COMMISSION STAFF WORKING DOCUMENT Accompanying the document Proposal for a Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries
Date: 2016-10-25
Institutions: Directorate-General for Taxation and Customs Union, European Commission
Subjects: EU Member State, corporation tax, tax avoidance, tax collection, tax harmonisation, tax law, third country

EN 

   EN 

   EUROPEAN COMMISSION  Strasbourg, 25.10.2016  SWD(2016) 345 final   COMMISSION STAFF WORKING DOCUMENT Accompanying the document Proposal for a Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries {COM(2016) 687 final}  
 
 
Introduction 

The taxation of multinational companies has come under scrutiny by tax administrations, 
tax  experts  and  the  general  public  in  recent  years.  Some  companies  use  aggressive  tax 
planning techniques to exploit loopholes in tax systems and mismatches between national 
rules  to  reduce  their  tax  liabilities.  These  activities  undermine  the  fair  burden  sharing 
amongst  taxpayers  and  fair  competition  between  businesses.  The  economic  crisis  of 
recent  years  requires  contributions  to  the  consolidation  of  public  finances  from  all 
taxpayers. Following the crisis and the increased revenue needs, the OECD, endorsed by 
the  G20,  launched  the  Base  Erosion  and  Profit  Shifting  (BEPS)  project  that  came  to 
completion in October 20151.  

The European Union fully supports the OECD/G20 BEPS conclusions. As it is essential 
for  the  EU  that  Member  States  implement  the  OECD/G20  BEPS  outcomes  in  a 
coordinated  way,  the  Commission  tabled  a  proposal  for  an  Anti-  Tax  Avoidance 
Directive on 28 January 20162. The ECOFIN Council reached a political agreement on 
the Anti-Tax Avoidance Directive on 20 June 2016. 

The Anti- Tax Avoidance Directive3 lays down rules against tax avoidance practices that 
directly affect the functioning of the internal market. The Anti-Tax Avoidance Directive 
responds  to  the  BEPS  project  as  well  as  to  demands  from  the  European  Parliament, 
several Member States, businesses and civil society, and certain international partners for 
a  stronger  and  more  coherent  EU  approach  against  corporate  tax  abuse.  The  schemes 
targeted  by  the  Anti-Tax  Avoidance  Directive  involve  situations  where  taxpayers  act 
against the actual purpose of the law, taking advantage of disparities between national tax 
systems, in order to reduce their tax bill. 

The  use  of  hybrid  mismatch  arrangements  is  a  widespread  aggressive  tax  planning 
technique which results in  a substantial  erosion of the taxable bases of Member States. 
The OECD has addressed hybrid mismatch arrangements in its report on Action item 2 
'Neutralising  the  Effects  of  Hybrid  Mismatch  Arrangements'  (hereinafter:  the  OECD 
report).  The  Anti-Tax  Avoidance  Directive  also  contains  rules  to  address  these 
arrangements. The hybrid mismatch rules in the Anti-Tax Avoidance Directive cover the 
most  common  forms  of  hybrid  mismatches,  namely  hybrid  entity  and  hybrid  financial 
instrument mismatches, but only within the EU. 

However,  taxpayers  in  the  EU  engaged  in  cross-border  structures  involving  third 
countries also take advantage of hybrid mismatches to reduce their overall tax liability in 
the EU.  

Political context 

It  is  widely  recognised  that  hybrid  mismatches  involving  third  countries  should  be 
countered as well. Therefore, as part of the final compromise on the Anti-Tax Avoidance 
Directive that was reached on 20 June 2016, the ECOFIN Council issued a statement on 
hybrid mismatches. In this statement the ECOFIN Council requested the Commission "to 
put forward by October 2016 a proposal on hybrid mismatches involving third countries 
in  order  to  provide  for  rules  consistent  with  and  no  less  effective  than  the  rules 

1 http://www.oecd.org/tax/beps/ 
2 COM(2016) 26 
3 Council Directive (EU) 2016/1164, OJ L 193/1. 

2 

 
 
                                                 
recommended  by  the  OECD  BEPS  report  on  Action  2,  with  a  view  to  reaching  an 
agreement by the end of 2016." 

In order to provide for a comprehensive framework consistent with and no less effective 
than  the  rules  recommended  by  the  OECD,  this  proposal  for  a  Directive  also  includes 
rules  on  hybrid  permanent  establishment  mismatches,  imported  mismatches,  so-called 
hybrid transfers and dual resident mismatches. 

Related policy initiatives 

Code of Conduct 

The Code of Conduct for Business Taxation was set up in  1998 to address harmful tax 
competition within the EU. In 2009, the Code Group started examining anti-abuse issues 
related to hybrid mismatches. It first concentrated its work on hybrid entities and hybrid 
permanent  establishments  (PEs).  Guidance  on  hybrid  entities  mismatches  between 
Member  States  was  agreed  in  December  2014,  on  the  basis  of  the  fixed  alignment 
approach.  It  would  compel  Member  States  to  change  their  qualification  of  the  hybrid 
entity  from  transparent  to  non-transparent  in  double  deduction  situations,  or  from  non-
transparent to transparent in deduction/no inclusion cases. Guidance was agreed in June 
2015  for  hybrid  PEs,  and  in  December  2015  for  hybrid  entities  in  situations  involving 
third  countries.  In  January  2016  guidance  was  agreed  for  hybrid  PEs  in  situations 
involving third countries. 

