Assessing the effectivity of proposed and adopted anti-hybrid entity measures within the EU

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Assessing the effectivity of

proposed and adopted

anti-hybrid entity

measures within the EU

Master thesis Economics of Taxation

By: F. Stapel Student number: 2167565

20-10-2017

University of Groningen Faculty of Economics and Business

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- 2 - Preface

This thesis marks the conclusion of my MSc Economics of Taxation. With the recently increased focus on the taxation of multinationals, e.g. the cases of Starbucks and Apple, at a community level and, subsequently, the legislative developments in this area, the landscape for all relevant stakeholders is changing. For me, this means that I’m even more excited to work in this field as it is a topic which is constantly in motion.

The above made me wanted to extensively deepen my knowledge in the field of International Taxation. Whilst it is commonly known that hybrid entities are an often-used vehicle for tax planning purposes and governments and NGO’s are aiming at tackling these practices at an increasing pace, this

constituted to an interesting topic on my behalf. That is why I choose to look how effective, in expectation, the approaches either proposed or adopted by the EU are going to be when they were to be implemented.

Finally, I like to thank professor Irene Burgers for her guidance in writing this thesis and more general, for her ongoing support throughout my studies.

That leaves me with saying: enjoy the read! F. Stapel

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1. Introduction

1.1. Cause

Tax planning using artificial structures is a phenomenon of all times. By taking advantage of disparities between the national tax systems of countries, companies are able to reduce their overall tax liabilities. In the past, and till the time of writing this thesis, an often-used tool to accomplish that objective is a hybrid entity, which could under circumstances result in a hybrid mismatch. Hybrid entities could be either classified as transparent or as non-transparent, dependent on which country classifies them. Hybrid mismatches find their origin in the lack of matching fiscal methods for classifying loan arrangements or entities and the independent application of those methods by countries. When applied in for companies the right manner, or for countries the undesirable manner, this could lead to situations where no tax is due. This thesis sees on those hybrid entities and with which approaches the European Union, keeping the international community in mind, is trying to fight them.

The international community is trying to put a stop to hybrid mismatches at an increasing pace. This trend was mainly initiated by the Organization for Economic Co-operation and Development

(hereafter: OECD) and the European Union (hereafter: EU). The OECD did so by publishing their OECD BEPS Report on Action 21_{, Neutralizing the effect of hybrid mismatch arrangements, in the light}

of anti-BEPS2_{on its website on the 5}th_{of October. Under the flag of the EU, the European Commission}

(hereafter: EC) published a proposal for a Directive with the objective to transform the

recommendations of the OECD into EU-law. The Council of the European Union (hereafter: CEA) later revised the latter proposal of the EC and adopted the Anti-Tax Avoidance Directive3_{(hereafter: ATAD}

I), which, subsequently, has been partially revised by an amending Directive, the ATAD II4_{, broadening}

its scope to more forms of hybrid mismatches than those addressed by the ATAD I and including third countries. The ATAD I and ATAD II will be implemented in the national tax systems of the Member States of the EU. These Directives must come into force 1 January 2020 at the latest. An exception is made for the clause on reverse hybrids (article 9a, ATAD II), which must come into force as of 1 January 2022.5

Both Action Plan 2 and the ATAD measures have the collective aim to put a halt to non-taxation by using hybrid entities. Also, the re-launch of the Proposal regarding a Common Consolidated Corporate Tax Base6_{(hereafter: 2016 CCCTB) and the Common Corporate Tax Base (hereafter: CCTB) by the EC}

on the 25th_{of October could, when adopted, eliminate the disparities between national tax systems}

whereas these proposals prescribe an allocation of profits between Member States based on economic determinants and not based on legal qualifications.

The Plans, i.e. the approach to tackle hybrid entity mismatches, of the OECD and the CEA provide a broadly similar but on details different approach to achieve the abovementioned aim. In this context, the evolution of the ATAD offers a more interesting view. On the 28th_{of January 2016, the EC chose to}

1_{OECD (2015), Neutralising the Effects of Hybrid Mismatch Arrangements, Action 2 - 2015 Final Report,}

OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris.

2_{BEPS: Base Erosion and Profit Shifting.}

3_{Directive laying down rules against tax avoidance practices that directly affect the functioning of the internal}

market, Council Directive (EU) 2016/1164 of 12 July 2016, L 193/1.

4_{Proposal for a Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third}

countries, 2016/0339 of 25 October 2016, COM(2016) 687 final.

5_{European Commission., 2017. Press Release: Commission welcomes adoption of new rules to block tax}

avoidance. Brussels, 29 May 2017.

6_{Proposal for an Common Consolidated Corporate Tax Base, Council Directive (EU) 2016/0336 of 25 October}

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- 7 - publish a proposal7_{, for the later approved ATAD, which would eliminate the existence of hybrid}

entities within the EU by fighting those at their core cause, to wit the disparities between the national tax systems of the member states with regard to a particular entity. Under that legislation, hybrid entities would be fully requalified using so-called “complete mutual recognition rules”.

This proposal of the EC differed significantly from both the recommendations made by the OECD BEPS Report on Action 2 and from the guidance of the EU Code of Conduct Group on business taxation.8_{It deviated from the measures recommended by the OECD by proposing an approach which}

prescribes a full requalification of the hybrid entity in state of the recipient of a payment when a difference in qualification leads to either a deduction in two states (Double Deduction; ‘DD’) or a deduction in one state without the corresponding payment being included in the taxable base in the other state (Deduction/No Inclusion; ‘D/NI’). This full requalification could also affect other legal provisions in the national tax systems of the Member States.9

The linking rules recommended by the OECD would only neutralize the cash flows associated with hybrid entities by rejecting the deductibility- or inclusion in the taxable base of a payment in resp. the source’s- or recipient’s state where the rules proposed by the EC would fully neutralize the negative, and possibly positive, features of those entities in tax terms. Examples of the implications of both the Proposal of the EC and the ATAD I & II will be provided in, respectively, chapter 5 & 6.

In this light, it may be said that it came as a surprise that after months of negotiation in the CEA, in comparison to the original plan of the EC, a very different approach was adopted to tackle hybrid mismatches. The adopted ATAD is, contrary to the proposal of the EC, in accordance with the

recommendations of the OECD BEPS Report on Action 2, as stressed multiple times in the preamble of both the ATAD I and the amending Directive, ATAD II. The ATAD, upon this time, should be

implemented by the Member States before the 1st_{of January 2019. However, the anti-mismatch}

provisions should be implemented before the end of 2019 and a specific provision concerning ‘reverse hybrids’ even later, on the 1st_{of 2022.}

The change of course poses a variety of questions. Apart from others, perhaps the most important question would be: Did the CEA a good job by revoking the rules proposed by the EC? The EC still claims to stand by their original proposal.

The original proposal of the EC included complete mutual recognition rules. These provisions are aiming to resolve mismatches by prescribing a uniform fiscal qualification of hybrid entities. The fiscal qualification given by the source state, the state of the payer of e.g. interest, in a certain transaction is the guiding principle and the other jurisdiction, the recipient state, is supposed to follow this

qualification.

