Los inicios del PRD: La resistencia al salinismo

3.1 Summary of Recommendations

3.2 The proposals in the Consultation Document are concerned with the development of linking rules. These are multi-layered and, it is suggested, will be entitled to apply in a priority order (paragraph 34).

3.3 However, the hybrid financial instrument rule is not clear on whether it is the payee or the payer who has the primary responsibility for deciding whether or not the rule should be applied in the other territory. For example, Recommendation a) on page 25 of the Consultation Document suggests that if the payee does not include the payment as ordinary income then a deduction should be denied for the payer. In other words, the treatment for the payer is determined by the application of the rule by the payee. However, at paragraph 108 (b), it seems that the payer is required to apply the ‘primary rule’ of deductibility or otherwise of the payment, and once this is established then the payee determines whether or to what extent the income should be recognised as ordinary income. It would be helpful to have some further clarity on where the onus or primary responsibility should lie.

3.4 With respect to repos in particular, repos originated as a mechanism to allow unlicensed moneylenders to conduct their trade without being caught by what were then the Banking Acts. In other words, they were a form of secured lending as the security was effectively the asset that was sold and bought back. With that as an economic background, it makes more sense to require income inclusion than it does to deny a deduction if the economic cost of the transaction is being borne in the payer jurisdiction. The Consultation Document says (very pragmatically) that it does not want a rule that produces lengthy enquiries into which jurisdiction has lost out from the hybrid instrument but that does not mean that it necessarily follows that denial of deduction should be the primary rule and income inclusion the back-up rule. We note that the amendments to the EU Parent/Subsidiary Directive prioritise

income inclusion. We think it is essential that any new rules should not apply to the large third party repo and stock-lending markets – the potential for market disruption would otherwise be very significant.

3.5 We assume that the purpose of the layering is to allow counteraction by one of the affected jurisdictions under a defensive rule even when the other jurisdiction has decided to be taxpayer friendly and not implement the OECD recommendations. Whilst this may lead to the single taxation of hybrids, it is worth noting that this is a radical concept; one jurisdiction has taken a deliberate policy decision not to tax something or to tax a fact pattern in a manner which produces a low tax result, and a counterparty jurisdiction is being allowed to benefit from additional tax revenues, that would not accrue to it in other circumstances.

3.6 Technical Discussion

3.7 Paragraph 84 of the Consultation Document suggests that jurisdictions should consider modifying their definition of ‘dividend’. We suggest that it would be difficult and unhelpful for wider company law purposes for domestic law definitions of ‘dividend’ to be altered. It would be more appropriate, as also suggested, for jurisdictions with dividend exemption rules, to modify the eligibility of those exemptions, for this purpose.

rule should apply to mismatches attributable to a hybrid element in the instrument itself. Clarification on this point would be helpful; we cannot see it is right to impose taxation on a charity, pension fund or other tax-exempt entity.

3.9 With regard to whether the outcome of the rules’ operation is clear, the intention of the outcome is clear to the extent that it is designed to capture and neutralise DD or D/NI transactions – however we are concerned that the rules could give rise to significant compliance burden. The compliance burden for tax authorities and for taxpayers is another reason why we believe the Top Down approach should be rejected.

3.10 Paragraph 88 suggests that timing differences will not in themselves bring into scope a financial instrument that would not otherwise be caught. However, it is not clear whether the treatment for both payer and payee should be determined at the beginning or the end of the life of the instrument. What would happen in the event that the rules in one or other jurisdiction changed during the life of the instrument? Are any grandfathering provisions being considered?

3.11 Scope

3.12 Hybrid financial instrument rule does not apply to payments that benefit from a dividend exemption

3.13 With regard to Paragraphs 113 to 115 of the Consultation Document, we suggest that it is excessive to recommend that dividend exemptions should be disallowed whenever the payment is deductible under the laws of the issuer's jurisdiction and also that there should be no limitation on the scope of this recommendation. 3.14 A number of jurisdictions allow deductions for dividend payments in specified

circumstances as an investment incentive. Additionally, some foreign tax systems may operate in a different way from the usual system whereby they may allow dividend payments as a corporate tax deduction and impose corporate taxes in a different way, such as primarily by way of dividend withholding taxes. In such cases excluding the payment from dividend exemption in the recipient country would effectively deny the companies involved the benefit of the investment incentives or be incompatible with the nature of some corporate tax regimes by imposing

additional tax burdens in other countries. 3.15 Overall approach to scope

3.16 We agree with the last sentence of paragraph 117. However, before considering the bottom up or top down approaches, we suggest there should be further consideration as to what the rule is intended to catch.

3.17 Paragraph 121 sets out the current thinking as to what the hybrid instrument rule should catch. However, the categories identified in paragraph 121 are very broad brush and could (even on a bottom up style of drafting) catch non-abusive

transactions. We are not clear about the policy reasons behind these broad categories.