Although  the  rules  in  the  guidance  as  agreed  by  the  Code  Group  do  not  entirely 
correspond  to  the  rules  in  the  Anti-Tax  Avoidance  Directive  and  the  rules  in  this 
proposal, it should be noted that the intended result is the same: to neutralise the effect of 
hybrid  mismatches  without  a  complete  re-characterisation  of  the  entity,  instrument  or 
commercial presence involved. 

European Parliament 

The  European  Parliament  has  been  closely  examining  the  issue  of  tax  avoidance,  in 
particular  through  the  Economic  and  Monetary  Affairs  (ECON)  Committee,  the  Tax 
Rulings  and  Other  Measures  Similar  in  Nature  or  Effect  (TAXE)  Committee  and  the 
Committee of Inquiry to investigate alleged contraventions and maladministration in the 
application of Union law in relation to money laundering, tax avoidance and tax evasion 
(PANA). 

There  is  a  clear  message  from  the  European  Parliament  that  tax  avoidance  needs  to  be 
addressed,  also  by  closing  down  hybrid  mismatches  arrangements.  In  the  legislative 
resolution on the Anti-Tax Avoidance Directive of 8 June 2016 the European Parliament 
adopted  amendments  extending  the  rules  on  hybrid  mismatch  arrangements  to  hybrid 
mismatch situations involving third countries. 

Fiscal State aid 

Some of the tax planning structures that have been investigated by the Commission in the 
context of State aid control involve hybrid mismatch arrangements. These structures are 
put  in  place  by  multinational  enterprises  (MNEs)  which  are  able  to  set  up  legal  or 
commercial offices in multiple countries to facilitate their cross-border operations. Those 
opportunities  are  not  available  to  small  and  medium-sized  enterprises  (SMEs)  whose 
businesses are generally limited to the domestic market.  

3 

 
MNEs can set up hybrid mismatch structures, such as a hybrid permanent establishment 
in a third state or a reverse hybrid entity in a Member State, to reduce their taxable base 
in the Member States involved. Hybrid mismatch arrangements can lead to considerable 
amounts of revenue loss by Member States, involving tens of millions of euros.  

Annex 1 includes three simplified figures of hybrid mismatch structures. These kinds of 
hybrid  mismatch  structures  have  also  been  identified  in  the  OECD  report  and  will  be 
addressed by this proposal. 

Consultations 

Hybrid  mismatches  have  been  subject  to  extensive  consultations.  The  rules  on  hybrid 
mismatches  build  on  the  outcomes  of  the  OECD/G20  BEPS  project,  the  discussions  in 
the Code of Conduct Group and, in particular, the discussions during the working parties 
on the Anti-Tax Avoidance Directive. 

Position of Member States 

During the working parties on the Anti-Tax Avoidance Directive several draft proposals 
on  hybrid  mismatches,  including  those  involving  third  countries,  were  tabled  by  the 
Presidency  and  other  Member  States  respectively.  These  proposals  were  examined,  but 
given the complexity of the issue it turned out that there was not enough time to reach a 
conclusive  outcome.  However,  as  demonstrated  by  the  statement  of  the  ECOFIN 
Council, it is clear that there is a strong demand by the Member States to address those 
hybrid mismatch situations that are not yet covered by the Anti-Tax Avoidance Directive. 

The  elements  of  this  proposal  have  been  discussed  with  Member  States'  delegations  at 
the  Working  Party  IV  meeting  of  26  July  2016.  It  has  become  apparent  that  there  is  a 
clear preference among a large majority of Member States to address the various kinds of 
hybrid  mismatch  arrangements  that  are  now  covered  by  the  proposal.  Five  Member 
States  have  provided  input  in  writing  to  assist  with  the  drafting  of  the  proposal  for  a 
Directive. 

Other consultations 

The  works  on  the  action  items,  including  Action  item  2  'Neutralising  the  Effects  of 
Hybrid  Mismatch  Arrangements',  of  the  BEPS  project  have  been  very  inclusive,  with 
public  consultations  and  the  release  of  discussion  drafts  and  working  documents.  Most 
Member States have been involved in the technical discussions on Action item 2 of the 
BEPS project. The OECD has invited interest parties to comment of the Discussion draft 
on Neutralising the Effects of Hybrid Mismatch Arrangements related to Action 2 of the 
BEPS  Action  Plan  released  on  19  March  2014.  A  Public  Consultation  was  held  on  15 
May 2014. The OECD received 70 public comments from various parties adding up to 
463  pages  in  total.  Most  public  comments  were  received  from  businesses,  business 
organisations and tax advisors, but NGOs and an academic have provided comments as 
well. Most respondents support, or appreciate, the intention to address hybrid mismatch 
arrangements. The public comments received mainly focus on the technical aspects of the 
rules in the discussion drafts. The public comments can be found on the OECD's website: 

http://www.oecd.org/tax/aggressive/comments-action-2-hybrid-mismatch-
arrangements.pdf. 

4 

 
Finally, the elements of this proposal for a Directive were presented in broad terms and 
discussed  with  business  and  non-governmental  organisations'  representatives  at  the 
meeting  of  the  Platform  for  Tax  Good  Governance  on  16  September  2016.  Many 
representatives  supported  the  approach  to  have  a  comprehensive  proposal  on  hybrids 
consistent with the OECD report. 

