292
International Chamber Of Commerce 296
International Securities Lending Association (ISLA) 298
International Underwriting Association (IUA) - Domestic Law 300
International Underwriting Association (IUA) - Tax Treaties 309
Investment Company Institute (ICI) & ICI Global 310
Investment Management Association (IMA) 325
Irish Debt Securities Association (IDSA) 329
Japan Foreign Trade Council 335
Keidanren Japan 340
KPMG 346
Loyens & Loeff 359
Lykken, Matthew (USA) 364
MacFarlanes – Submitted after deadline 366
Maisto e Associati 369
MEDEF 377
National Foreign Trade Council (NFTC) 382
New York State Bar Association 387
Organization for International Investment (OFII) 395
Otterspeer Haasnot & Partners 400
PWC 406
Swiss Bankers Association & Swiss Insurance Association 429
Tax Executive Institute (TEI) 433
TD Bank 443
Thuronyi, Victor 453
United States Council for International Business (USCIB) - Domestic Law 454
United States Council for International Business (USCIB) - Tax Treaties 458
Alternative Investment Management Association

Tax Treaties, Transfer Pricing and Financial Transactions Division
OECD/CTPA
OECD Headquarters
2 rue André Pascal
75116 Paris
France

Attention:

Achim Pross
Head, International Co-operation and Tax Administration Division

Sent by email to: [email protected]

1 May 2014

Dear Sirs,

OECD Discussion Draft BEPS Action 2: Neutralise the Effects of Hybrid Mismatch Arrangements
(Recommendations for Domestic Laws)

The Alternative Investment Management Association1 wishes to comment on four of the proposals set out in the
OECD discussion draft on BEPS Action 2.

AIMA is concerned that certain aspects of the measures recommended in the Discussion Draft will, if adopted in
their present form, have significant effects on the ability of collective investment schemes in general (and not
limited to those in the alternative investment sector which AIMA represents) to make and manage investments at
a time when many economies are looking to sources of finance outside the banking sector. The asset management
industry globally now accounts for some $64 trillion assets under management.

The measures in our view have been drawn up with the activities of multinational corporations in mind and
without sufficient consideration for their potential effect on investment funds as providers of capital2.

Prospective Application – Question 5.2 Page 79

Investment funds pool investors’ capital to enable their investment into a range of underlying asset classes and
are an important source of cross-border investment capital. Company law and tax law differ both in form and
interpretation from country to country. Alternative investment funds invest in asset classes that have different
risk and liquidity profiles compared to listed shares and debt. As a result, their investments are often made with
the intention of long term capital growth and there is a more limited market to exit which also makes
restructuring existing arrangements challenging. AIMA believes that it is important for the certainty that
taxpayers and capital markets require that any tax changes are prospective in application and there is
grandfathering of existing arrangements and transactions which are compliant with existing tax laws.

In response to Question 5.2 on Page 79 of the Discussion Draft “Are there further technical recommendations that
should be addressed in the final report?”, AIMA requests that there is grandfathering in all jurisdictions of existing
arrangements and transactions.

1 AIMA is the trade body for the hedge fund industry globally; our membership represents all constituencies within the sector – including
hedge fund managers, funds of hedge fund managers, prime brokers, fund administrators, accountants and lawyers. Our membership
comprises over 1,300 corporate bodies in over 50 countries.
2 It should be noted that an investment fund is a corporation or partnership owned by investors whose assets are managed
by an investment manager on a discretionary basis. The investment fund, its investments, the investors and the
investment manager will very often be located in different jurisdictions and subject to different tax regimes.
The Alternative Investment Management Association Limited
167 Fleet Street, London, EC4A 2EA
Tel: [phone] Fax: [phone] E-mail: [email protected] Internet: http://www.aima.org

Registered in England as a Company Limited by Guarantee, No. 4437037. VAT registration no: 577 5913 90. Registered Office as above
3
Scope of Hybrid Financial Instrument Rule – Paragraphs 118-124

The Discussion Draft outlines two approaches to defining the scope of the hybrid financial instrument rule:
defining what is included (a “bottom-up” approach) or defining what is excluded (a “top-down” approach).

An investment fund which invests internationally will have multiple local tax compliance obligations. It is
critically important to investors and investment funds when making international investments that certainty can
be achieved in taxation treatment at the time of making the investment. In addition, an investment fund cannot
distribute returns to investors to the extent it needs to retain provisions for uncertain tax positions.