The adopted ATAD prescribes provisions with less impact than the approach proposed by the EC by linking the domestic tax treatment of one jurisdiction of a financial instrument to the tax treatment of that same instrument in the other jurisdiction, aiming only at neutralization, i.e. prevention of non-taxation, of the associated cash flow with that particular transaction. The rules originally proposed by the EC, instead, alter the whole tax treatment of a single hybrid entity, i.e. the requalification of a hybrid entity is also followed for other applicable provisions of the tax system for the hybrid entity due. A global description of what both approaches are entailing is presented in Section 1.3.

7_{Proposal for a Council Directive laying down rules against tax avoidance practices that directly affect the}

functioning of the internal market, 2016/0011 of 28 January 2016, COM(2016) 26 final.

8_{Rigaut, A., 2016. Anti-Tax Avoidance Directive (2016/1164): New EU Policy Horizons. European Taxation,}

volume 56, no. 11.

9_{See e.g. Lohuis, R., Reijnen, J.J.H. Hybride entiteiten: een einde met haken (V/Λ) en ogen (á´)?, WFR 2016/48,}

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1.2. Objective

Evaluating and comparing the abovementioned plans proposed by the EC and the ATAD will be core of this thesis. A comparison will be made in the light of the recommendations done by the OECD and deviations thereof by the latter mentioned plans. Leaving the evaluation of political dynamics to a minimum, the aim is to map and evaluate the advantages and disadvantages of the methods used by the EC and the CEA for tackling the negative features of hybrid entities in cross-border tax structuring. The latter with the objective to point out which approach would be most effective when implemented in the national tax systems of the Member States.

By mapping those advantages and disadvantages a conceptual framework could be derived with which the similarities and the differences of the proposed and adopted Plans to tackle hybrid entity mismatch situations can be assessed in a structured manner. In this conceptual framework, key conditions will be used to identify possible pitfalls or effective components of a certain approach.

The key conditions are those of the OECD Taxation Framework:

1. Neutrality: Taxation should seek to be neutral. It should not discriminate between nationalities or places of establishment. The considerations underlying business decisions should be economic rather than based on tax considerations. Taxpayers in similar conditions should be subject to similar levels of taxation.

2. Efficiency: The administrative costs for tax authorities and compliance costs for taxpayers should be minimized.

3. Certainty and simplicity: In order to have certainty about the tax consequences of a certain transaction in advance, the tax rules should be stated in a clear and simple manner. This includes how, when and where the tax is to be accounted.

4. Effectiveness and fairness: Tax rules should be designed such that they produce the right amount of taxation at the right time. By doing that, the potential for tax evasion and tax avoidance should be minimized while acting on those threats with reasonable counteract.

5. Flexibility: The tax rules should be able to ensure proper taxation when the commercial and legal landscape changes. It has to be able to react upon new tax evasion and tax avoidance threats. The abovementioned key conditions are derived from the Ottawa Taxation Framework Conditions.10

The interpretation is adjusted bearing the context of anti-hybrid entity mismatch measures in mind. How the key conditions are determined, i.e. what do they entail and how should they be interpreted, is discussed in depth in Chapter 4.

Since no perfect solutions exist until the whole world implements a completely harmonized tax system, this framework could be a useful tool to rank approaches that tackle hybrid entity mismatches in their effectiveness. This is relevant as the ATAD leaves plenty room for inconsistent implementation of the provisions in the national law of the Member States.11_{The ATAD sets a “minimum level of protection”,}

therefore giving the individual Member States the possibility to choose a more radical approach. Promoting a theoretical understanding of the considered Plans could enrich the discussion on relevant points throughout the implementation process and ultimately foster a consistent implication of the provisions in the ATAD. From a scientific perspective, the research question is relevant as it sheds light on matters relevant for obtaining an effective approach to eliminate the occurrence of hybrid entity mismatches in the EU and among the OECD Member States.

10_{OECD, 2001. Taxation and Electronic Commerce - Implementing the Ottawa Framework Conditions, OECD}

Publishing, Paris.

11_{Fibbe, G.K., 2016. Hybride mismatches onder de ATAD; symptoombestrijding is geen oplossing, WFR}

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1.3. Background of anti-hybrid mismatch provisions

Before the research gap is addressed, in this subparagraph a summary of the background is given. The first important report concerning hybrid entities dates back to the 29th_{of February of 2012.}12_{On that}

date the EC published its report “The internal market: factual examples of double non-taxation cases”. The staff working document was meant to be a public consultation paper. Eight factual examples of double non-taxation cases are presented, of which the first one sees directly on mismatches resulting from hybrid entities.

The EC, also, a month prior to the staff working document, published its report “Communication on Double Taxation in the Single Market”13_{, in which is stated that a consultation on this topic should be}

started to map possible cases of non-taxation in case tax payers make us of hybrid mismatches. Another report, “Hybrid mismatch arrangements: Tax Policy and compliance issues”14_{, concerning}

hybrid entities was published by the OECD almost simultaneously with the EC report. This report maps policy issues and coherent options for policy makers to reduce the negative effects resulting from hybrid mismatch arrangements. It provides for suggestions for specific rules to tackle these

mismatches and evaluates some action already taken, back in March 2012, by a certain group of EU-member states.15

Following these reports, the EU Code of Conduct group noted that addressing hybrid entities is a topic which deserves particular priority16_{and therefore prepared guidelines to address this issue}17_.

Subsequently, in 2012, the European Commission also published its “Action plan to strengthen the fight against tax fraud and tax evasion”.18

Bearing in mind this history, it could be argued that the topic of hybrid entities and how to tackle their negative features is receiving increasing interest in the international community. In particular, the European Union took action by adopting ‘hard law’ in the form of the ATAD19_{on the 19}th_{of July 2016.}

Simultaneously, the CEA requested the EC to put forward an additional Directive to, also, address hybrid mismatch situations arising with regard to third countries. On the 20th_{of October 2016, the EC}

published the so-called ATAD II20_{, on which on the 21}th_{of February, 2017 political agreement is}

reached in the ECOFIN. On 29 May 2017, the CEA adopted the ATAD II, which corresponds with the content agreed upon by the ECOFIN.

The core design of the approach of the ATAD is given in article 2 (9) ATAD (defining hybrid

mismatches), article 2 (4) ATAD (definition associated enterprise) and article 2 (11) ATAD (definition structured arrangement) and article 9 ATAD. Article 9 ATAD refuses the deduction of interest in the situations defined in article 2 (9) ATAD. The approach adopted in those articles to tackle non-taxation when using hybrid entities differs, as stated before, from the approach proposed on the 28th of January 2016 by the European Commission.

12_{The internal market: factual examples of double non-taxation cases, Consultation document, Brussel,}

2012, TAXUD D1 D(2012).