Rationale 

The  existence  of  profit  shifting  and  base  eroding  practises  is  demonstrated  in  many 
studies.4  Although  the  extent  of  these  practices  and  its  impact  on  total  tax  revenues  is 
hard  to  measure,  it  might  be  considerable.  However,  tax  planning  schemes  are  often 
complex  and  might  involve  several  combined  tax  planning  tools.  According  to  the 
OECD5  the  effective  tax  rates  (ETR)  of  MNEs  affiliates  are  on  average  2.5  to  5 
percentage points lower compared to non-MNE entities with similar characteristics. This 
could  be  partially  attributable  to  the  fact that MNEs  can  take  advantage  of  mismatches 
between  tax  systems  whereas  non-MNEs  are  not  able  to  do  so.  Several  OECD  reports 
have identified hybrid mismatch arrangements as playing a major role in aggressive tax 
planning  and  highlighted  the  negative  impact  of  such  arrangements  on  tax  revenues  as 
well as competition, transparency and fairness  

Problems addressed 

The  OECD  report  focuses  on  three  possible  outcomes  under  a  hybrid  mismatch 
arrangement:  a  deduction/no  inclusion  outcome  (D/NI  outcome),  a  double  deduction 
outcome  (DD  outcome)  or  an  indirect  D/NI  outcome.  The  Public  Discussion  Draft  on 
Branch  Mismatch  Structures  released  on  22  August  2016  also  focuses  on  non-taxation 
without inclusion. 

A great number of hybrid mismatch arrangements exploit differences in the tax treatment 
of  an  entity  or  instrument  under  the  laws  of  two  or  more  tax  jurisdictions  to  achieve 
double  non-taxation.  The  OECD  has  included  80  examples  of  hybrid  entity  and  hybrid 
financial instrument mismatches in its report. The OECD report also deals with so-called 
imported  mismatches  and  hybrid  transfers.  Imported  mismatches  shift  the  effect  of  a 
hybrid  mismatch  between  parties  in  third  countries  into  the  jurisdiction  of  a  Member 
State  through  the  use  of  a  non-hybrid  instrument.  Hybrid  transfers  are  arrangements  to 
transfer a financial instrument where the laws of two jurisdictions differ on whether the 
transferor  or  the  transferee  has  got  the  ownership  of  the  payments  on  the  underlying 
asset.  Furthermore,  the  OECD  report  deals  with  dual  resident  mismatches,  although 
strictly speaking they do not involve a hybrid entity or a hybrid financial instrument. The 
Public  Discussion  Draft  on  Branch  Mismatch  Structures  includes  several  examples  of 
hybrid permanent establishment mismatches. 

The  study  on  Structures  of  Aggressive  Tax  Planning  and  Indicators6  (hereinafter  the 
"ATP  Study"),  whose  results  were  published  in  January  2016,  has  identified  seven 
structures that are most commonly used by MNEs that engage in aggressive tax planning. 

4 See also COM (2016) 23, p. 6. 
5 OECD (2015), Measuring and Monitoring BEPS, Action 11 - 2015 Final Report, p. 58-60, 101, 
OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris. 
6 Ramboll Management Consulting and Corit Advisory (2016), Study on Structures of Aggressive Tax 
Planning and Indicators, European Commission Taxation Paper, 61. 

5 

 
                                                 
Annex 2 includes two aggressive tax planning structures identified in the ATP Study that 
involve  a  hybrid  entity  and  a  hybrid  loan  structure,  both  resulting  in  a  D/NI  outcome. 
These structures will be addressed by this proposal as well. 

The  ATP  study  also  revealed  that  the  lack  of  anti-abuse  rules  is  striking  in  the  area  of 
hybrid  entities.  Twenty-five  Member  States7  have  been  identified  as  having  no  rule  to 
counter  mismatches  in  the  qualification  of  a  local  partnership  or  company  by  another 
state. In eighteen Member States, the tax qualification of a foreign partnership does not 
follow  the  qualification  of  the  other  state.  The  lack  of  anti-abuse  rules  to  counter 
mismatches in hybrid financial instruments is also identified by the study as an important 
factor in the ability of MNEs to set up ATP structures. More countries have rules in place 
to counter mismatches in hybrid financial instruments than in hybrid entities. 

Approach chosen 

The hybrid mismatch rules in the Anti-Tax Avoidance Directive are based on the OECD 
approach in the sense that they neutralise the effect of a hybrid mismatch. This proposal 
is  based  on  the  same  approach.  Like  the  Anti-Tax  Avoidance  Directive  this  proposal 
applies to all taxpayers which are subject to corporate tax in a Member State. The aim is 
to capture all hybrid mismatch arrangements where at least one of the parties involved is 
a corporate taxpayer in a Member State. 

Objectives 

This proposal is intended to address mismatch situations attributable to differences in the 
legal  characterisation  of  an  entity  or  a  financial  instrument.  Furthermore,  this  proposal 
addresses  mismatch  situations  as  a  result  of  different  rules  on  the  treatment  of  a 
commercial  presence  as  a  permanent  establishment.  Under  the  rules  of  this  proposal 
Member States will have the obligation to deny the deduction of a payment by a taxpayer 
or to require the taxpayer to include a payment or a profit in its taxable income, as the 
case may be. 