AIMA believes that there should not be barriers imposed to international investment by uncertain tax legislation
and implementation and that tax legislation should be as clear and targeted as possible. Accordingly, AIMA
expresses its support for a “bottom-up” approach.

Related Parties – Paragraphs 126-130

AIMA believes that the 10% or greater ownership threshold is too low for a party to have sufficient knowledge or
information about its counterparty’s tax treatment. Without a commercial override in the proposed structure of
the rules, the 10% related party test could catch many ordinary commercial transactions. For example, in the
context of an investment fund which is widely held and open-ended, an investor could move through the 10%
threshold without any action of its own (e.g. if another investor redeemed). AIMA believes that the ownership
threshold should be set at a level at which a party has the ability to control the structure of the transaction.

In addition, the proposed definition of “acting in concert” would appear to catch many investors in investment
funds structured as limited partnerships and contractual funds without any percentage ownership requirement.
AIMA would support an exemption for investors in investment funds structured as limited partnerships or
contractual funds where the investors do not have the ability to control the vehicle.

Comprehensive Hybrid Mismatch Rules & Reporting – Paragraphs 218-236

The Discussion Draft refers to new filing and information reporting requirements for entities which are
“intermediaries”. In addition, the Discussion Draft refers to a possible approach of deeming an intermediary to
be resident in an investor jurisdiction where an intermediary is part of the same group (50% or more) as an
investor.

The asset management industry has significant experience in implementing existing tax reporting requirements
and providing the tax reporting that investors require for numerous local jurisdictions. It is currently working to
comply with the introduction of FATCA, the revised EU Savings Directive and other AEOI measures.

Taking into consideration the different circumstances that apply to investment funds, compared with
multinational corporations, AIMA would support the creation of a dedicated specialist working group to assess
these suggested requirements for intermediaries to the extent they should be applied to investment funds. AIMA
would be pleased to work with the OECD in sharing existing experience on investor tax reporting requirements
that investment funds provide to investors and, if required, the development of a common standard for these
matters.

Yours faithfully,

Paul Hale
Director, Head of Tax Affairs

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Finance for Europe

St Michael's House British Bankers’ Association
1 George Yard Pinners Hall
London EC3V 9DH 105-108 Old Broad Street
Telephone: [phone] London EC2N1EX
Email: [email protected] T [phone]
Website: www.afme.eu F [phone]
E [email protected]
W www.bba.org.uk

2 May 2014
By email to: [email protected]

Dear Sir,
Discussion draft on neutralising the effects of hybrid mismatch arrangements

1 2
AFME and the BBA welcome the opportunity to respond to the OECD’s discussion
discussion draft
draft entitled “BEPS Action 2: Neutralise the effects of hybrid mismatch arrangements”
published on 19 March 2014 (the ). We wish to make clear that while
AFME and the BBA have separate and distinct memberships, for the purposes of the
OECD discussion draft, both organisations have decided to submit a single, combined
response since our respective members share some concerns with the OECD’s proposals
in the discussion draft.
General Comments

We welcome that the OECD is consulting with business on its proposals. We believe that
this approach is to the benefit of both policymakers and business and helps to avoid any
unintended consequences arising from the OECD’s proposals. We believe that it is also
valuable for the OECD to take account of the views of business on the practical aspects
of operating the intended policy.

1
The Association for Financial Markets in Europe (AFME) represents a broad range of European and global participants in the
wholesale financial markets. Its members comprise pan-EU and global banks as well as key regional banks and other financial
institutions. AFME advocates stable, competitive and sustainable European financial markets, which support economic growth and
benefit society.

2
The British Bankers’ Association (BBA) is the leading association for the UK banking and financial services sector, speaking for
180 banking members, headquartered in 50 jurisdictions and operating in over 180 territories worldwide jurisdictions, on the full

range of UK or international banking issues. Collectively providing the full range of services, our member banks make up the
world's largest international banking centre.

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Given the relatively short time available it has been hard to consider all aspects of the
discussion draft and we are therefore providing specific comments on some of the most
important issues of concern to us. We may write to you again with further comments

once we have had a chance to consider the proposals in greater detail.
“Bottom-up” v “top-down” approach

We note that paragraphs 119 and 120 of the discussion draft set out two possible
approaches to defining the scope of the hybrid financial instrument rule: a “bottom-up”
approach - where the arrangements (specifically related party transactions and
“structured” transactions) that are to be covered by the proposed anti-hybrid rules are
defined - or a “top-down” approach - where there is a broad rule that applies to all
hybrid mismatches other than those that fall within certain defined exceptions where it
would be impossible or unduly burdensome for the taxpayer to comply with the rule.