13_{Communication on Double Taxation in the Single Market, 2011, COM(2011)712.} 14_{Hybrid mismatch arrangements: Tax Policy and compliance issues, March 2012.}

15_{I.e. Denmark, Germany, New Zealand, the United Kingdom, the United States and others.}

16_{Code of Conduct Group to the ECOFIN Council on the 11th of June of 2012 (doc.10903/12 FISC 77).}

17_{Code of Conduct Group, 2nd semi-annual report of 2014, nr. 16553/1114, Fisc 225, Ecofin 1166; Code of Conduct}

Group, 1th semi-annual report of 2015, nr. 9620/1 5, Fisc 60, Ecotin 443.

18_{European Commission, An action plan to strengthen the fight against tax fraud and tax evasion COM(2012) 722}

final.

19_{See Directive laying down rules against tax avoidance practices that directly affect the functioning of the internal}

market, Council Directive (EU) 2016/1164 of 12 July 2016, L 193/1.

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- 10 - The ATAD II amended the latter ATAD by introducing a variety of situations where hybrid mismatches are present. It addresses mismatches concerning hybrid permanent establishments (article 9 (1)-(2) in conjunction with article 9 (5)), ‘hybrid transfers’ (article 9 (2)-(6)), imported mismatches from third countries (‘imported mismatches’; article 9 (3)), ‘reverse hybrids’ (article 9bis) and tax residency mismatches (article 9ter). The EC hereby has the objective to align the already adopted ATAD with the report on Action Plan 2 – OECD Final Report, where these mismatches were already provided for. Both approaches leave out transfer-pricing mismatches, e.g. in informal capital contributions- or hidden dividend situations.

Both approaches, of the EC in their original Plan and that of the ATAD, have their up- and downsides, which are partly documented in recent literature. As stated in the section on the objective of this thesis (Section 1.2), the aim is to derive a conceptual framework to assess the effectiveness of both

approaches by pointing out their main differences, and possibly other approaches in the future (e.g. the specific rules which Member States are planning to implement in their national tax systems). This assessment will be conducted using the key conditions mentioned in Section 1.2. Below the research gap is discussed and to what respect this thesis is contributing to academic literature.

Several authors assessed the effectiveness of one of the considered Plans to tackle hybrid entity mismatches. Most of them, however, only addressed the effectiveness with respect to a particular part of the original approach of the EC or the approach of the CEA. The main areas which, upon the time of writing of this thesis, received interest were the possible breach with international law21_{, the effects on}

the fiscal attractiveness of a jurisdiction22_{, the scope of the approach}23_{, the possible occurrence of}

double taxation.24_{This thesis aims at combining those assessments and categorizing them with the key}

conditions in mind. In that way, a comprehensive assessment of the effectivity of both approaches can be carried out.

1.4. Research question

As noted above, the CEA did deviate from the complete mutual recognition rules proposed by the EC to fight hybrid entity mismatch arrangements by closely tying the linking rules they adopted to the OECD recommendations. This change of course poses multiple questions of which a significant one is

whether the CEA wisely revoked the original plan of the EC. To determine whether this is the case, a framework including key conditions, with which a comparison can be performed, is necessary to determine the main similarities and differences. After establishing such a framework, the following research question will be answered:

After comparing the approaches of the EC and the CEA, to tackle hybrid entity mismatches, which approach is expected to be more effective?

Hypothesis

Based on the available literature, my hypothesis is that the approach of the CEA will prove to be more effective, as it is less rigorous in neutralizing hybrid entity mismatches and thus, scores better with

21_{See e.g. Panayi, C.H.J.I., 2016. ‘The Compatibility of the OECD/G20 Base Erosion and Profit Shifting Proposals}

with EU Law’, Bulletin for International Taxation, January/February 2016. Referring to the EU Case Cadbury Schweppes, hey discuss a possible breach with EU Law now that the rules apply even though there is no ‘wholly artificial structure’ present.

22_{See e.g. for the Netherlands: NTFR 2017/514 Motie Tweede Kamer over ingangsdatum richtlijnvoorstel hybride}

mismatches met derde landen, Tweede Kamer, 14 februari 2017, nr. 21 501. By taking away imported mismatches, the Netherlands an often used structuring option which is beneficial for American firms.

23_{See e.g. Lohuis, R., Reijnen, J.J.H. Hybride entiteiten: een einde met haken (V/Λ) en ogen (á´)?, WFR 2016/48,}

p.8. or Fibbe, G.K., 2016. Hybride mismatches onder de ATAD; symptoombestrijding is geen oplossing, WFR 2016/186, p.10. Noting that the scope is limited to double deduction- and deduction/no inclusion situations.

24_{See e.g. Action 2 – OECD Final Report, nr. 202. The OECD mentions that in certain situations double taxation}

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- 11 - regard to Taxation Framework. However, the latter notion regarding the proposal of the EC is also where the CEA can learn from the original approach of the EC. By eliminating the hybrid entity mismatches at its core, under the original plan of the EC disparities between national tax systems with regard to the qualification of entities will no longer exist.

Sub questions

1. How are hybrid mismatches dissolved under the considered Plans?

2. When applying the key conditions, how is the original approach of the EC characterized? 3. When applying the key conditions, how is the approach of the ATAD characterized?

4. When comparing the approaches of the EC and the CEA, to tackle hybrid entity mismatches, what are the main similarities and differences?

1.5. Delimitation

To obtain an answer to the research question, a delimitation of the material dealt upon is necessary. The focus of this thesis will mainly be the European context. Also, the international context from an OECD-perspective is considered but more from a comparative point of view. In practical terms, both the original plan of the EC and the adopted Directive of the CEA are examined. After both plans are considered, a framework will be established with which the considered Plans could effectively be assessed.

An important note is that when in this thesis effectiveness, beneficial and other coherent words are used, this is mentioned with the government in mind.

In testing the framework, the, in the section on the research gap, mentioned key conditions will be leading. These key conditions will be used for an assessment of the effectivity in tackling hybrid entity mismatches. Subsequently, by making a comparison, the main similarities and differences between the considered approaches could be stipulated. In drawing that conclusion, the focus will be on the

material cohering with the key conditions.

Politics are a relevant component in the discussion on how to implement the provisions in the national tax systems, especially since the ATAD prescribes a minimal standard. Political motives could lead to either implementing the absolute minimum or implementing a more far-reaching measure. However, politics will not contribute to an objective review of the provisions. Only where these political

considerations have significant value, they will be stated and dealt with for obtaining the conclusions.

1.6. Research method

The research method will consist of a desk study. The following strategy will then be employed. First, a systematic literature research is conducted. In obtaining relevant literature, the databases of IBFD, Kluwer Navigator and NDFR were used. Only articles released after the OECD BEPS Report on Action 2 was published are considered, apart from a limited number of key articles. The documents

considered are those included in the footnotes.

