Legal Alert – European Union Proposes Rules on Restricting Cross-border Hybrid Financing
On 25 November, the European Union published a proposal for amending a directive which aimed to curb the use of hybrid financing instruments. The changes would be enacted by amendments to the Directive 2011/96/EU on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States, i.e. the amended Parent-Subsidiary Directive.
In brief, hybrid loans arrangements are financial instruments that have characteristics of both debt and equity. Due to different tax qualifications given by Member States to hybrid loans, payments under a cross-border hybrid loan may be treated as a tax deductible expense in one Member State and as a tax exempt distribution of profits in another Member State. Effectively, this results in a double non-taxation.
In accordance with the new proposed legislation, the Member State of the receiving company, i.e. parent company, would refrain from taxing the received profits distribution only to the extent that the profits distributions are not deductible in the source Member State, i.e. in the Member State of the subsidiary. The portion of profits that is deductible in the subsidiarys Member State would thus be taxable in the parent companys Member State.
The proposed amendments relate to the Action Plan adopted by the Commission to strengthen the fight against tax fraud and tax evasion on 6 December 2012. In addition, hybrid instruments were the subject of, for example, the current OECD work on Base Erosion and Profit Shifting and Hybrid Mismatch Arrangements: Tax Policy and Compliance Issues as well as similar initiatives of the EU Code of Conduct group. In different instances, public voices and sources have implied that the use of hybrid instruments is a form of aggressive tax planning. A major reason for the proposed amendment was an increase in fiscal revenue it would generate; a breakdown of the specific amount of fiscal benefit in question is not obtainable, however. Published cases implicate that the monetary concern of hybrid financing would amount to billions of euros.
The Member States shall implement the Directive into national law by 31 December 2014. If implemented in its current form, it could lead to major changes in structures using cross-border intra-group hybrid financing.