We believe that a bottom-up approach would be preferable to a top-down approach. We
are concerned that the latter runs the risk of being overly broad, may create unintended
consequences, and may capture ordinary lending arrangements that present little risk
from a hybrid mismatch perspective. We note also that a top-down approach could
introduce the compliance concerns and information reporting requirements set out in
paragraphs 142 to 144 of the discussion draft.

We note in paragraphs 146 to 157 of the discussion draft, the suggested exemption from
the anti-hybrid rule for “widely-held” instruments. We note that paragraphs 150 to 152
of the discussion draft discuss whether the exemption for widely-held instruments
should be limited to issuers so that holders would still be required to include a
deductible payment in income even if the issuer benefitted from the widely-held
exemption. Paragraph 152 of the discussion draft notes that such an approach would
require a mechanism that allowed the issuer to communicate information to the holder
about the tax treatment of the instrument involved and the holder would likely have to
obtain tax advice on differences between foreign and domestic treatment in order to
comply with the hybrid mismatch rule. As the discussion draft acknowledges, such an
approach may be costly and resource intensive and would be imposed on all
instruments regardless of whether they contained a hybrid element. We believe those
deficiencies would indeed arise, and are therefore concerned that such an approach
could limit the depth of the primary markets and reduce liquidity in the secondary
markets.

We note that paragraph 157 of the discussion draft suggests that any exception for
traded instruments would need to be limited so as to exclude those cases where the
transfer is to a related party or the transfer is part of structured arrangements designed
to engineer a hybrid mismatch. If the OECD does decide to proceed with a top-down

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approach, we note that such an approach would need to be carefully addressed with
respect to related party underwriters and related party market makers.

In summary, we think that there are fundamental problems with a top-down approach,
which will lead to unintended effects on cross-border business that is not tax motivated
and result in an impractical compliance burden.
Further comments on the bottom-up approach

Whilst we believe that a bottom-up approach is preferable to a top-down approach, we
also note that the bottom-up approach in the form proposed by the OECD would require
the hybrid financial instrument rule to apply to all instruments held between related
parties (including persons acting in concert). We do not think that that is a properly
targeted measure.
First, as the discussion draft sets out, the intended target is tax motivated arrangements.
Accordingly, we do not agree that it is appropriate to have a rule which proceeds on the
basis that all related party transactions are potentially subject to counteraction under
the BEPS hybrids rules. This would mean that a local subsidiary of a foreign group
would be disadvantaged when compared to domestic competitors in the same market.
We therefore consider that the bottom-up approach needs to better target tax
motivated arrangements, rather than proceeding on the basis that all related party
transactions giving rise to a mismatch need to have their tax treatment adjusted.
Second, paragraph 128 of the discussion draft proposes a 10% ownership test to define
related persons. We are concerned that such an ownership threshold is far too low and
may catch transactions that present no risk from a hybrid mismatch perspective. A
threshold at that level also presents a number of practical problems. We suggest that
the OECD considers using a greater than 50% ownership requirement, augmented by a
rule that deals with parties acting in concert, which should be much better targeted at
cases of potential concern.
Measures may also be needed to cover takeover situations, and any other cases where a
third party independently acquires a stake in another company or group, which
suddenly makes it related for the purposes of a hybrids rule. This is a general point, but
may be particularly relevant to banks, which may issue a wide range of securities to
third party investors in the ordinary course of business. For example, it would be
normal business for many banks to issue asset linked notes. These are instruments that
allow investors to gain financial exposure to an underlying asset, such as movements in
the value of an index of shares. The tax characterisation of such instruments might be
different in different jurisdictions. If a third party holder of such an instrument (or any
other hybrid) subsequently makes a substantial investment in the shares of that
banking group, that investor may become a related party. The approach outlined in the
discussion draft suggests that the tax treatment of the asset linked note would then