Features 

The proposal for a Directive addresses the following hybrid mismatch arrangements that 
were not covered by the Anti-Tax Avoidance Directive: 

  a hybrid entity mismatch involving a third country leading to a double deduction; 

  a hybrid entity mismatch involving a third country leading to a deduction without 

an inclusion. 

  a  hybrid  financial  instrument  mismatch  involving  a  third  country  leading  to  a 

deduction without an inclusion; 

  a  hybrid  permanent  establishment  mismatch,  both  between  Member  States  and 

between a Member State and a third country, leading to a double deduction; 

7 At the time the survey was conducted. 

6 

 
                                                 
  a  hybrid  permanent  establishment  mismatch,  both  between  Member  States  and 
between a Member State and  a third country,  leading to  a deduction  without  an 
inclusion; 

  a  hybrid  permanent  establishment  mismatch,  both  between  Member  States  and 
between  a  Member  State  and  a  third  country,  leading  to  non-taxation  without 
inclusion; 

  a hybrid transfer, both between Member States and between a Member State and 
a third country, where the return on a financial instrument is regarded as derived 
simultaneously by two jurisdictions, leading to a deduction without an inclusion 8; 

  a hybrid transfer, both between Member States and between a Member State and 
a third country, where the return on a financial instrument is regarded as derived 
simultaneously by two jurisdictions, leading to a double tax credit 9; 

  an imported mismatch where a double deduction is imported by a Member State 

through a non-hybrid instrument; 

  an  imported  mismatch  where  a  deduction  without  an  inclusion  is  imported  by a 

Member State through a non-hybrid instrument; 

  a dual resident mismatch between a Member State and a third country leading to a 

double deduction. 

This  proposal  carefully  pursues  the  hybrid  mismatch  arrangements  identified  in  the 
OECD report. However, it is not intended to affect the general features of the tax system 
of a jurisdiction but only mismatches as a result of conflicting tax rules between two or 
more jurisdictions. Therefore, the proposal does not address situations in which little or 
no tax has been paid due to a low tax rate or the tax system of a jurisdiction. 

Impacts 

Implementation  of  the  proposal  for  a  Directive  would  deprive  MNEs  of  a  widespread 
aggressive  tax  planning  technique.  Therefore,  it  can  be  expected  that  the  corporate 
income tax (CIT) bases in Member States will increase. This would have a positive effect 
on CIT revenues.  Nevertheless, as  also  stated  by the OECD10, an economic analysis of 
hybrid mismatch arrangements requires detailed company-level data. It requires not only 
information on transactions between associated enterprises but also on the tax treatment 
of those transactions in the various jurisdictions involved. This kind of data can hardly be 
found in public sources. Those data would only become available if tax administrations 
were  to  make  extra  efforts  to  identify  hybrid  mismatch  arrangements,  including 
requesting additional information from taxpayers. 

Moreover, it might be difficult to measure those fiscal effects as revenues would not be 
expected to come from disallowed deductions or disallowed exemptions under the hybrid 
mismatch  rules  themselves.  Revenues  would  rather  come  from  MNEs  dismantling 
structures that were intended to exploit mismatches; MNEs would thus no longer claim 
deductions or benefit from exempt income arising under a hybrid mismatch scheme. 

8 For example through a sale and repurchase agreement (repo). 
9 For example through a securities lending agreement. 
10 OECD (2015), o.c., p. 224-225. 

7 

 
                                                 
References 
European  Commission  (2016)  Commission  Staff  Working  Document  of  28.1.2016 
Communication  from  the  Commission  to  the  European  Parliament  and  the  Council  – 
Anti  Tax  Avoidance  Package:  Next  Steps  towards  delivering  effective  taxation  and 
greater tax transparency in the EU {COM(2016) 23 final} 

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. 

OECD  (2016),  Discussion  draft  on  branch  mismatch  structures  under  Action  2  of  the 
BEPS  Action  Plan,  OECD/G20  Base  Erosion  and  Profit  Shifting  Project,  OECD 
Publishing, Paris. 

OECD  (2015),  Measuring  and  Monitoring  BEPS,  Action  11  -  2015  Final  Report, 
OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris. 

Ramboll  Management  Consulting  and  Corit  Advisory  (2016),  Study  on  Structures  of 
Aggressive Tax Planning and Indicators, European Commission Taxation Paper, 61. 

8 

 
 
 
Annex I 

Hybrid mismatch structures  

9 

Hybrid entity deduction without inclusionA Co I is transparent in the MS, but regarded as non-transparent by the third state(reverse hybrid entity).Royalty payment to a reverse hybrid entityin the MS (A Co I).Payment deducted by A Co II.Neither included by A Co I nor by B Co.A Co IIA Co IB CoRoyaltypayment0-0Third stateMSHybrid entity deduction without inclusion IIC Co is a taxpayer in MS II.B LP is transparent in MS I, so no taxpayer.B LP is regarded as non-transparentby Third State.Royalty payment deducted by C Co,neither included by B LP nor A Co.Both B LP and A Co are associated enterprisesof the taxpayer (which is C Co).Deduction without inclusion between MS IIand 3rdState.No mismatch between MS I and MS II.Mismatch between MS I  and Third State is out of scope because B LP is not a taxpayer. •C CoB LPA CoRoyaltypayment0-0Third State MS IMS II 
 
 
 
 
 
