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Budget 2020: Hybrid rules


In the Spring Budget the government announced that it would publish a consultation on the UK's "hybrids" anti-avoidance regime. The consultation was published on 19 March 2020 and looks at three particular areas which have caused real difficulties for investment funds.

The OECD's Profit Shifting and Base Erosion Project (BEPS) recommended in its 2015 final reports that countries take steps to neutralise the effects of hybrids mismatch arrangements. The UK wholeheartedly embraced the proposals and was an early adopter, introducing its domestic regime in 2017 and even "gold plating" certain provisions such that they go further than the BEPS proposals.  By contrast, under the equivalent EU rules member states only had to introduce hybrid rules in two main phases, one from January 2019 and the other from January 2020, and the EU mandated rules are narrower than the UK regime.

It was not clear from the Budget what the scope of the consultation would be and it is therefore welcome that its focus is on situations where the rules are currently giving rise to real difficulties for taxpayers but where it is hard to see any good policy reason for them doing so.  Under the consultation the government is seeking views on three areas.

The first of these is the provisions relating to double deduction mismatches (essentially, situations where there are two tax deductions for the same payment). In particular, a technical flaw with the rules has led to UK taxpayers not being able to claim tax deductions in some common benign situations, typically involving supplies between a UK service provider which has been subject to a "check the box" election for US tax purposes and a related overseas customer.

The second of these is the wide definition in the regime of when parties are considered to "act together" in relation to another person.  This definition is important because it increases the situations in which the rules will apply. The reason for this is that when parties act together in relation to another person, broadly, the aggregate rights and interests those parties have in the other person are attributed to each other, so that their holdings in that other person are more likely to satisfy the regime's size thresholds.

The third of these areas is the application of the rules relating to "deduction/non-inclusion" outcomes (essentially, situations where a party gets a tax deduction for a payment but the recipient is not taxed on receipt) where the recipient of the payment is a hybrid entity and the ultimate owner is exempt from tax. At the moment this is leading to a denial of a tax deduction in benign situations and causing real problems in common structures involving, for example, pension funds.

As the consultation is focussing on reducing the situations where the regime is either unclear or too wide, rather than increasing its scope, it is a promising first step. However, the issues raised in the consultation document are not the only ones which have been giving rise to real issues for businesses and it is a little disappointing that some other difficulties with the regime, of which we understand HMRC are aware, are not being addressed. For example, in certain situations the regime does not apply where, broadly, it is reasonable to suppose that no equivalent non-UK rule will apply. As EU jurisdictions have had to implement their own hybrids regime from January this year, taxpayers and their advisors have recently been particularly interested in getting clarity as to how to understand the references to equivalence in the UK rules, and it is unfortunate that this issue is not addressed. That being said, the consultation is certainly good news and if it ultimately results in a more proportionate hybrids regime, this would only increase the UK's competitiveness as an asset management hub and would, accordingly, be very welcome.

The closing date for comments on the consultation is 29 May 2020.


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