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need to be adjusted, which it would not have been prior to the investor acquiring the
shares in the bank.
It is instructive to consider the above example where the order of events is reversed, i.e.,
the starting point is that the investor already holds sufficient shares in the banking
group to be a related party, and then wishes to make an investment in a note with a
return linked to the performance of a national index of shares. In that case, the OECD’s
proposed approach would mean that the bank (bank 1) knows, before it issues the asset
linked note, that the hybrids rule will counteract its local tax deduction for payments
under the asset linked note (again assuming the investor does not have a matching tax
treatment on the income). This means that bank 1’s cost of issuing that asset linked note
is substantially higher than the cost to a domestic competitor bank (bank 2), if bank 2 is
not related to the investor, such that bank 1 cannot properly compete with bank 2. This
illustrates the general point: a rule which adjusts the treatment of all related party
hybrids is too broad as it distorts competition where there is no policy need to deny a
tHayxb dreiddu rcetgiounl.a tory capital

The level of capital which banks are required to hold is currently subject to extensive
and developing regulatory rules designed to ensure the stability of banks and the wider
financial system. This includes Basel 3 which sets a requirement that financial
institutions hold minimum levels of capital with the aim of ensuring that banks have
sufficient regulatory capital to continue operations throughout times of economic and
financial stress. In particular, banks are required to hold 6% of their risk weighted
AT1
assets in the form of Tier 1 capital, of which 1.5% may be met with Additional Tier 1
instruments ( ). AT1 instruments provide an important and readily available source
of capital in times of financial crisis. Such instruments have both equity and debt like
characteristics and many countries have determined or are in the process of
determining which treatment should follow for tax purposes. Accordingly, certain forms
of cross-border regulatory capital could be considered as hybrid instruments for the
purposes of Action 2 of the OECD Action Plan on BEPS. We believe that it is important
that any recommendations made by the OECD in relation to Action 2 do not undermine
the regulatory regime which is designed to ensure that banks are able to raise adequate
regulatory capital.
An additional concern with regard to the treatment of regulatory capital as hybrid
instruments would be any presumption that all forms of hybrid capital should be
subject to increased scrutiny. We believe that any anti-avoidance provisions aimed at
hybrid instruments should be limited to specific instruments where there is a justified
concern over the use of the instrument. A bottom-up approach more properly focussed
on tax motivated transactions should remove the need for any special rules for
regulatory capital.

48
As noted in paragraph 160 of the discussion draft, as part of a wider move towards
“single point of entry” resolution, a number of regulators are encouraging banks
domiciled in their jurisdiction to issue all their loss absorbing capital at top holding
company level and then pass this capital down through the group to the relevant
operating subsidiaries. As further noted in paragraph 160 of the discussion draft, such
arrangements of intra-group capital may also be motivated by the fact that regulatory
capital issued directly to the market at subsidiary level may, in certain situations, be
discounted or disregarded for consolidated regulatory capital purposes. As such,
special consideration needs to be given to the ability of banks to issue such instruments
within a group. Inconsistent treatment of intra-group regulatory capital and capital
issued to the market would create tax distortions in a financial institution’s
consolidated regulatory capital, and financial institutions operating under a single point
of entry funding model would be placed at a competitive disadvantage relative to
groups issuing directly to the market at the subsidiary level. As we have noted already
in our general remarks, such an inconsistent treatment would also place inward
investing groups at a competitive disadvantage relative to domestic institutions. We
therefore welcome the inclusion in the discussion draft of paragraphs 158 to 162 and in
particular the suggestion that consideration should be given to the inclusion of a co-
ordination rule which would allow the tax effect of the issuer’s deduction to be passed
down through chains of related parties to the ultimate borrower. We are in the process
of considering how a co-ordination rule might operate in practice and we may write to
the OECD again in due course with further specific proposals. We are concerned to
ensure that any proposals are appropriate for all stakeholders and do not have any
unintended consequences for banks and tax authorities. For the avoidance of doubt, the
approach we would advocate (a better targeted bottom up approach) would mean that

allocation rules or co-ordination rules would not be required.
Repo transactions

We note that paragraphs 65 to 80 and 262 to 270 of the discussion draft set out that
hybrid transfers are typically a particular type of collateralised loan agreement or
derivative transaction where the counterparties to the same arrangement in different
jurisdictions both treat themselves as the owner of the loan collateral or subject matter
of the derivative. We are concerned that the examples provided of hybrid transfers
involving sale and repurchase transactions (repos) may appear to give the impression
that repo transactions are only used for tax planning purposes. For example, we note
that paragraph 66 of the discussion draft states that “the most common transaction
used to achieve a mismatch in tax outcomes under a hybrid transfer is a sale and
repurchase arrangement…over an asset where the terms of the repo make it the
economic equivalent to a collateralised loan.”

Repos are entered into in the ordinary course of business on a daily basis by financial
institutions for commercial purposes which are not motivated by tax reasons. We

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