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1.7. Chapter division

The chapter division of this thesis will be as follows. Chapter 1: Introduction

Chapter 2: Hybrid entity mismatch description

Chapter 3: Global developments in fighting hybrid entity mismatch arrangements Chapter 4: Establishing a Taxation Framework

Chapter 5: Hybrid entities under the Plan of the EC Chapter 6: Hybrid entities under the adopted ATAD Chapter 7: Comparison of the approaches

Chapter 8: Conclusion

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2. Hybrid entity mismatch description

2.1. Introduction

Hybrid mismatches arise from disparities between national tax systems. Mismatches find their origin in many circumstances but they mainly exist using one of the following elements: hybrid instruments, hybrid entities, hybrid transfers or dual-resident entities. When hybrid mismatches are employed with the aim to take advantage of differences in the tax treatment, those transactions or corporate

structures are called hybrid mismatch arrangements. Hybrid mismatches could arise from of hybrid financial instruments, hybrid entities, hybrid transfers or dual-resident entities. In order to grasp the differences between several elements underlying these hybrid mismatches, a brief description of hybrid mismatches is given. Following that description, the hybrid entity mismatch will be examined in depth.

Paragraph 2.1.1. Hybrid financial instruments

A case of a hybrid financial instrument appears when a financial instrument under the national tax system of one state is classified as equity and under the national tax system of another state as debt (i.e. a loan arrangement). In the state that classifies the financial instrument as equity, the payment under the financial instrument will be qualified as a dividend payment. In the state which classifies the financial instrument as a loan arrangement, the payment under that instrument will be qualified as interest.

The latter effect could be beneficial for the parties involved in the financial instrument. Most countries tax interest payments, i.e. either inclusion in the taxable base for the payee or deduction of the interest payment for the payer. However, the payment or the receipt of a dividend will not give rise to tax consequences in most countries with regard to corporate tax. If a hybrid instrument is used with the aim of reducing a company’s tax liabilities, the instrument is designed such that the state of the recipient of the payment under the financial instrument classifies the instrument as equity and the state of the payer classifies the instrument as debt.

The result of designing a financial instrument in that way leads to an interest deduction in the state of the payer and no corresponding inclusion of the payment in the taxable base in the state of the recipient. The receipt of dividend is treated as exempt dividend for dividend tax purposes, in most countries by applying e.g. a group relief or participation exemption regime.

Paragraph 2.1.2. Hybrid entities

Whereas a hybrid instrument mismatch arises from an disparity between national tax systems with regard to the classification of a financial instrument, a hybrid entity mismatch arises from a different classification of an entity by two (or more) national tax systems. An entity can either be classified as transparent or non-transparent. When an entity is marked transparent, that entity is ignored for tax purposes. The income earned and the costs made by a transparent entity are treated as if they are made by the underlying participants. This is different from the situation wherein an entity is marked as non-transparent. In that case will be taxed as a separate entity. Income and costs are assigned to that entity.

A hybrid entity mismatch occurs when one state classifies an entity as transparent and another state will classifies that same entity as non-transparent. With regard to hybrid entity mismatches, there are always three entities involved. For example, Company A is situated in State I and Company B and C are situated in State II. From the perspective of State I, Company B is transparent. For a graphical

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- 14 - Figure 1. Hybrid entity mismatch – Double Deduction

If Company C borrows money to Company B, this constitutes to an interest deduction for Company B and inclusion of the payment of interest in the taxable base. This would also be the case if no hybrid entity mismatch was present. However, now that State I classifies Company B as transparent, they treat the loan provided by Company C to Company B as a loan provided by Company C to Company A. This gives rise to an additional interest deduction for Company A. In total, the loan in this situation results at an interest deduction for both Company A and B and the payment is only included in a taxable base ones, namely at Company C. This inclusion in the taxable base of one state (here State II) is typically set off by the deduction of payment under application of a group tax regime.

Both hybrid instrument mismatches and hybrid entity mismatches occur in many other different forms than those described above. The differentiating element between hybrid instruments and hybrid entities is, as stipulated above, the element which is classified differently by national tax systems. In the case of hybrid instrument, it is the financial instrument which is classified as either equity or debt. In the case of hybrid entities, it is the entity which is classified either as transparent or

non-transparent.

Paragraph 2.1.3. Hybrid transfers

A hybrid transfer arises when a financial instrument is transferred to another owner and the

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- 15 - Paragraph 2.1.4. Dual-resident entities

A dual-resident entity is an entity which is acknowledged as a resident under the law of two jurisdictions. This dual residency could trigger the double deduction of a single payment if that payment is deductible under the law of two jurisdiction in which the dual-resident entity is based. Of course, a dual residency could also give rise to a double inclusion of income if one receipt is taxed under the law of two jurisdictions. It has to be noted that most of the dual-resident entity mismatches are resolved due to tax treaties (i.e. by application of tie-breaker rules).

This thesis focuses merely on anti-hybrid entity measures. Possible outcomes and some of the appearances of hybrid entity mismatches will be discussed in Section 2 of this chapter.

2.2. Different effects of hybrid entities

In accordance with the OECD Final Report on Action 2, three different outcomes are identified as a result of hybrid entity mismatch arrangements. These are a double deduction of one payment, a deduction of a payment with no corresponding inclusion and lastly, an indirect deduction of a payment and no corresponding inclusion. The latter outcomes are explained below.

Paragraph 2.2.1. Double Deduction

A double deduction situation arises when one payment is deductible in two states. In Section 1 of this chapter, a graphical illustration of a situation which gives rise to a double deduction is given in Sub section 2.1.2., figure 1.

Expenses and losses of an entity are treated in different ways for tax purposes by means of whether an entity is classified as non-transparent or transparent. When an entity is treated as non-transparent in one state, expenses and losses are deductible from the taxable base of the entity in that state. A case of double deduction of the same expense or loss occurs when another state treats the same entity as transparent. As a result, all the expenses and losses are assigned to the participant of that entity for tax purposes. The participant, subsequently, deducts the same expense or loss that the entity in the former state already deducted as well.

Paragraph 2.2.2. Deduction/ No Inclusion

Similar to the case of a double deduction situation, a case of a deduction of a payment without a corresponding inclusion of that payment in the taxable base results from a different classification of an entity by two states. A case of deduction without inclusion arises when the state in which an entity is created or originally formed classifies that entity as transparent for tax purposes and another state classifies that entity as non-transparent for tax purposes. In literature, the latter is referred to as a reverse hybrid.

Payments made to the hybrid entity are deductible in the state that classifies the entity as transparent with the assumption that the participants of the hybrid entity include the payment in the taxable base in that state. However, if that state classifies the hybrid entity as non-transparent for tax purposes, that state assumes that the payment is already included in the taxable base in the state that classifies the entity as transparent. In that way, both state are not including the payment in the taxable base and therefore only a deduction of the payment remains without a corresponding inclusion of that payment. Below an example is given.

