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OECD Issues Recommendations On Branch Mismatch Arrangements

Friday 4th August 2017

The OECD has recently issued its report and recommendations for branch mismatch rules that would bring the treatment of these structures into line with the treatment of hybrid mismatch arrangements as set out in the 2015 BEPS Report on Neutralising the Effects of Hybrid Mismatch Arrangements.

The Action 2 Report set out recommendations for domestic rules designed to neutralise mismatches in tax outcomes that arise in respect of payments under a hybrid mismatch.  The recommendations in that report set out rules targeting payments made by or to a hybrid entity that give rise to one of three types of mismatches:

  • Deduction/No inclusion (D/NI) outcomes, where the payment is deductible under the rules of the payer jurisdiction but not included in the ordinary income of the payee.
  • Double deduction (DD) outcomes, where the payment triggers two deductions [for payer and payee] in respect of the same payment.
  • Indirect deduction/no inclusion (indirect D/NI) outcomes, where the income from a deductible payment is set off by the payee against a deduction under a hybrid mismatch arrangement.

The Action 2 Report included specific recommendations for improvements to domestic law intended to reduce the frequency of such mismatches as well as targeted hybrid mismatch rules which adjust the tax consequences in either the payer or payee jurisdiction in order to neutralise the hybrid mismatch without disturbing any of the other tax, commercial or regulatory outcomes. The Report considered mismatches that are the result of differences in the tax treatment or characterisation of an instrument or entity, but it did not directly consider similar issues that can arise through the use of branch structures.

Branch mismatches occur where the residence jurisdiction (i.e. the jurisdiction in which the head office is established) and a branch jurisdiction (i.e. the jurisdiction in which the branch is located) take different views as to the allocation of income and expenditure between the branch and head office and include situations where the branch jurisdiction does not treat the taxpayer as having a taxable presence in that jurisdiction.

As branch mismatches turn on differences in tax accounting rather than legal characterisation, the same basic legal structure may call for the application of different branch mismatch rules, depending on the accounting treatment adopted by the branch and head office.

In August 2016, the Committee on Fiscal Affairs (CFA) issued a discussion document on branch mismatch arrangements inviting interested parties to comment on recommendations for branch mismatch rules that would bring the treatment of these structures into line with the treatment of hybrid mismatch arrangements as set out in the Action 2 Report.

The recommendations in the latest report have been prepared in light of the comments received on that discussion document and the legal changes that countries have made since the release of the Action 2 Report.

OECDs latest report identifies five basic types of branch mismatch arrangements:

  • Disregarded branch structures where the branch does not give rise to a permanent establishment (PE) or other taxable presence in the branch jurisdiction.
  • Diverted branch payments where the branch jurisdiction recognises the existence of the branch but the payment made to the branch is treated by the branch jurisdiction as attributable to the head office, while the residence jurisdiction exempts the payment from taxation on the grounds that the payment was made to the branch.
  • Deemed branch payments where the branch is treated as making a notional payment which results in a mismatch in tax outcomes under the laws of the residence and branch jurisdictions.
  • DD branch payments where the same item of expenditure gives rise to a deduction under the laws of both the residence and branch jurisdictions.
  • Imported branch mismatches where the payee offsets the income from a deductible payment against a deduction arising under a branch mismatch arrangement.

Annex A of OECDs latest report summarises the recommendations and Annex B sets out a number of examples illustrating the intended operation of the recommended rules.

 

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