ATO Practical Compliance Guidelines on imported hybrid mismatches

21 April 2021

ATO Practical Compliance Guidelines on imported hybrid mismatches

In brief 

On 21 April 2021, the Australian Taxation Office (ATO) provided 19 pages of draft guidance in Practical Compliance Guideline PCG 2021/D3 (PCG) which sets out the Commissioner of Taxation’s approach to assessing whether a taxpayer has undertaken reasonable enquiries in relation to the imported hybrid mismatch rules.   

The PCG sets out the level of supporting information the Commissioner expects taxpayers to obtain prior to filing income tax returns and to sustain deductions for payments to offshore related parties. The PCG is an important consideration particularly for taxpayers preparing income tax returns for the second year of operation of the Australian hybrid mismatch rules (i.e. year ended 31 December 2020 or ending 30 June 2021).   

The PCG provides welcome guidance for taxpayers grappling with these rules in a self-assessment environment but does set a high bar in terms of the information and documentation expected to be obtained by all taxpayers in relation to the global operations of a multinational company (MNC).   

In detail

The Australian hybrid mismatch rules were released in draft form in late 2017, enacted in August 2018 and took effect for tax periods commencing on or after 1 January 2019.  It continues to be our experience that many subsidiaries of foreign MNCs are finding it challenging to interpret and apply this complex and novel legislation which can impact any related-party cross border payments (and in some cases, third party payments) that are otherwise deductible for Australian income tax purposes.  

A key element of difficulty is the imported hybrid mismatch rule which requires Australian taxpayers to make judgments about the operation of foreign tax laws as well as the presumption that the Australian taxpayer has perfect knowledge of the overseas group structure, relevant foreign tax law and the flow of payments through the global group structure. This “tracing” exercise arguably may involve payments that have no direct or commercial link to payments made by the Australian entity and can make it very difficult to apply in practice.  In our experience, this tracing rule typically goes further than other countries that have adopted the hybrid mismatch rules designed by the Organisation of Economic Cooperation and Development (OECD) as part of the Base Erosion and Profit Shifting (BEPS) project.

Australia operates a self-assessment system which places the onus on taxpayers to ensure compliance with the taxation laws. However, in many cases the information required to fulfil this obligation in relation to imported hybrid mismatches may not be available in Australia. 

The PCG is designed to explain the ATO assessment of compliance risk associated with the imported hybrid mismatch rules including the level of documentation that is expected.  The PCG is very detailed but the key elements and takeaways are are follows:

• The Commissioner’s view is that taxpayers should not claim a deduction for a payment to an offshore related party unless they are able to obtain sufficient information from the global group to support a conclusion that the deduction in respect of the payment is not disallowed under the imported hybrid mismatch rule. It is expected that the Australian entity will document their enquiries and obtain the information prior to lodgment of the income tax return and this documentation would be capable of being provided to the Commissioner within a reasonable time of a request being made.  Taxpayers that have not obtained information prior to lodgement, but later confirm entitlement to a deduction for that payment, can lodge an amendment request to claim the deduction. 
  
• The Commissioner expects that regardless of whether the hybrid mismatch is structured or not, the Australian taxpayer would readily have the necessary information to undertake the assessment or failing that, their foreign affiliates will provide “full and complete disclosure” of “all relevant information” to the Australian entity. 
  
• It is expected that members of the “Division 832 control group” will have robust processes in place to identify any relevant hybrid mismatch outcomes and inform the taxpayer accordingly.
  
• The ATO’s recommended approach to undertaking enquiries involves the taxpayer making and documenting formal requests for information and the responses. Taxpayers need to make requests to the responsible individuals or suitably qualified representatives responsible for the group. The appropriately qualified responsible individuals must include the person primarily responsible for the group’s tax obligations, such as the Head of Tax for the group. 
  
• For Australian headquartered groups, the PCG indicates that an internal file note of the relevant information and positions adopted (including justification) will be sufficient and that the responsible individual may include the Public Officer.
  
• The ATO’s recommended approach can be achieved by a ‘top-down’ (identify whether the group has any hybrid mismatch outcomes) or ‘bottom-up’ (determine if payments made by Australia, directly or indirectly, fund an offshore hybrid mismatch) approach. An Appendix to the PCG sets out the information the Commissioner considers relevant to demonstrating compliance with each of these approaches and this information may be requested when the ATO is assessing risk during any engagement or assurance activity.
  
• The PCG includes a complex risk rating involving eight categories based on a number of factors including the materiality of related party payments and compliance with the ATO’s recommended approach to making reasonable enquiries. The situations where a taxpayer can disclose a ‘green’ or ‘low risk’ rating are limited to situations where taxpayers:
  
  • demonstrate there are no offshore mismatches or all offshore mismatches have been neutralised by either Australia or a foreign country’s hybrid mismatch rules; or
    
  • where the Australian taxpayers have not sought to claim deductions for payments made to members of the Division 832 control group.
    
    
• Some taxpayers may be required to report this PCG risk rating on the Reportable Tax Position Schedule which is lodged with their annual income tax return.  The impact of this will depend on various factors including the timing of the final PCG and therefore, at this time, it is not clear if tax returns for the year ended 31 December 2020 will be impacted. 
  
• The Commissioner also makes it clear any assessment must consider the nuances of the Australian hybrid mismatch rules and it is not sufficient for taxpayers to rely on any analysis undertaken based on the OECD principles or a foreign jurisdiction’s equivalent of the imported hybrid mismatch rules.   
  
• The PCG sets out the ATO’s approach to penalties in relation to the imported hybrid mismatch rules including where the Commissioner will consider that a taxpayer has taken “reasonable care”. This will be relevant in any circumstance where it is determined that a taxpayer has not correctly applied the imported hybrid mismatch rules and a tax shortfall is identified.
  
• The PCG will apply both before and after its issue.
  
• Taxpayers are invited to comment on the PCG, including the proposed date of effect, by 21 May 2021.

In December 2020, the New Zealand Inland Revenue released an exposure draft setting out the steps taxpayers are expected to have undertaken before claiming deductions for payments to offshore related parties under the imported hybrid mismatch rules.  In most scenarios, the Inland Revenue’s expectation is that the New Zealand taxpayer will obtain a written statement from the group’s head office tax function confirming the steps that have been taken to ensure that there are no imported hybrid mismatches that have been funded by the New Zealand payer.  The approach adopted by the Commissioner in the PCG appears to require a much more detailed work to be undertaken prior to filing the Australian tax return.

Practical compliance guidelines are not prepared for the primary purpose of expressing a view on the way a tax law provision applies and are not public rulings. Therefore, the PCG does not provide guidance in relation to any of the challenging interpretative issues associated with the imported hybrid mismatch rules and taxpayers are expected to adopt positions on these issues.  For example, an important and potentially contentious issue is what countries may be considered to have corresponding foreign hybrid mismatch rules including countries in the EU and the United States which have adopted certain rules dealing with hybrid mismatches.  This may impact the existence of an offshore hybrid mismatch under the top-down approach as well as the tracing that may be required under the bottom-up approach.  The PCG also hints at potential ATO views, for example, the PCG expresses a concern about a view being taken that not all payments between entities must be traced.

The takeaway

All taxpayers making cross-border related party payments will need to consider the PCG and what work may be required to meet the proposed ATO requirements prior to lodging their Australian tax return.  Although these ATO requirements are not required by law, it will be important to consider the consequences of not meeting ATO expectations including the tax return disclosures that may be required (after the PCG is finalised) and the impact on penalties in the event a tax shortfall is later identified.