Company A is situated in State I, Company B in State II and Company C in State III. Company B is the hybrid entity in this example. From the perspective of State I, Company B is classified as

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- 16 - Figure 2. Hybrid entity mismatch – Deduction/ No Inclusion

If an interest payment is made by Company C to Company B due to the loan arrangement, this interest payment is deductible for tax purposes for Company C. Now that State III classifies Company B as transparent, from the perspective of Company C, State III assumes that Company A will include the interest payment in its taxable base. Moreover, State II classifies Company B as transparent, therefore that state is not taxing the interest payment. State I, as mentioned above, classifies Company B as non-transparent for tax purposes. Therefore, from the perspective of Company A, State I assumes that Company B includes the interest payment in its taxable base and is not taxing that interest payment as well. The latter results in the situation where State I accepts an interest deduction for Company C and neither State II and III are taxing that interest payment.

The above is just one situation which could lead to a deduction of a payment without a corresponding inclusion of that payment in the taxable base in a state. There are other examples which give rise to the same outcome. Those examples are discussed when they proof worth mentioning.

Paragraph 2.2.3. Indirect Deduction/ No Inclusion

This outcome arises when a hybrid entity arrangement between two states is transferred in terms of its outcome to another state. This case is often referred to as an imported mismatch.

More precisely, an imported mismatch arises when somewhere in the structure of a business group a mismatch appears but that mismatch is not neutralized by, for instance, a Member State. This mismatch is then transferred, by using a non-hybrid financial instruments, to another Member State. Below an illustration of an imported mismatch is given. Note that the technicality of an imported mismatch is more complex than for the abovementioned other types of hybrid mismatches. Therefore, a distinction between Member States (MS) and third-countries (3C) is necessary to clarify the

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- 17 - The companies A, B, C and D are associated. Company A is situated in country 3C II. Companies B and C are situated in country 3C I. Those companies apply a group tax regime which allows them to

consolidate their results with each other. Company B is a hybrid entity. From the perspective of country 3C I, company B is a non-transparent entity. From the perspective of country 3C II, company B is a transparent entity. Company D is situated in country MS. See the figure below.

Figure 3. Hybrid entity mismatch – Indirect Deduction/ No Inclusion25

In this example, interest is paid by Company D to Company C (Interest Payment I) due to a loan arrangement. This payment is deductible in MS and will, in principle, be taxed in 3C I. However, the results of Company C and Company B can be consolidated due to a group tax regime in 3C I. Company B, a hybrid entity, pays interest to an independent party (Interest Payment II). Now that company B is a transparent entity from the perspective of country 3C II, this interest payment (Interest Payment II) will also be deductible in country 3C II. This results in the outcome that Interest Payment II is double deductible. That hybrid entity mismatch (double deduction/ no inclusion) is imported by country MS due to the loan connected with Interest Payment I.

The imported mismatch situation only occurs when the third-countries, in the above figure states 3C I and 3C II, will not apply anti-hybrid entity mismatch measures that neutralize the mismatch involved with Interest Payment II.

To sum up, in this chapter the main forms of hybrid mismatches were introduced. These were mismatches involving hybrid financial instruments, hybrid entities, hybrid transfers or dual-resident entities. It was stipulated that this thesis only sees on hybrid entity mismatches. Then the various outcomes of hybrid entity mismatches were given and some of its appearances. In the following chapter, global developments in fighting hybrid mismatches are set out with the purpose of better understanding the recent action taken by the European Union in fighting those mismatches.

25_{This example is based on: Proposal for a Council Directive amending Directive (EU) 2016/1164 as regards}

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- 18 -

3. Global developments in fighting hybrid entity mismatch

arrangements

3.1. Introduction

In this chapter an overview is given of the actions taken with regard to hybrid entities in the international community. Those actions are predominantly taken by the OECD and the EU. Their efforts are therefore primarily discussed because of their importance for explaining the narrative of the action taken by the European Union in the form of the EC approach and the ATAD I & II.

This chapter is divided as follows. First the action of supranational organisations leading up to the BEPS-reports will be discussed. Subsequently, OECD BEPS Report on Action 2 in coherence with the action taken by the EU action is dealt upon. Lastly, the Multilateral Convention to Implement Tax Treaty related Measures to Prevent Base Erosion and Profit Shifting, as documented in the OECD BEPS Report on Action 15, is discussed and how it may help in the fight of tackling hybrid entity mismatches.

3.2. Action leading up to the OECD BEPS Report on Action 2

As mentioned above, leading up to the OECD BEPS Report on Action 2, the most relevant actions with regard to tackling hybrid entities are mainly taken by the OECD and the EU. The initiatives of these organisations are interrelated and have catalysed the literature in this field.

On the 11th of November of 2011, the EC published a staff working document in which they stated that the EC is increasing their efforts to put a hold to double non-taxation situations by starting an internet consultation in which the EU was aiming to map the situations in which double non-taxation could occur. This report, “Communication on Double Taxation in the Single Market”, recognized that the landscape for companies involved in cross-border activities within the EU, as a results of exercising fundamental freedoms, made it more convenient for these companies to trade with other Member States. This enhanced trade, subsequently, resulted in more possibilities for tax planning in the involved countries due to uncooperative, uncoordinated domestic tax systems.26_{Also, the latter could}

give rise to double taxation, which is also addressed.

At this point, the problem of double taxation deserves particular attention as it is seen as a threat for the single market. That is why the report intended to examine how this problem can be reduced and how this should be translated into double tax conventions (hereafter: DTL) within Member States. The main conclusion by the EC was that Member States should enhance their cooperation in the field of international tax law as well as by working towards ‘good governance’ principles.27

Almost simultaneously with the latter report, on 29th of February of 2012, the EC published the first important report concerning hybrid entities. This report also was a staff working document. Eight factual examples of double non-taxation cases were presented of which one case involved a hybrid entity mismatch involving a double deduction situation.28_{This mismatch, which was graphically}

explained in this report, was accompanied by a questionnaire which should give the EC guidance on whether it should, in the eyes of the respondents, take action to tackle that particular mismatch. On the 5th of July of 2012, the EC published a summary report of the received responses on the questionnaire.29_{The contributors consisted of people from the business community as well as}

non-governmental organisations. All of the respondents acknowledged that double non-taxation resulting

26_{Communication on Double Taxation in the Single Market, 2011, COM(2011)712, pp. 3.}

27_{Fibbe, G.K., 2016. Hybride mismatches onder de ATAD; symptoombestrijding is geen oplossing, WFR}

2016/186, pp. 2.

28_{The internal market: factual examples of double non-taxation cases, Consultation document, Brussels, 2012,}

TAXUD D1 D(2012), pp. 6.

29_{Summary report of the responses received on the public consultation on factual examples and possible ways to}

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- 19 - from hybrid entities is a topic which should be addressed in future discussions on double

non-taxation.30_{The respondents also provided the EC with other possibilities of hybrid entities resulting in}

mismatches, apart from the double deduction example.

Also the OECD, in their report “Hybrid mismatch arrangements: Tax Policy and compliance issues”31_,

contributed to delimitating the problem of hybrid mismatches by defining elements of hybrid

mismatches and providing examples of how they may occur. This report discusses multiple underlying elements and categories of hybrid mismatches which can be useful for mapping-purposes.

