On June 20, 2014 the European Union's Council of Economic
and Finance Ministers agreed to amend the EU Parent-Subsidiary
Directive (PSD) to prevent double non-taxation resulting from
hybrid loan arrangements. It is expected the amendment will be
adopted during the upcoming Council of the European Union and would
then be enacted in the domestic tax laws of the EU member
The PSD was originally intended to prevent tax obstacles within
the EU. Prior to the proposed amendment, the PSD forbade the
taxation of corporate dividends received by a parent company from
its corporate subsidiary within the EU. As a result, the PSD
promoted the free repatriation of profits between EU member
countries and prevented double taxation of corporate income.
A tax loophole existed because certain EU countries permit
companies to deduct distributions paid on financial arrangements
that have both equity and debt features. Thus, under such a hybrid
arrangement, the subsidiary could deduct the payment from its
taxable income but the parent company would not have to include it,
resulting in double non-taxation. The amendments to the PSD (the
"Amended PSD") will require EU members to "refrain
from taxing such profits to the extent that such profits are not
deductible by the subsidiary, and tax such profits to the extent
that such profits are deductible by the subsidiary."
Xavier Hubaux, Head of Tax at AMMC Law in Luxembourg commented,
"For a Luxembourg tax resident company, this would mean that a
dividend derived from a foreign subsidiary which deducted said
dividend from its tax basis should be taxable at an aggregate
corporate income tax and municipal business tax of 29.22% (assuming
the Luxembourg company has its registered address in Luxembourg
city). However, such dividend income may benefit from a 50%
exemption based on article 115.15.a of the Luxembourg Income Tax
Law under certain conditions, assuming the latter provision would
not be regarded as to be amended in application of the Amended PSD
(indeed, after the 50% exemption, the dividend would still be
taxable at an effective tax rate of about 14.6%)."
The amendment should not result in the taxation of dividends
where the holder or the issuer of the financial instrument is
located outside of the EU. Xavier Hubaux adds: "Therefore,
hybrid arrangements between EU Member States (Belgium, France,
Luxembourg, UK, Germany, Poland, etc.) can still be contemplated in
the future provided the holder or issuer of the instrument is not
resident in an EU Member State; e.g. a Canadian company holding
hybrid shares (distributions deductible in a EU Member State) would
not be covered by the provision of the Amended PSD."
However, other challenges to the use of hybrid financial
instruments may be forthcoming. As part of its Base Erosion and
Profit Shifting project
(http://www.oecd.org/ctp/BEPSActionPlan.pdf), the Organisation for
Economic Co-operation and Development (OECD) is reviewing various
options to neutralize the tax effects of hybrid arrangements. The
OECD's proposed solutions include a similar approach to that of
the EU - tax the parent if the subsidiary received a deduction
– or the opposite – disallow the deduction by the
subsidiary if the parent is not going to be taxed on the income.
There is a significant risk for double taxation if countries fail
to harmonize their rules.
EU Member States will have to adopt the amendment into their
domestic law by December 31, 2015. Therefore, existing intra-EU
hybrid arrangements should reconsidered before this date as no
grandfathering period is contemplated by the Amended PSD.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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