INTM550086C | Hybrids: introduction: examples of interaction with transfer pricing: hybrid payee

These two examples demonstrate how part 6A and the Transfer Pricing rules apply in the case of a hybrid payee. The diagram is the same for both fact patterns.

Example 1 analysis

In a scenario where:

• a payment of £100 is made by the payer in country D to the hybrid payee in country C

• investor 1 in country A sees the hybrid payee as transparent

• investor 2 in country B sees the hybrid payee as opaque

• under arm’s length terms, the payment from payer to hybrid payee would be £60, not £100

Applying transfer pricing with Part 6A factored in

Step 1: Test outcome of actual provision, disregarding transfer pricing rules

Payer makes payment of £100. This is the relevant deduction for part 6A purposes. Total payee ordinary income is £50. Counteraction under chapter 7 would therefore be reduction of relevant deduction by £50. Total relief available to payer would therefore be £50.

Step 2: Test outcome of arm’s length provision

Payer makes payment of £60. This is the relevant deduction for part 6A purposes. Total payee ordinary income would be £30. Counteraction under chapter 7 would therefore be reduction of relevant deduction by £30. Total relief available to payer would therefore be £30.

Step 3: Test if payer is a potentially advantaged person for transfer pricing purposes

Payer’s tax relief under the actual provision would be £50, but under the arm’s length provision it is £30. Payer is therefore potentially advantaged.

Step 4: Recompute payer’s tax position as if the arm’s length provision was imposed

Payer is taxed as if it has made a payment of £60. Deductibility of the payment is reduced by £30 due to counteraction under chapter 7. Payer therefore claims deduction of £30.

To the extent relevant, corresponding adjustments would be available under section.174 as if the arm’s length payment of £60 had been made.

Applying Part 6A (Chapter 7) to consider whether a further counteraction is required

Step 1: Identify relevant deduction (i.e. relief available disregarding hybrids rules)

Payer makes payment of £100. However, this exceeds the arm’s length amount so transfer pricing would require re-computation of payer’s tax position as if it was paying £60. Relevant deduction is therefore £60.

Step 2: Identify payees’ total ordinary income

Only investor 1 is recognising ordinary income. It receives £50. So, the total ordinary income of all payees is £50.

Step 3: Test if there is a hybrid payee deduction/non-inclusion mismatch

The relevant deduction is £60, and the total ordinary income of payees is £50. There is therefore a hybrid payee deduction/non-inclusion mismatch of £10.

Step 4: Apply counteraction

The relevant deduction (of £60) which may be deducted by the payer is reduced by the mismatch amount of £10. The maximum the payer may deduct is therefore £50. However, since the application of the transfer pricing rules has led to a claimed deduction of only £30, the counteraction has no effect in practice.

Note that if a corresponding adjustment claim was made by Investor 1, part 6A would have imposed a counteraction of £30 (as total payee ordinary income would have been reduced to £30), setting a maximum deduction of £30, leading to the same outcome as part 4. Part 6A would therefore have had no effect in its own right.

Example 2 analysis

In a scenario where:

• investor 1 sees the hybrid payee as transparent

• investor 2 sees the hybrid payee as opaque

• under arm’s length terms, the payment from payer to hybrid payee would be £40, not £100

Applying transfer pricing with Part 6A factored in

Step 1: Test outcome of actual provision, disregarding transfer pricing rules

Payer makes payment of £100. This is the relevant deduction for part 6A purposes. Total payee ordinary income is £50. Counteraction under chapter 7 would therefore be reduction of relevant deduction by £50. Total relief available to payer would therefore be £50.

Step 2: Test outcome of arm’s length provision

Payer makes payment of £40. This is the relevant deduction for part 6A purposes. Total payee ordinary income would be £20. Counteraction under chapter 7 would therefore be reduction of relevant deduction by £20. Total relief available to payer would therefore be £20.

Step 3: Test if payer is a potentially advantaged person for transfer pricing purposes

Payer’s tax relief under the actual provision would be £50, but under the arm’s length provision it is £20. Payer is therefore potentially advantaged.

Step 4: Recompute payer’s tax position as if the arm’s length provision was imposed

Payer is taxed as if it has made a payment of £40. Deductibility of the payment is reduced by £20 due to counteraction under chapter 7. Payer therefore claims deduction of £20.

To the extent relevant, corresponding adjustments would be available under section.174 as if the arm’s length payment of £40 had been made.

Applying Part 6A (Chapter 7) to consider whether a further counteraction is required

Step 1: Identify relevant deduction (relief available disregarding hybrids rules)

Payer makes payment of £100. However, this exceeds the arm’s length amount so transfer pricing would require re-computation of payer’s tax position as if it was paying £40. Relevant deduction is therefore £40.

Step 2: Identify payees’ total ordinary income

Only investor 1 is recognising ordinary income. It receives £50. So, the total ordinary income of all payees is £50.

Step 3: Test if there is a hybrid payee deduction/non-inclusion mismatch

The relevant deduction is £40, and the total ordinary income of payees is £50. There is therefore no hybrid payee deduction/non-inclusion mismatch.

Since there is no hybrid payee deduction/non-inclusion mismatch, there is no counteraction. Payer claims deduction of £20 in accordance with the outcome of applying the transfer pricing rules.

Note that if a corresponding adjustment claim was made by Investor 1, part 6A would have imposed a counteraction of £20 (as total payee ordinary income would have been reduced to £20), setting a maximum deduction of £20, leading to the same outcome as part 4. Part 6A would therefore have had no effect in its own right.