On the 11th of June of 2012, the EU Code of Conduct Group published “Measures to prevent double non-taxation (hybrid mismatches)”, which elaborates on the progress achieved by both the EC and the OECD in the latter reports. The report denotes that they are targeting hybrid entities and (hybrid) permanent establishments, in the cases that these mismatches result in double non-taxation.32

Following this report the Code of Conduct Group designed guidelines which are elaborated upon in two semi-annual reports of end 2014 and the beginning of 2015.33 _{These reports give guidance to}

Member States on how to treat hybrid entities, also in relation to third countries. This guidance was accepted by the Member States but material changes to the legislation of the Member States was not yet adopted.

All of the above developments were increasing the pace of the international community to tackle hybrid entity mismatches. But none of them introduced an integrated approach to accomplish that objective. Therefore the OECD in its BEPS project published Action Plans of which Action 2 directly concerns hybrid mismatches.34_{This Action Plan also explicitly addresses hybrid entity mismatches.}

The recommendations in the OECD BEPS project on Action 2 were followed by action taken by the EU. First, the EC published a proposal for a Directive in which hybrid entities in the situation of

qualification differences between the payer’s state and the recipient’s state are completely requalified by following the fiscal qualification given by the source state, the state of the payer. The CEA chose not to adopt this approach and amended this by aligning their approach with the recommendations made by the OECD in its Action Plan 2. This led to ATAD I and ATAD II, of which the latter amended but mainly formed an extension on ATAD I with regard to hybrid entity mismatches.

Adopting ‘hard law’ is seen as a necessary step in tackling hybrid entity mismatches, which was recognised by the EC. The guidelines provided by the Code of Conduct Group could not lead to a coherent, effective implementing of anti-abuse measures in this respect. The EC emphasized that a coherent and effective implementing among Member States is key because the problem arises from disparities between the national tax systems of those Member States.35

3.3. OECD BEPS Report on Action 2 and its coherence with the action taken

by the EU

As mentioned before, the OECD published its OECD BEPS Report on Action 2 providing recommendations on how to effectively tackle hybrid entity mismatches. This report aims at combining all previous literature on hybrid entity mismatches, and other mismatches, with the objective to transform this knowledge into effective anti-mismatch measures in domestic tax systems.

30_{Summary report of the responses received on the public consultation on factual examples and possible ways to}

tackle double non-taxation cases, Brussels, 5 July 2012, TAXUD D1 D(2012), pp. 13.

31_{OECD, 2012. Hybrid mismatch arrangements: Tax Policy and compliance issues. March 2012.} 32_{Code of Conduct Group to the ECOFIN Council on the 11th of June of 2012 (doc.10903/12 FISC 77).} 33_{Code of Conduct Group, 2nd semi-annual report of 2014, nr. 16553/1114, Fisc 225, Ecofin 1166; Code of}

Conduct Group, 1th semi-annual report of 2015, nr. 9620/1 5, Fisc 60, Ecotin 443.

OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris.

35_{See Preamble of Directive laying down rules against tax avoidance practices that directly affect the functioning}

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- 20 - In chapter 2, the various standard forms in which a hybrid entity mismatch can occur were discussed. All these forms are also discussed in the BEPS report. In putting the negative features of hybrid entity arrangements to a stop, the approach of the OECD BEPS ties the rejection of a deduction or the inclusion of a payment in a taxable base to the financial cash flows. By denying the deductibility of a payment in the case of a double deduction outcome, the financial cash flows are neutralised, resulting in a deduction in the source’s state and an inclusion in the recipient’s state.

The Action Plan introduces a primary response and a defensive rule. The latter forms the primary response rule. If the payer jurisdiction did not implement the primary response, the defensive rule enters into force by classifying the amount of the deduction that should be denied, by application of the primary response, as ordinary income. Therefore, for the approach to work it is not required that the payer jurisdiction as well as the recipient jurisdiction have implemented the OECD

recommendations.

Also, the recommendations deal with certain situations in which the anti-mismatch measures should not apply. One of which a more common one, i.e. the provisions should only apply in those situations where there is a material hybrid mismatch. If the double deduction of one payment is set-off against “dual inclusion income”, the provisions should not apply. Dual inclusion income arises when income is included in both the payer and the payee jurisdictions. The scope of the rules are limited to taxpayers that are part of a control group (related parties) or a structured arrangement. Whereas the threshold for a control group is a participation of 50%.36 The definition of a structured arrangement is dealt upon in chapter 6.

Both the proposal of the EC and the adopted ATAD I and II show similarities with the OECD BEPS Report on Action 2. However, one more than the other. The proposal of the EC entailed a considerably different approach to counter hybrid entity arrangements than the OECD recommendation prescribed. The EC committed itself to the recommendations but argued that a unilateral and divergent

implementation of the recommendation would cause a fragmentation of the single market within the EU. According to the EC it could raise “policy clashes, distortions and tax obstacles for businesses in the EU”.37 Therefore the EC chose to implement the BEPS recommendations - as a minimum - by using the recommendations as guidance for effective anti-hybrid entity measures.

Those minimum standards with regard to the provision on hybrid entities mainly encompasses the usage of the definitions as well as the various forms of mismatches introduced by the OECD

recommendations, to make sure that those are caught by the EC Proposal. This Proposal was altered by the CEA, resulting in the ATAD I. As mentioned before, the ATAD I was amended by the ATAD II, mainly broadening its scope to a few other forms of hybrid mismatches and including third-country situations. In this, adopted, Directive the CEA stresses that they wanted to find a “common, yet flexible, solutions at the EU level consistent with OECD BEPS conclusions”.38 Therefore the approach prescribed by the ATAD entails a similar approach as the approach recommended in the OECD BEPS report.

By rejecting the deduction of a payment in the case of a hybrid entity mismatch resulting in a double deduction or a deduction/no inclusion situation, the approach is very similar to that of the OECD. Also, the ATAD II entails a primary response and a defensive rule, similar to the OECD’s BEPS Action 2 proposal. However, in the ATAD I and II it is still stressed that the BEPS recommendations should

36_{An exception is made for a very restrictive situation where a third party has a 50% or greater investment in a}

party which is part of a control group. This example is not further discussed here.

functioning of the internal market, 2016/0011 of 28 January 2016, COM(2016) 26 final, pp. 3.

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- 21 - be implemented as minimum standards but the discouragement of tax avoidance practices is added as a pillar.

To summarize, it could be said that the development of the legislation in the EU in the field of hybrid entity mismatches ultimately is coherent with the OECD BEPS recommendations. Nevertheless, the ATAD I stipulates that it should offer a ‘minimum level of protection’39, which means the

implemented provisions in the national tax systems of the Member States could show deviations to the ATAD or the recommendations of the OECD in the case of a Member States choosing to implement firmer measures. A Member States chooses this path, for instance, if they expect that the ‘minimum level of protection’ does not sufficiently mitigate the problem of hybrid entity mismatches.

