- Royal Decree-law 4/2021 of 9 March amends corporate income tax and non-resident tax to neutralise hybrid mismatches.
- A hybrid mismatch allows deducting an expense without anyone taxing the income, or deducting it twice.
- It has applied since 11 March and covers periods starting from 1 January 2020.
On 10 March 2021 the BOE published Royal Decree-law 4/2021 of 9 March, amending the Corporate Income Tax Law and the consolidated Non-Resident Income Tax Law as regards hybrid mismatches. The rule transposes part of the EU directive against tax avoidance, amended in 2017 to extend these rules to third countries, whose transposition deadline expired on 31 December 2019. It entered into force on 11 March and applies to tax periods starting on or after 1 January 2020 that have not yet ended.
It is a technical reform, aimed at multinational groups, but it touches instruments that family businesses with subsidiaries or financing in other countries also use: participating loans, mixed financial instruments, companies that each country classifies differently. It is worth knowing whether any of your own structures falls within its scope, because the consequence is that an expense that used to be deductible may stop being so.
What a hybrid mismatch is
A hybrid mismatch arises when two countries classify the same instrument, payment or entity differently. The result can be that a payment is deducted as an expense in one country without being included as income in the other, known as a deduction without inclusion, or that the same expense is deducted twice. In both cases a group’s overall tax is reduced without any economic activity that justifies it.
A simple example is a financial instrument that one country treats as a loan, and so a deductible expense, and the other as equity, whose return is exempt. Another is an entity that one State regards as transparent and another as a company. The new rules aim to neutralise the tax effect in one of the two countries, so that the group does not obtain an advantage neither legal system intended.
How the rule works
The law sets a primary rule and a secondary one. Under the primary rule, the payer’s country denies the deduction of the expense when it is not taxed in the recipient’s country. If that country does not apply it, the secondary rule requires the recipient’s country to include the income in its base. The Spanish text sets out both in the new article 15 bis of the Corporate Income Tax Law, and allows the deduction to be recovered in the following three years when the expense is later offset by income that is taxed.
The rules apply between associated parties, which include those holding at least 25% of voting rights or of the right to profits, or when the mismatch arises in a structured arrangement, that is, a scheme designed or priced to obtain that tax advantage. Outside those situations the rule does not usually come into play, which limits its reach to transactions between related parties.
What to review
Companies with subsidiaries, branches or intra-group financing in other countries should review with their adviser how their transactions are classified in each jurisdiction, especially if they use participating loans, hybrid instruments or entities with different tax treatment. Because the rule applies with effect from 2020, the adjustment may already affect that year’s returns.
It is worth documenting the treatment other countries give to each transaction, because the rule depends on it, and assessing whether the structure has a clear economic justification. This information is general in nature and does not replace advice on each case, especially where several jurisdictions are involved.
A technical rule, effective from 2020, that forces a fresh look at international structures.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