3.18 In paragraph (a) instruments held by “related parties” will always be caught, even if, say, the transactions are identical to ones which would not be in scope if they were

parent company instruments held in a trading companies dealing book or insurance portfolio? Would it make a difference if these instruments are normally widely held/traded and if not, why not?

3.19 Similarly “structured arrangements” are always caught, except in certain

circumstances as in the case of regulatory capital (paragraph 158 et seq.) or some deferred consideration arrangements (paragraph 133). We understand that the OECD have avoided a motive rule because of complications with proof etc, however it is interesting to note that at paragraph 121 (b), the consideration of whether or not something has been ‘designed to produce a mismatch’ implies a motive.

3.20 We suggest that paragraph 121 (c) regarding widely held instruments being outside the scope of the rule could cause confusion with repos and exchangeable debt where the underlying/deliverable is widely traded.

3.21 The related party threshold is set at 10% although paragraph 126 asserts that “parties that share a significant degree of common ownership or control can be expected to identify and negotiate an appropriate allocation of risk” – this not likely to be the case for a 10% shareholder. We suggest that a 10% investment is too low a threshold for a ‘related party’. It is strongly recommended that this percentage is increased to greater than 50%, which is the normal definition of control.

3.22 We suggest that the test for the concert party rule (“regularly acts in accordance with”) will be hard for companies to apply in practice. Rule of this nature in the UK frequently causes uncertainty in practice.

3.23 In terms of widely held/regularly traded, if this concept is used (and the policy reasons for it are not clear), exemptions would be needed for situations where a company was the subject of a bid or where trading was suspended for some reason. What would be the position if the instrument was listed and a market maker offered a pricing but trading volumes merely happened to be thin in the reference period? Would an instrument that had previously been outside scope come within the scope of the hybrid mismatch rules if the issuer was in financial trouble and a bond trustee or other creditors representative was acting? What would be the position if otherwise actively traded instrument were bought into the group or into treasury to support the price or with a view to their cancellation? What happens if part of an issue is bought back so that a person who did not have 10% pre-buyback then has more than 10%? 3.24 Paragraph 157 is part of a discussion on ‘traded instruments’.

3.25 The last sentence of paragraph 157 indicates that any exception from the hybrid rules for traded instruments should be excluded in those cases where the transfer is to a related party or is part of a structured arrangement designed to engineer a hybrid mismatch. This is much too broad an exclusion, particularly with regard to transfers to related parties. Such transfers are already subject to extensive anti abuse rules, such as transfer pricing provisions, thin capitalisation provisions and rules excluding reliefs where there is a non-commercial purpose. There are no grounds for excluding a traded instrument exemption just because the transaction is with a related party. Such a rule would have a major adverse impact on normal commercial transactions between related companies.

3.26 Overall, we favour the bottom up approach as this seems to give a more measured approach to achieving the same objective.

a particular type of instrument. However, as we note above, it is not clear to us why transactions between third parties should be targeted where they are not part of a wider group scheme.

3.28 With regards to banking groups and regulatory capital, we note that insurance groups are also required to meet capital adequacy requirements by insurance industry regulators and so are subject to similar constraints as the banking industry. Debt instruments which are able to be included for capital/solvency purposes will have certain features relating to interest deferral and loss absorbency which make them similar to equity. These features are mandated by local regulators, and such requirements will become more stringent upon the introduction of Solvency II in 2016.

3.29 These debt instruments have not been designed with tax mismatch in mind, but instead are required to ensure that the insurance industry is able to meet its capital adequacy requirements effectively and efficiently.

3.30 Over the last 10 years, insurers in EU countries in particular have been required to hold greater levels of capital in order to strengthen their ability to withstand market shocks or unexpected losses. The holding of regulatory hybrid capital has been encouraged as a means of providing a cost effective way to achieve this and to raise non-dilutive capital. If the ability to deduct interest on these is denied then there is a concern that EU insurers will be at a competitive disadvantage with non-EU insurers. 3.31 For insurance groups, it is quite common for hybrid regulatory capital instruments to

be issued externally at top company level and then passed down the group –

however this is not always the case. The decision on where to issue the instruments will depend on a number of commercial considerations; for example the recognition of regulatory capital by different local regulators, a need to access a particular capital market to benefit from certain terms and conditions being offered at a certain point in time and the extent to which there is cash already available in the top company or elsewhere in the group.

3.32 Some groups may have a dedicated Group Treasury company which would be used to obtain better market rates than one of the regulated intermediate holdings

companies. After the introduction of the UK’s new CFC regime, a number of groups restructured their group treasury functions in order to be able to access the

preferential tax rates being offered.

3.33 Hybrid regulatory capital instruments will typically be passed down a group on a like for like basis – but not always. The facts and circumstances of the group will

ultimately determine the flow of funds.

3.34 Hybrid regulatory capital instruments may have similar or same form as other instruments – however it is the purpose for which they are being held (to support regulatory capital requirements) that should be sufficient to allow them to be excluded from scope. We acknowledge that obtaining multiple deductions within a group should not be protected.