IRS Guidance on Hybrid Arrangements Related to Multinational Group Structures
By Douglas Nakajima, International Tax Co-Leader
Effective April 8, 2020, the IRS released final and proposed rules (T.D. 9896) aimed at clarifying 2017 tax law changes that targeted hybrid mismatch arrangements in which companies exploit differences between two countries’ rules to avoid taxes. These targeted hybrid arrangements involve multinational group structures where U.S. and foreign tax law classify a transaction or entity differently for tax purposes. One example of such different treatment is where a U.S. company has made a “Check-the-Box” election to treat an eligible foreign legal entity as “disregarded” as a separate entity for U.S. tax purposes. The new regulations also address dual consolidated losses and entity classifications that target taxpayers’ ability to claim the same deduction under the laws of both the United States and a foreign jurisdiction, and taxpayers that pay or receive hybrid dividends.
Rules preventing hybrid mismatch arrangements were part of the Organisation for Economic Co-operation and Development’s (OECD) project to curb base erosion and profit shifting (BEPS). The European Union’s (EU) second Anti-Tax Avoidance Directive (ATAD2) limited the deductibility of payments involving hybrid companies. The 2017 U.S. Tax Cut and Jobs Act added two provisions affecting treatment of hybrid arrangements:
- Section 245A(e) disallows the Dividends Received Deduction (DRD) for any dividend received by a U.S. shareholder from a controlled foreign corporation (CFC) for amounts qualifying for deduction under new section 245A(a) and for which the CFC received a deduction or other tax benefit in a foreign country; hybrid dividends between CFCs with a common U.S. shareholder can result in immediate income inclusion to the shareholder.
- Section 267A denies deductions where there is a hybrid mismatch for any disqualified related party amounts, including interest or royalties paid or accrued to a related party, where the related party does not include the income or is allowed a deduction in the foreign tax jurisdiction.
These provisions neutralize the potential double non-taxation produced by hybrid dividends or deductible payments made by or to a hybrid entity.
Together with these new regulations providing guidance on their application, the U.S. tax treatment of hybrid arrangements moves toward consistent treatment with the rules adopted by the EU.
If you have any questions concerning the new hybrid mismatch regulations, please contact a member of Marcum’s International Tax Group.