Anti Tax Avoidance Directive (ATAD) – Hybrid mismathes

On 19 June 2020 the Cyprus Parliament voted into law the remaining provisions of ATAD.

The second measure in addition to Exit Taxation is Hybrid Mismatches.

Hybrid Mismatches – Applicable from 1 January 2020

Hybrid mismatch is the result of differences in the tax treatment of a payment or an entity under the laws of two or more jurisdictions.

To safeguard the above, the EU Commission adopted common measures within the EU in order to neutralize such effects.

The hybrid mismatch has usually the following tax effects:

  • the payment is deducted in both jurisdictions OR
  • the payment reduces the tax income in one jurisdiction but without increasing the tax income in the other jurisdiction

In order for the Hybrid mismatch to be applicable, the transaction must be made between related parties such as:

  • transactions between associated enterprises
  • transactions between head office and permanent establishments
  • transactions between permanent establishments of the same entity
  • mismatches resulting from a structures arrangement involving the taxpayer

The Directive provides for 2 corrective mechanisms to neutralize the effects of hybrid mismatch arrangements which are:

  1. The Primary Rule which provides that where there is a deduction without inclusion of the income, the payer will be denied deduction of the payment.
  2. The secondary Rule which provides that where the payment is deductile at the level of the taxpayer, the corresponding income will be included at the level o the recipient

Double deduction

In case Cyprus is the investor jurisdiction and a hybrid mismatch will result to a double deduction as explained above, then the deduction will be denied in Cyprus following the PRIMARY RULE.

Deduction without inclusion

In case Cyprus is the payer jurisdiction and a hybrid mismatch results to a deduction without inclusion, then the deduction will be denied in Cyprus following the PRIMARY RULE.

In case the Cyprus is the recipient jurisdiction and the deduction is not denied in the payer jurisdiction, then the amount of payment will be included in Cyprus under the SECONDARY RULE. This rule will not apply in certain types of arrangements.

Imported mismatch

Cyprus shall deny the deduction for any payments to the extend that such payments directly or indirectly funds deductible expenditure which gives right to a hybrid mismatch through a transactions between related entities or entered into as part of a structured arrangement.

The above is applicable only if one of the jurisdictions involved in the transactions did not made an equivalent adjustment in respect of such hybrid mismatch.

Disregarded Permanent Establishment (DPE)

In case the hybrid mismatch involves DPE income which is not subject to tax in Cyprus, the taxpayer will need to include in its net income the income attributed to DPE.

The above is applicable unless there is a specific double tax treaty between Cyprus and a third country which exempts the PR income.

Hybrid transfer

Where the hybrid transfer is designed to produce a tax relief on withholding tax on a payment derived from a transferred financial instrument to more than one of the parties involved, Cyprus will have to limit the benefit of such relief in proportion to the net taxable income regarding such payment.

Tax residency

In case of payments, expenses or losses which are deductible in 2 jurisdictions because the taxpayer is resident for tax purposes in 2 jurisdictions, then Cyprus shall deny the deduction of such payments, expenses or losses.

Cyprus will allow the deduction of the above provided that the other jurisdiction is an EU member state with which Cyprus has concluded a double tax treaty under which the taxpayer is deemed to be a Cyprus tax resident.

Reverse hybrid mismatches

A reverse hybrid is an entity which is treated as transparent under the laws of the jurisdiction where it is established but as a separate entity under the laws of the jurisdiction of the investor.

This means that the income of a reverse hybrid may be neither taxable in its establishment jurisdiction nor in the jurisdiction of the investor. As a result, a deduction with no inclusion mismatch may arise.

In such cases, Cyprus will regard such hybrid entities as tax resident of Cyprus and tax its income accordingly.

The above does not apply to collective investment vehicles.