3.4. Multilateral Convention

Another interesting, very relevant, development with regard to tackling the benefits a company derives from deploying a hybrid entity in their corporate structure, is the Multilateral Convention (hereafter: MLI).40 This instrument does not aim to change domestic law but to change bilateral tax treaties of all the states who signed the MLI. On the 7th of June 2017, at a signing ceremony, a total of 67 states and jurisdictions signed the MLI41, thereby obliging themselves to adjust their bilateral treaties with other signatory parties. This number of states and jurisdictions that have signed the MLI is since the signing ceremony only increasing. According to the OECD, the MLI has the potential of changing 2000 treaties42 of which with the current signatory parties already 1100 bilateral treaties are modified. At the time of writing (October 2017), 71 jurisdictions signed the MLI.

In article 3, the MLI addresses hybrid entity mismatches in situations wherein these mismatches lead to either a double deduction- or a deduction/no inclusion outcome with regard to a payment. This article incorporates the treaty-based provisions which were recommended in the OECD BEPS Action Plan 2. If this is the case, the state of residence does not have to, if appropriate, grant an exemption for the avoidance of double taxation. This makes the hybrid entity not eligible to treaty benefits any more. This provision is closely tight to article 1(6) of the 2016 United States Model Income Tax Convention, as well as in a significant number of other treaties throughout the U.S. treaty network.43 In respect of the bilateral treaties to which it is going to apply, it will replace existing provisions of a similar type with regard to hybrid entities. The approach of article 3, MLI deviates from the approach of the EC, the OECD or that of the ATAD I and II by taking away the treaty benefits of hybrid entity mismatches. When not granting an exemption, an entity is effectively taxed at the level of the parent company of the hybrid entity.

This article on hybrid entity mismatches is a non-mandatory part of the MLI. The MLI consists of a part with provisions that are ‘minimum standards’ and a part which consists of provisions of which it is not mandatory to implement them into the bilateral treaties of a signatory party.

At the time of writing (October 2017), only one-third of the signatory parties (25 states/ jurisdictions) communicated that they will commit themselves to the provision on hybrid entity mismatches.44

39_{See article 3 of the Directive laying down rules against tax avoidance practices that directly affect the}

functioning of the internal market, Council Directive (EU) 2016/1164 of 12 July 2016, L 193/1.

40_{Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting}

(MLI) (Nov. 24, 2016).

41_{http://www.oecd.org/tax/ground-breaking-multilateral-beps-convention-will-close-tax-treaty-loopholes.htm} 42

http://www.oecd.org/tax/treaties/countries-adopt-multilateral-convention-to-close-tax-treaty-loopholes-and-improve-functioning-of-international-tax-system.htm

43_{U.S. Department of the Treasury, 2016 United States Model Income Tax Convention,}

https://www.treasury.gov/resource-center/tax-policy/treaties/Documents/Treaty-US%20Model-2016.pdf

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- 22 -

4. Establishing a Taxation Framework

4.1. Introduction

In this chapter the framework is established with which both the proposal of the EC and the later adopted ATAD to tackle hybrid entity mismatches are assessed. Obtaining a suitable framework is key to being able to assess the approach effectively. Before establishing the framework itself, the

characteristics are stipulated.

Hybrid entities are characterized by disparities between national tax systems. The cause of the

problem of non-taxation in relation with hybrid entities is not a result of hybrid entities themselves but of how States perceive those entities, transparent or non-transparent, and the manner in which

payments made by or received by such an entity are treated. These payments consist of expenditures such as interest, service payments, royalties and other payments that can be set-off against ordinary income.45

Taking the above into account, it may be said that the payments to or received by hybrid entities to which the anti-hybrid entity measures apply are immaterial by nature. This is also denoted by the way those services, i.e. lending or the obtaining of funding, managing intellectual property etc., can be provided. These services can be operated remotely and independently from the place of business which is mentioned in the contracts.

These characteristics help in determining which taxation principles in the framework are suitable to assess the various approaches. Following these characteristics, delimitating the objective of the framework is also key.

4.2. Objective framework

After denoting the characteristics of which hybrid entity arrangements consist, the objectives of the assessment for which the framework is used is determined. With “objective” in this context is meant the overall purpose of the approach. Denoting the objectives is critical because a standalone

assessment of the approaches against the individual taxation principles could possibly not grasp the overall intention of the approaches. This reason for this is that an approach can score well on

particular points but if the overall effectivity is not satisfying, the Plan cannot constitute to a, in theory, effective measure against hybrid entity arrangements. Therefore the objective of the Plans help in rationalising the outcomes.

The main reason of anti-hybrid entity measures is, of course, preventing that the use of a hybrid entity leads to non-taxation outcomes. This is a shared objective of both the proposal of the EC and the later adopted ATAD. Another objective which is shared for both approaches is the consistency with current legislation within the EU. It is clear why both the EC and the CEA attach significant value to the latter objective. The origin of hybrid entity mismatch is found in disparities between national tax systems. If the proposed legislation in fighting those mismatches turns out to be inconsistent with the domestic law of the 28 Member States, the EU could eventually unintentionally create even more disparities because Member States were not able to implement the Directives in the proper manner.

In this respect, the objectives of the EC and the CEA are consistent with the objectives of the OECD BEPS recommendations.4647_{However, the OECD adds an objective of which it may be called odd that}

the EU does not pay attention to it at all. This is the prevention of double taxation situations. Where disparities between national tax systems create loopholes which, if exploited, could lead to non-taxation outcomes, this same disparities could very well lead to double non-taxation outcomes. The OECD,

OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, pp. 53.

functioning of the internal market, 2016/0011 of 28 January 2016, COM(2016) 26 final, pp. 3.

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- 23 - in its OECD BEPS Report on Action 2, mentions explicitly that these situations should be tackled with the same care as situations where non-taxation occurs.

In both the approach of the EC and the ATAD, this outcome is not discussed and therefore it is unknown how Member States should act if double taxation occurs with regard to hybrid entities. In relations strictly within the EU, these double taxation situations would not occur because of the bilateral relations between the Member States. However, ATAD II introduces anti-hybrid mismatch measures, also, for third country situations. For these relations, double taxation is not unthinkable. Still, this thesis sees on approaches with which the European Union is trying to fight the, for

governments negative, outcomes that result of hybrid entity arrangements. Therefore for validating whether a standalone assessment of the approach against the taxation principles yields the right conclusions, the following objectives of an approach are determined:

1. Mitigating the use of hybrid entities for the purpose of lowering a groups’ taxable amount; 2. Consistency with the existing national tax systems of the Member States.

The above constitutes to an objective test, which is assessing the approach against the taxation principles, and a subjective test, which is evaluating whether the expected outcome of an approach is consistent with its objectives.