10 

Reverse hybrid permanent establishment:no taxation without inclusionReverse hybrid PE in a Third State:Third State does not see a PE.MS recognisesPE in Third State(reverse hybrid PE).Profits attributed to reversehybrid PE are exempt in MS.No taxation without inclusionas a result of a hybrid PE mismatch.Hybrid      PEA Co00MS Third State 
 
Annex 2  

Hybrid mismatch cases in the Aggressive Tax Planning Study 

Hybrid loan ATP structure  

(based 
identified 
report)  

on 

a  model 
in  an  OECD 

The structure takes advantage of the hybrid mismatch in 
qualification of a financing instrument. It benefits from a 
deduction of the payment in one MS (e.g. as interest) in 
combination  with  no  inclusion  in  another  MS  (e.g.  as 
tax-free dividend). By inserting an intermediate company 
resident  in  a  third  country,  this  structure  still  allows  to 
benefit from a hybrid mismatch.  

Structure 1 - Hybrid loan ATP structure  

This ATP structure is a variation of an example presented in the OECD BEPS reports.11 
The  publicly  available  literature  identified  that  addresses  this  structure  includes 
“Neutralising the Effects of Hybrid Mismatch Arrangements”, pp. 33-34 (OECD, Action 
2: 2014 Deliverable). This structure describes a debt-shifting ATP channel. 

The  ATP  structure  takes  into  account  the  revision  of  the  Parent/Subsidiary  Directive.12 
This  ATP  structure  takes  advantage  of  the  hybrid  mismatch  in  the  qualification  of  a 
financing  instrument.  Accordingly,  the  ATP  structure  benefits  from  a  deduction  of  the 
payment in  one MS (e.g. as interest) in combination with no inclusion in the other MS 
(e.g.  as  a  tax-free  dividend).  By  inserting  an  intermediate  company  resident  in  a  third 
country, this structure could still allow benefiting from a hybrid mismatch.  

Introduction  

The ATP structure is established in connection with a multinational group’s acquisition 
of an operating  company in  MS C,  but  it is  worth  observing that  in  many situations, it 
could  also  have  been  established  in  an  existing  MNE  group  outside  the  context  of  an 
acquisition. 

The  structure  assumes  that  the  MNE  group,  a  multinational  parent  company 
headquartered in MS A, has agreed to acquire a profitable operating company, Target Co, 
resident in MS C. The purchase price is EUR 1,000 million. EUR 400 million is funded 
by means of funds that the MNE group already has available to it, whereas the remaining 
EUR 600 million has to be borrowed from an external bank on normal market terms. The 
structure has two tax objectives13: 

11 Two variations have been devised:  
(i) In the OECD example, MNE Group lends the funds to L Holdco. The authors of the study consider it an 
unnecessary  complication  that  would  limit  the  practical  use  of  the  structure  to  circumstances  where  the 
MNE group had other taxable income in Member State L and tax-deductible costs in Member State P. In 
practice, it would be simpler and more flexible for the funds to be transferred to L Holdco as share capital.  
(ii) The reference to MS L by state B (for Holding) has been replaced. MS L could erroneously be taken to 
mean Luxembourg.  
12 Council Directive 2014/86/EU of 8 July 2014 amending Directive 2011/96/EU on the common system of 
taxation applicable in the case of parent companies and subsidiaries of different Member States. 
13 In addition to tax objectives, business objectives often play a significant role. 

11 

 
 
 
                                                 
Firstly,  it  aims  to  obtain  tax  relief  in  MS  C  for  the  external  financing  costs  of  the 
acquisition. This  objective  should  not  in  itself  generally  be  considered aggressive, as  it 
normally just seeks to align the location of the tax deduction for the external financing 
costs with the location of the taxation of the profits of the acquired company. Therefore, 
it does not lead to any undue tax benefit for the MNE group.14 

Secondly,  the  structure  aims  to  obtain  additional  tax  relief  for  internal  (artificially 
created)  financing  costs  which  do  not  reflect  any  external  financing  costs  of  the  MNE 
group.  This  is  achieved  by  means  of  a  hybrid  loan  that  produces  an  additional  tax 
deduction  for  interest  in  the  hands  of  the  borrower  company  in  MS  C,  but  triggers  no 
taxation of the corresponding income in the hands of any other member company of the 
MNE group (nor by any external lender). Clearly, given the exploitation of a mismatch in 
tax  treatment  as  well  as  the  artificial  nature  of  the  hybrid  loan,  this  is  the  element  that 
makes it an ATP structure. 

The mechanisms of the structure  

The ATP structure is established by means of the following transactions:  

(1) A holding company, B Holdco, is established in State B – a state outside of the 
EU  –  as  a  wholly-owned  subsidiary  of  the  MNE  group.  The  MNE  group 
subscribes to a share capital in B Holdco of EUR 400 million.  

(2) A  holding  company,  C  Holdco,  is  established  in  MS  C  as  a  wholly-owned 
subsidiary of B Holdco. B Holdco subscribes only to a nominal (minimal) share 
capital in C Holdco. In addition, C Holdco takes out a loan from B Holdco in the 
amount  of  EUR  400  million.  The  loan  is  structured  on  such  hybrid  terms  and 
conditions15  that  for  local  tax  purposes,  State  B  qualifies  the  loan  as  an 
investment in shares whereas MS C qualifies it as debt. As a result, MS C allows 
a tax deduction for the interest accrued (or paid); whereas State B does not tax the 
interest  received  but  instead  treats  it  as  a  tax-exempt  dividend  from  a 
shareholding.  

