INTM552060 | Hybrids: hybrid transfers (Chapter 4): conditions to be satisfied: condition A - dual treatment condition

The dual condition treatment is satisfied if the arrangement involves a transfer of a financial instrument, and

• gives rise to a financing expense in the jurisdiction of the company that incurs the funding cost (the in-substance borrower), but

• the tax jurisdiction of the counterparty (the in-substance lender) does not recognise it as a lending transaction

Such transactions tend to be built around the concept of a ‘repo’ arrangement. This involves the transfer of a financial instrument for a price. The instrument is then transferred back later at a predetermined or pre-determinable higher price. The price differential is the funding cost to the transferor and will be higher for a longer-term repo that a shorter term one. The financial instrument transferred may be plain shares, with no inherent hybridity characteristics.

Repo transactions are very common in the financial markets and play a vital role in maintaining liquidity. The great majority of transactions do not create deduction/non-inclusion mismatches, as they are treated for tax purposes as financing or financial trading transactions from the perspective of both parties.

There can be mismatches, however, where

• the transferor treats the transaction in line with its substance, as equivalent to a transaction for the lending of money, and

• the transferee treats that transaction in line with its form, as an acquisition and subsequent disposal

Where the transferee jurisdiction taxes capital transactions in a more favourable manner than finance transactions then this will create a mismatch.

There are examples of transactions at INTM552490, INTM552500 and INTM552510 demonstrating how the dual treatment condition applies.