ATO finalises its compliance approach to the imported hybrid mismatch rule
On 16 December 2021, the Australian Taxation Office (ATO) issued Practical Compliance Guideline PCG 2021/5 (PCG), which finalises its compliance approach to the assessment of relative levels of tax compliance risk associated with imported hybrid mismatches addressed by Subdivision 832-H of the Income Tax Assessment Act 1997 (ITAA 1997). The final PCG confirms the ATO's approach contained in the draft PCG released on 21 April 2021.
Australia’s hybrid mismatch rules, introduced in 2019, are designed to deter the use of certain hybrid arrangements that exploit differences in the tax treatment of an arrangement and/or entity under the income tax laws of two or more countries and to implement Australia’s adoption of the hybrid mismatch rules under the OECD/G20 base erosion and profit shifting (BEPS) initiative. In general terms, the hybrid mismatch rules come into play where a payment gives rise to a deduction in Australia, but the payment is not included in the income tax base of a counterparty in another jurisdiction or where a payment gives rise to a deduction in both Australia and a foreign country. The hybrid mismatch rules broadly operate to disallow deductions in Australia (or include amounts in assessable income) for various payments such as interest, rents, royalties, service fees, etc.
An imported hybrid mismatch arises where:
- An Australian entity makes a deductible payment to a foreign entity (either directly or via an interposed entity);
- The payment is made within members of the same group or under a structured arrangement that gave rise to the hybrid mismatch; and
- The foreign entity is a party to an offshore hybrid mismatch.
An offshore hybrid mismatch arises where:
- A hybrid mismatch arises outside Australia;
- The Australian taxpayer is not a party to the offshore hybrid mismatch;
- Earlier hybrid mismatch rules do not apply to the arrangement; and
- There are no hybrid mismatch rules in the foreign countries or the rules do not prevent this arrangement.
The final PCG outlines the compliance obligations and expected level of enquiry undertaken by taxpayers and their controllers to identify and assess the expected tax treatment of payments to entities in foreign counterparty jurisdictions (limited to members of the same Division 832 control group or payments made under a structured arrangement).
PCG 2021/5 applies retroactively for income years that commenced on or after 1 January 2019 for importing payments made under a structured arrangement, and 1 January 2020 for all other imported hybrid mismatch arrangements.
What is unchanged in the final PCG
- The Commissioner’s expectation is that taxpayers demonstrate they have taken appropriate and adequate steps to collect information showing that the imported hybrid mismatch rule does not apply, or that the taxpayer has identified all imported hybrid mismatches, including where there is a disallowance of Australian tax deductions.
- The Commissioner’s view is that a taxpayer should not claim a deduction for any cross-border payments made to a member of its Division 832 control group unless the taxpayer is able to obtain sufficient information to support a conclusion that a deduction is not disallowed under the imported hybrid mismatch rule.
- The recommended methodologies (“top-down” and “bottom-up”) should be used to demonstrate that reasonable enquiries have been made in assessing the application of the imported hybrid mismatch rule.
- The risk framework for taxpayers to self-assess their compliance risk and the likelihood of ATO engagement and assurance activity continues to apply.
Changes in the final PCG
The final PCG contains a number of changes from the draft, most of which clarify how a taxpayer should apply the methodologies and risk assessment framework, including:
- ATO’s recommended approach: The PCG clearly states that a combination of the top-down and bottom-up approach is acceptable if the process results in sufficient information to substantiate the taxpayer’s position.
- Broader scope for an indirect payment: The PCG explicitly states that payments considered indirect payments to an offshore entity that result in a hybrid mismatch do not need to be a series of payments—it is sufficient that further payments are made from the interposed offshore entity to the offshore entity with the hybrid mismatch.
- Risk zone changes: There are fewer risk zones, as well as some changes to risk zones and definitions in the self-assessment risk framework, including:
- An expansion of the green zone, which now includes the AUD 2 million de minimis entry that previously was in the blue zone. This should give a lower risk rating for taxpayers undertaking a risk self-assessment with lower international related party dealings;
- The new yellow zone enables multinational groups that have, and apply, a global policy for managing risks associated with imported hybrid mismatches consistent with the OECD Action 2 report; and
- A taxpayer can rely on the risk self-assessments completed in two preceding income years where the circumstances have not materially changed for the blue and green zones.
- Consequence of risk rating: The ATO has included a table indicating its level of compliance activity for each level of self-assessed risk, thus providing taxpayers clear expectations of the consequences for noncompliance or low compliance with the PCG.
- Insight into the ATO’s risk assessment: For larger taxpayers, i.e., those that have to file a reportable position schedule, there is an increased risk of review activity by the ATO, unless a reasonably high level of compliance with the PCG exists and, therefore, the reporting of a self-assessed blue zone or better.
- Relevance of foreign tax advisors: The PCG includes an example to further illustrate the need for the Australian taxpayer to review whether the basis of a foreign tax advisor’s conclusion that foreign hybrid mismatch rules do not apply is consistent with the requirements of Australian imported hybrid mismatch rules.
- Voluntary disclosure: The ATO will consider reducing the shortfall penalties and interest charge for voluntary disclosures made within 18 months from the publication of this PCG.
With the final guidance issued, taxpayers that have not already started the process of re-assessing their international payments and collating relevant evidence (e.g., loan agreements, group treasury policies, etc.) should do so now and complete the re-assessment before filing the next tax return. Where a review process indicates a need to submit a voluntary disclosure to the ATO, taxpayers should consider doing so within the 18-month period after the publication of this PCG to take advantage of the ATO’s increased propensity to reduce penalties and interest. Taxpayers, particularly those that need to file a reportable tax position schedule, should consider what risk rating is deemed acceptable in the context of their tax governance policy and complete sufficient work before filing the tax return to obtain such a rating.