(3) C Holdco takes out an interest-bearing loan from an external bank in the amount 
of EUR 600 million. The loan is obtained on normal market terms and conditions, 
backed by a guarantee issued by the MNE group. C Holdco pays a guarantee fee 
to MNE Group.  

(4) C Holdco enters into a share purchase agreement with the sellers of the shares in 

Target Co and pays the purchase price of EUR 1,000 million.  

(5) Interest on the bank loan is accrued and paid. C Holdco claims a tax deduction in 
MS  C  for  the  interest  accrued/paid.  (The  external  bank  is  taxed  on  the  interest 

14  In  practice,  variations  in  the  MS’s  tax  rules  such  as  different  tax  rates,  different  limitation  rules  on 
interest deductions, etc., can give rise to some tax benefits - or even tax disadvantages - for a MNE group. 
While such issues will normally have to be addressed by MNE groups when considering whether to push 
down debt into MS C, they are not considered core elements of ATP. 
15  Examples  of  such  terms  include  perpetuity,  super-long  maturity,  profit  participation,  optional  or 
mandatory conversion features etc.  

12 

 
                                                 
income under the normal tax rules of its home Member State16.) Also, C Holdco 
claims a tax deduction for the guarantee fee paid to MNE Group.  

(6) Interest  on  the  hybrid  loan  from  B  Holdco  is  accrued,  and  C  Holdco  claims  a 
local tax deduction in MS C for the interest as it accrues. B Holdco is not taxed 
on the interest income either in State B or in MS C.17 

(7) Since C Holdco is a pure holding company with no income-generating activities 
of  its  own,  the  utilization  of  its  tax  deductions  pertaining  to  the  interest  on  the 
bank loan and the hybrid loan has to be achieved by means of a local tax grouping 
(consolidation) with Target Co.18 Target Co is assumed to have sufficient taxable 
profits to shelter the interest deductions of C Holdco.  

(8) To the extent that C Holdco makes actual payment of the interest accruing to B 
Holdco on the hybrid loan, B Holdco would generate cash that could be used to 
pay a dividend to MNE Group. Such a dividend would not be taxable in the hands 
of  MNE  Group  under  MS  A’s  tax  rules,  nor  would  it  be  tax-deductible  to  B 
Holdco under State B’s tax rules. Moreover, it is assumed that State B does not 
levy any withholding tax on the dividend.  

The figure below illustrates the structure. 

16  To  keep  things  simple,  it  is  assumed  that  MS  C  does  not  levy  any  withholding  tax  on  the  interest 
payments. 
17  Again,  it  is  assumed  that  MS  C  does  not  levy  any  withholding  tax  on  the  payment  of  interest. 
Alternatively, a tax treaty between state B and MS C exempts the interest from MS C withholding tax.   
18 If a tax grouping is not possible in MS C, there are alternative arrangements for achieving similar results. 
These include a downstream  merger (C Holdco would merge into Target Co), and a reduction of capital 
(Target Co would declare a capital reduction payment to C Holdco and receive an interest-bearing loan in -
return).   

13 

 
 
 
 
 
                                                 
Step 1 

MNE  Group’s  equity  investment  in  B  Holdco  will  typically  not  trigger  any  direct  tax 
consequences  in  either  MS  A  or  State  B.  However,  there  can  be  an  indirect  tax 
consequence to MS A in that the funds might have generated taxable interest or similar 
return on investment before they were transferred to B Holdco. After their transfer to B 
Holdco, the investment return will normally only come back to MS A in the form of a 
tax-exempt  dividend.  The  tax  consequences  of  dividend  payments  are  discussed  in 
further detail below under Step 819. 

Step 2  

The  subsequent  use  of  the  proceeds  from  the  capital  increase  as  a  hybrid  loan  from  B 
Holdco to C Holdco would normally not directly trigger any tax consequences in State B 
or MS C upon issuance of the hybrid instrument. The tax consequences with respect to 
the yield are discussed below under Step 6.  

Step 3  

The  loan  obtained  by  C  Holdco  from  a  third-party  bank  would  typically  not  directly 
trigger any tax consequences in MS C upon issuance.  

Step 4  

The sale of shares by Seller will, as a main rule, be tax-exempt in many MS, assuming 
that the Seller has been the sole shareholder prior to the sale. The actual receipt of cash 
payment  by  the  Seller  should  not  trigger  any  tax  consequences.  The  acquisition  of  the 
shares by C Holdco would, as a main rule, not trigger any tax consequences in MS C.  

Step 5  

The yields on the third-party bank loan, in the form of interest payments, can be assumed 
to be deductible for tax purposes in most (if not all) MSs. This is a crucial feature in the 
overall  tax  benefits  of  leveraged  acquisitions.  A  number  of  MSs  have  introduced  tax 
rules to  restrict  interest deductions. Some  of these  rules apply  only to  interest  on inter-
company  loans,  but  that  can  include  external  loans  guaranteed  by  other  member 
companies of the group. Other rules (e.g. EBITA and EBIT rules) apply to the interest on 
all loans, including third-party debt.  