4.3. Earlier Taxation Frameworks

In the past, both the UN and the OECD endorsed taxation principles of which those organizations suggest they should apply to certain legislation to ensure that taxation is fair as well as prevents unintended non-taxation.

During the Ottawa Ministerial Conference, in 1998, which the OECD hosted, taxation principles for e-commerce were endorsed. These principles are meant to ensure that taxable bases of states which are affected by e-commerce are fairly shared.48_{Nowadays, the principles designed during this Conference}

are widely accepted taxation principles.49_{Also, both e-commerce and the services underlying the}

payments made by and to hybrid entities, i.e. interest, royalties etc., are immaterial by nature and these payments can be executed independently and remotely from the state of residence of the payer’s- or recipient’s (hybrid) entity. Therefore these principles could be suitable for establishing the

framework for assessing anti-hybrid entity measures.

For the purpose of assessing legislation in the field of e-commerce, the Ottawa principles require taxation to be:50

 Neutral: Taxation must be neutral and equitable between different forms of commerce. Business decisions must not be motivated by tax considerations;

 Efficient: Compliance cost must be minimized as far as possible;

 Certain and simple: Taxpayers must be able to anticipate the tax consequences of their actions in advance. Therefore, tax rules must be simple and clear.

 Effective and fair: Tax rules must result in the right amount of tax at the right time. The potential for tax evasion and tax avoidance must be minimized while keeping countermeasures proportionate to the risks involved.

 Flexible: Tax rules must be flexible so that they can keep pace with future developments.

48_{OECD (2015), Addressing the Tax Challenges of the Digital Economy, Action 1 - 2015 Final Report, OECD/G20}

Base Erosion and Profit Shifting Project, OECD Publishing, Paris.

49_{Sixdorf, F., Leitch, S., 2017. Taxation of Technical Services under the New Article 12A of the UN Model –}

Improved Taxation or a Step in the Wrong Direction? European Taxation, June 2017.

50_{OECD (2015), Addressing the Tax Challenges of the Digital Economy, Action 1 - 2015 Final Report, OECD/G20}

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- 24 - The above principles are a good starting point for the framework used for assessing anti-hybrid

mismatch measures. Also, these principles were previously used to assess the allocation of taxing rights with regard to services, in specific article 12A of the UN Model (2017).51_{In that respect, similar}

taxation principles were used.

Because of the widely agreed upon consensus on using these principles for other purposes than solely assessing e-commerce legislation, this thesis uses them for assessing anti-hybrid mismatch measures. Of course, the manner of interpreting these principles should be altered with the context of assessed measures in mind.

4.4. Translation to hybrid entities

As stipulated, the above mentioned principles were applied to the taxation of e-commerce and the taxation of services. Even though there are clear similarities between the taxation of the latter two subjects and the taxation of payments made or received by hybrid entities, assessing these payments in relation with hybrid entities needs a slightly altered framework.

For this purpose of assessing anti-hybrid entity measures, not only the effective taxation in both the source’s- and the recipient’s state of the payment has to be assessed but also, more importantly, the effectiveness in mitigating the benefits which can be obtained by using hybrid entity arrangements. Below the Taxation Framework for assessing anti-hybrid entity measures is given. Following the principles provided for in this Framework, a slightly different explanation on the choice of description of each principle, bearing the previous frameworks in mind, is given.

The latter principles are largely consistent with the taxation principles in the OECD Framework.

51_{Sixdorf, F., Leitch, S., 2017. Taxation of Technical Services under the New Article 12A of the UN Model –}

Improved Taxation or a Step in the Wrong Direction? European Taxation, June 2017. pp. 239. Taxation Framework - Hybrid entity mismatches

1. Neutrality

Taxation should seek to be neutral. It should not discriminate between nationalities or places of

establishment. The considerations underlying business decisions should be economic rather than based on tax considerations. Taxpayers in similar conditions should be subject to similar levels of taxation.

2. Efficiency The administrative costs for tax authorities and compliance _{costs for taxpayers should be minimized.}

3. Certainty and simplicity

In order to have certainty about the tax consequences of a certain transaction in advance, the tax rules should be stated in a clear and simple manner. This includes how, when and where the tax is to be accounted.

4. Effectiveness and fairness

Tax rules should be designed such that they produce the right amount of taxation at the right time. By doing that, the potential for tax evasion and tax avoidance should be minimized while acting on those threats with reasonable counteract.

5. Flexibility

The tax rules should be able to ensure proper taxation when the commercial and legal landscape changes. It has to be able to react upon new tax evasion and tax avoidance threats.

6. Transparency

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- 25 - Neutrality

For legislation to be neutral, it should not discriminate. Who to or what to discriminate is dependent on the situation on hand. It can therefore also regarded to as an equitable distribution of taxation. With regard to hybrid entities, this can be specified to the nationality of a hybrid entity or the place of establishment of a hybrid entity. This differentiates from the OECD Taxation Framework because there they look at different forms of commerce and how taxable rights are allocated between states in the case of e-commerce. For hybrid entities it could be said that the place of establishment is a given. Therefore the Taxation Framework for hybrid entities with regard to neutrality should look at whether the hybrid entity is not discriminated due to its place of establishment or nationality.

Efficiency

When looking at efficiency, often only the compliance costs of taxpayers are discussed when introducing new legislation. In this respect, given the international nature of hybrid entities, it is crucial that not only the compliance costs are minimized but also the administrative costs of states for executing the anti-hybrid mismatch measures in kept in mind. If the administrative costs are too high, the states executing the provisions could not be incentivized because the benefits do not outweigh the costs. In the OECD Taxation Framework only the costs for taxpayers are considered. Because of the above reasons, it is relevant to consider the costs for the tax authorities as well.

Certainty and simplicity

In cross-border trade, the interests are usually significant. Not knowing what tax consequences a certain transaction is a serious barrier. Therefore, certainty and simplicity are key for taxation to be effective. Certainty can be obtained by both simplicity and the possibility for a taxpayer to consult with tax authorities before a transaction is undertaken. This principle is consistent with the OECD Taxation Framework.

Effectiveness and fairness

Effective in this respect means the right amount of tax at the right time. In achieving this objective, legislation should be designed in such way that is specifically suitable for and only applies on the object or subject it was designed for. Also, it should be proportionate. When taxation is not perceived as proportionate and, therefore, fair it will incentivize taxpayers to avoid or even evade taxation. This principle is consistent with the OECD Taxation Framework.

Flexibility

In the current era, the landscape is changing rapidly. For taxation to be sustainable and effective over time, it should be flexible. Economies and legal systems will change to adjust to new developments. Tax systems should as well. In this respect this means that the anti-hybrid mismatches measures should be robust to e.g. new legal entities, other forms of payments etc., to ensure proper taxation. This differentiates from the OECD Taxation Framework because for the latter framework primarily focuses on how commercial transactions change due to digitalisation. With regard to hybrid entities, flexibility encompasses a broader spectrum of elements subject to change.

Transparency

Assessing the effectivity of proposed and adopted anti-hybrid entity measures within the EU