The Parent-Subsidiary Directive (“Directive”) requires, inter alia, that European Union (EU) member states refrain from a residence state taxation/withholding tax on qualifying profit distributions received by a parent company from their EU subsidiary. At this point, the Directive does not take into account any mismatches between the qualification of debt versus equity instruments under the national laws of the various EU member states. As a result, multinational companies within the EU can utilize so-called “hybrid mismatches” to reduce their overall effective tax rate. A hybrid mismatch in this regard could be created by providing a “hybrid loan,” a loan that qualifies as a loan in the borrower’s EU state of residence and as capital under the national laws of the lender’s EU residence state. As a result, payments on such instruments may be tax deductible for the payor/borrower in state A (where they are considered interest paid on a loan) and tax exempt for the payee/lender in state B (where they are considered dividends paid on an equity instrument).
The Council of the EU now agrees on implementing a new anti-abuse measure in which it aims to fix this mismatch. This anti-abuse measure is structured under a matching principle. If the payment on the instrument is tax deductible at the level of the EU payor, the EU parent company/recipient cannot claim an exemption upon receipt of that payment. However, if the payment on the instrument is not tax deductible at the level of the EU payor, the EU parent company/recipient can continue to apply its domestic exemption upon receipt of that payment. As a result, the deduction in one EU member state is matched to the non-exemption in the other EU member state.
Originally, this anti-abuse measure was part of a broader overhaul of the Directive. However, in order to attain early implementation of the hybrid loan amendment, the Council of the EU decided to split the hybrid mismatch provision from the broader proposal that includes a new general anti-abuse provision (which is not specifically designed to combat hybrid mismatch arrangements). The Council of the EU will continue to work on the general anti-abuse provision.
Under EU law, EU directives do not have direct effect to taxpayers. Instead, EU Member States will have time until December 31, 2015 to implement the new anti-abuse provision for hybrid mismatches into national law.
In our view, it would have been preferable to introduce a measure at the level of the payor/subsidiary, rather than at the level of the payee/parent. The current measure still allows for a deduction in the EU member state where the economic activities take place, which thus results in local base erosion and the shift of profit away from the EU member state where the economic activity of a group is located. Therefore, introducing a measure at the level of the subsidiary, which contains the disallowance of the interest deduction, would in our view lead to a more balanced outcome as it retains taxation rights in the EU member state where the economic activity is conducted. Moreover, this approach would be more in line with the approach currently suggested by the Organization of Economic Co-operation and Development’s proposals to combat base erosion and profit shifting (the so-called BEPS project). On the other hand, our preference to introduce a measure at the level of the payor/subsidiary is outside the scope of the Directive (because the Directive solely applies to the recipient side of the dividend flow).
In anticipation on the new rules that should be implemented by the EU Member States, it is advisable to review your company financing structure in the near future. Some arrangements may need to be restructured in order to avoid the negative impact of the aforementioned measure. In addition, the measure still allows for sufficient tax planning opportunities and even creates new planning possibilities. We would be happy to discuss the impact on and the new possibilities for your company.