Step 6  

In the ATP structure set out above, the yield on the hybrid loan instrument will take the 
form  of  tax-deductible  interest  in  the  hands  of  C  Holdco  in  MS  C  and  tax-exempt 
dividends in State B in the hands of B Holdco. Such a mismatch can arise because the 
classification of hybrid instruments largely depends on domestic case law in each state. 
For example, a mismatch of tax qualification can arise if MS C treats the instrument in 
accordance with its legal form and maintains the debt classification, while State B views 
the  instrument  in  accordance  with  its  economic  substance  and  classifies  it  as  equity. 
Accordingly,  in  State  B  the  yield  constitutes  dividend,  which  falls  under  the  scope  of 
State B’s domestic-law participation exemption regime, i.e. it is tax-exempt. As another 

19 Some MSs impose capital duty or stamp duty with respect to capital increases (e.g. a flat amount plus a 
low percentage (e.g. 0.6%)) computed on the basis of the nominal value of the capital increase. Such taxes 
are rare and are therefore not taken into account here. 

14 

 
                                                 
example, the same result could be obtained via hybrid equity where State B maintains the 
legal  form  as  equity (certain  variations  of  preference  shares)  while  MS C  classifies the 
instrument in accordance with its economic substance as debt, and accordingly treats the 
yield as deductible interest payments.  

In this ATP structure, it is assumed that State B is not an MS and therefore is not affected 
by the change of the Parent/Subsidiary Directive20. 

If B Holdco is the beneficial owner of the yield of the hybrid instrument, the payment of 
the interest from C Holdco to B Holdco would normally not trigger any withholding tax 
on  the  interest  in  MS  C.  This  could  follow  either  from  an  applicable  double  tax  treaty 
between  State  B  and  MS  C,  or  from  the  fact  that  MS  C  does  not  levy  any  interest 
withholding tax under its domestic law. 

Step 7  

To  ensure  the  overall  economic  benefit  of  the  leveraged  acquisition  ATP  technique,  C 
Holdco  should  be  able  to  offset  the  deductible  interest  payments.  Being  a  holding 
company,  C  Holdco  is  unlikely  to  generate  taxable  income  on  a  stand-alone  basis. 
Therefore, the economic benefit is typically ensured by the application of domestic group 
taxation regimes  (also  referred to  as fiscal unity, tax grouping,  group  tax relief or  joint 
taxation)  through  which  the  interest  payments  in  C  Holdco  can  be  offset  against  the 
taxable operating profit of Target Co.  

Step 8  

A dividend payment to the MNE group would normally not trigger any tax consequences 
in  MS  A  due  to  the  existence  of  participation  exemption  type  legislation,  which  will 
effectively exempt the income from taxation. If a double tax treaty (based on the OECD 
Model Tax Convention) is in place between MS A and State B, Article 10 of the double 
tax treaty will normally result in 0% or 5% withholding tax in State B.) 

Absence of CFC taxation  

Finally, it should be noted that the ATP structure set out above assumes that MS A does 
not  apply  any  CFC  rules  to  the  structure.  Generally,  if  CFC  rules  exist  in  MS  A,  they 
would  normally  prevent  the  ATP  structure  since  MNE  Group  would  be  required  to 
include in its own taxable income in MS A the interest (treated as dividend in State B) 
received by B Holdco on the hybrid loan.21 

20 Council Directive 2014/86/EU. 
21 Of course, this assumes that MS A does not apply the same tax qualification to the hybrid loan as state B.   

15 

 
 
 
                                                 
entity 

Hybrid 
ATP 
structure (based on a model 
identified 
in  an  OECD 
BEPS report) 

The  structure  relies  on  allocating  interest  costs  to  a 
company which is considered a taxable entity in the state 
of  incorporation  and  as  a  transparent  entity  for  tax 
purposes  in  the  state  of  the  participants.  The  structure 
takes  advantage  of  the  hybrid  mismatch  in  qualification 
of  an  entity.  It  results  in  a  tax  deduction  for  interest  in 
one  MS  without  any  inclusion  of  the  payment  in  the 
other MS.  

Structure 2 - Hybrid entity ATP structure 

This  structure  is  a  variation  of  the  OECD  example  referred  to  in  paragraph  72  of 
“Neutralising 
the  Effects  of  Hybrid  Mismatch  Arrangements:  Action  2:  2014 
Deliverable”. The structure falls into the debt category. 

The ATP structure relies on allocating interest costs to a company which is considered a 
taxable  entity  in  the  state  of  incorporation,  and  which  at  the  same  time  is  considered  a 
transparent entity for tax purposes in the state of the participants. Such a mismatch in tax 
subjectivity  is  often  referred  to  as  a  hybrid  entity  (or  rather,  in  the  case  at  hand  it  is  a 
reverse hybrid). Therefore this ATP structure takes advantage of the hybrid mismatch in 
the  qualification  of  an  entity,  which  results  in  a  tax  deduction  for  interest  in  one  MS 
without any inclusion of the payment in the other MS.  

Introduction  

The ATP structure is established in connection with a multinational group’s acquisition 
of an operating  company in  MS B,  but  it is  worth  observing that  in  many situations, it 
could  also  have  been  established  in  an  existing  MNE  group  outside  the  context  of  an 
acquisition.  The  structure  assumes  that  MNE  Group,  a  multinational  parent  company 
headquartered in State A (MS or non-MS), has agreed to acquire a profitable operating 
company, Target Co, resident in MS B.  

