European Union: EU Council Reaches Agreement Expanding Hybrid Mismatch Rules

On Feb. 21, 2017, the Council of the European Union (EU Council) reached agreement on the terms of a draft that expanded Anti-Tax Avoidance Directive (ATAD 2). ATAD 2 expands the existing hybrid mismatch rules adopted in July 2016 and known as the ATAD. The ATAD rules were limited to hybrid entity or instrument mismatches occurring between EU member states.

The ATAD 2 expands the rules to cover hybrid entity or instrument mismatches between EU member states and nonmember states or "third countries." It also introduces new provisions addressing hybrid mismatches resulting from arrangements involving permanent establishments, dual residents, imported mismatches and reverse hybrid entities.

The primary rule of the directives is that a tax deduction should be denied by the member state. The secondary rule is that income should be taxed by the member state where a nonmember state does not deny the deduction. Under the reverse hybrid rule, a hybrid entity will be regarded as a resident of the member state of incorporation or establishment and will be taxed on its income to the extent the income is not otherwise taxed (with an exception for collective investment vehicles).

The ATAD 2 will be adopted once the European Parliament has given its opinion. The ATAD 2 must then be implemented in the EU member states respective laws and regulations, such that it applies no later than Jan. 1, 2020, for all provisions, with the exception of the provisions on reverse hybrid mismatches, which will be required to apply as of Jan. 1, 2022.

The EU Council's adoption of the ATAD is a significant development in European direct tax and represents the EU's movement to further adopt the recommendations in the OECD's Base Erosion and Profit Shifting Action Item 2, which deals with neutralizing the effects of hybrid mismatch arrangements.

For previous Grant Thornton coverage of the OECD's BEPS initiative click here.

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