The  structure  aims  to  obtain  tax  relief  for  internal  (artificially  created)  financing  costs 
which do not reflect any external financing costs of the MNE group. This is achieved by 
means of a hybrid entity in MS B that takes out a loan from the MNE Group in state A. 
This produces a tax deduction for interest in the hands of the borrower company in MS B 
without  any  taxation  of  the  corresponding  income  in  the  hands  of  the  MNE  group  in 
State A.  

This ATP structure can either be a result of: (1) different classification of partnerships for 
tax purposes in the states involved, or (2) check-the-box rules or similar legislation.  

As none of the EU MSs currently have legislation similar to the US check-the-box rules, 
State A cannot be an EU MS in the second scenario. Thus, State A is considered to be an 
MS in Scenario 1 and non-MS in Scenario 2. 

The mechanisms of the structure  

The ATP structure is established by means of the following transactions:  

16 

 
 
(1)  MNE  Group  establishes  a  legal  entity,  B  Hybrid,  in  MS  B.  B  Hybrid  takes  out  an 
interest-bearing loan from MNE Group.  

(2) B Hybrid uses the funds borrowed to pay the purchase price for the shares in Target 
Co and acquires 100% of the shares.  

(3) In its state of incorporation, MS B, B Hybrid is treated as a taxable entity. B Hybrid 
claims a local tax deduction in MS B for the interest as it accrues.22  

(4)  Since  B  Hybrid  has  no  income-generating  activities  itself,  the  utilization  of  its  tax 
deductions for interest on the loan has to be achieved by means of a local tax grouping 
(consolidation) with Target Co. Target Co is assumed to have sufficient taxable profits to 
shelter the interest deductions of B Hybrid.  

(5)  In  the  State  of  its  owner,  State  A,  B  Hybrid  is  seen  as  a  transparent  entity  and  is 
therefore regarded as an integral part of MNE Group. Consequently, the interest income 
from  B  Hybrid  is  seen  as  stemming  from  the  taxpayer  itself  and  hence  is  ignored  for 
State A’s tax purposes.23 

The figure below illustrates the structure: 

Discussion of the ATP indicators  

Below the factors and characteristics are highlighted which can either facilitate or restrict 
ATP in the structure set out above. The discussion follows the order of the transactional 
steps.  

22 It is assumed that MS B does not levy any withholding tax on the payment of interest, either as a result 
of domestic law, a tax treaty between state A and MS B, or the EU Interest/Royalty Directive.   
23 Alternatively, state A recognises the interest income from B Hybrid, but at the same time a tax deduction 
is allowed for the interest cost of B Hybrid.   

17 

 
 
 
 
 
 
                                                 
 Step 1  

In  many  cases,  B  Hybrid  would  be  a  limited  partnership.  This  would  normally  require 
more than one owner, including a limited partner. In such cases, it is assumed that MNE 
Group would hold the largest possible degree of ownership/profit participation rights in 
C Hybrid. The granting of the loan by MNE Group to B Hybrid has no tax implications 
in itself.  

Step 2  

Payment of the consideration for the shares in Target Co has no tax implications in itself.  

Step 3  

Interest  payments  should  be  deductible  for tax purposes  in  most  MSs. This  is  a crucial 
feature in the overall tax benefits of leveraged acquisitions. Many MSs have introduced 
tax rules to restrict interest deductions in cases of so-called thin capitalization. Some of 
these  rules  apply  only  to  interest  on  inter-company  loans;  other  rules  (e.g.  EBITA  and 
EBIT  rules)  apply  to  interest  on  all  loans,  including  third-party  debt.  While  such 
restrictions will have to be observed by the MNE group, they may not necessarily work 
to disallow all interest deductions.  

Step 4  

Subject to thin-capitalization restrictions, if any, B Hybrid claims a tax deduction in MS 
B for the interest cost on the loan from MNE Group. 

The interest deduction is passed on to Target Co by means of domestic group taxation in 
MS  C  (also  referred  to  as  fiscal  unity,  tax  grouping,  group  tax  relief  or  joint  taxation). 
This is a critical factor for the tax benefit of the structure.  

It  is  critical  that  MS  B does  not  levy  any  withholding  tax  on  the  interest  paid to  MNE 
Group in state A. Such exemption from withholding tax may follow either from domestic 
law, a tax treaty between State A and MS B, or the EU Interest/Royalty Directive.  

Step 5  

Most MSs apply their own tax qualification of foreign companies and partnerships when 
determining whether a resident owner (partner) should include the income and cost items 
of the foreign entity in the taxpayer’s local tax return. Typically, such qualification would 
be  based  on 
entities 
that 
established/incorporated  in  that  MS.  Such  qualification  is  rarely  linked  to  that  of  the 
other MSs. Therefore, the qualification of a foreign entity in the owner’s MS can differ 
from that of the entity’s MS (state of residence/incorporation).  

to  domestic 

applied 

criteria 

same 

are 

the 

In  the  case  at  hand,  it  is  assumed  that  State  A  qualifies  B  Hybrid  as  a  partnership  and 
hence as a tax-transparent entity. In general, this would normally imply that the owner, 
MNE Group, will have to include in its own taxable income the income and cost items of 
B Hybrid. However, most MSs would probably ignore the interest cost and income from 
the  loan  between  MNE  Group  and  B  Hybrid.  Either  way,  in  effect  there  would  be  no 
taxation in State A of the interest received from the loan. 

18