ATAD 2’s impact on U.S. multinationals
Many U.S. multinationals use foreign hybrid entity structures to optimize their non-U.S. effective tax rate and/or to defer U.S. taxation on their non-U.S. earnings. With regard to the Amendments of the Anti-Tax Avoidance Directive (ATAD 2), EU member states are now given the tools to tax such earnings. This is what you need to know about the impact of ATAD 2 on your business.
On February 21, 2017, the Economic and Financial Affairs Council of the European Union (ECOFIN) reached agreement on amendments to the Anti-Tax Avoidance Directive (ATAD 1). These amendments (ATAD 2) extend the scope of ATAD 1 to hybrid mismatch structures with third countries such as the well-known Dutch ‘CV/BV-structure’ and the Luxembourg ‘SCS/SARL-structure’. ATAD 2 is an important step of the EU towards taxing the overseas earnings of U.S. multinationals.
Member states must implement the ATAD 1 hybrid mismatch rules by December 31, 2018 and the ATAD 2 rules by December 31, 2019. The reverse hybrid mismatch rules (described first below) have a later ultimate implementation date of December 31, 2021. Some member states will implement the rules earlier and some have already done so (e.g., the UK and Germany).
For U.S. multinationals, in particular the rules on reverse hybrid mismatches, deduction / no inclusion and imported mismatches are important.
Reverse hybrid mismatches
In a reverse hybrid mismatch structure, an entity is considered transparent from the perspective of the country where it is incorporated, and non-transparent from the perspective of the country where its partners are located. The income of the reverse hybrid entity is not taxed on a current basis, but taxed when repatriated to the hybrid entity’s partners. ATAD 2 prescribes that the hybrid entity must be considered a resident of the member state where it was formed and must be taxed on its income in that member state to the extent that such income is not taxed elsewhere.
A commonly used reverse hybrid structure is the CV/BV-structure. In this structure, the CV’s income will become subject to tax in the Netherlands as per 2022. The real impact of ATAD 2 depends on the function of the CV. CVs used for U.S. repatriation and/or deferral purposes only should not be affected significantly (see figure 1). CVs used for licensing and financing may however be affected more significantly (see figure 2).
Such CVs will most likely already need to be restructured prior to January 1, 2020 because of the deduction / no inclusion rules described below.
Deduction / no inclusion
In a deduction / no inclusion structure, an entity in a member state makes a payment to an associated (reverse) hybrid entity. The payment is deductible at the payer level, but is not taxed at the payee level. ATAD 2 prescribes that the payer member state should deny the deductibility of the payment as per 2020.
This rule in particular affects hybrid entity structures that make use of non-member state incorporated hybrid entities. Such entities are not targeted by the reverse hybrid rule, because they are incorporated outside of the EU. For instance, royalty payments by a Dutch BV to a reverse hybrid Bermuda LP (which owns the non-US IP of a U.S. multinational) will no longer be deductible under the deduction / no inclusion rule (see figure 3).
Hybrid entity structures that make use of member state incorporated hybrid entities may be affected as long as the hybrid entity’s income is not subject to tax. In CV/BV-structures, payments to the CV may be non-deductible until the CV’s income becomes subject to tax in the Netherlands on January 1, 2022 on the basis of the reverse hybrid rule (see figure 4).
Hybrid entity structures used for financing and licensing require restructuring prior to January 1, 2020 because of the deduction / no inclusion rule. Earlier restructuring will be required with respect to member states that implement ATAD 2 or similar rules earlier (e.g. UK and Germany).
Imported mismatches shift the effects of a hybrid mismatch in a non-member state country into the EU. Imported mismatches would undercut the effectiveness of ATAD 2 if no additional measure had been included. Therefore, ATAD 2 prescribes that the payer member state should also deny the deductibility of payments that are indirectly made to an associated (reverse) hybrid entity or are linked to a hybrid financial instrument.
Hybrid entity structures may typically be affected by the imported mismatch rules if they make use of non-member state incorporated hybrid entities and do not route the payments through a member state incorporated entity (see figure 5). In member state incorporated structures , the reverse hybrid or deduction / no inclusion rules should generally prevent the mismatch. The imported mismatch rules may however apply in member state incorporated hybrid entity structures if member states implement the imported mismatch rules before January 1, 2020 (e.g., the UK).
Swiss principal structures with limited risk distributors (LRDs) in member states may potentially also be affected by the imported mismatch rules. We see this as a risk when an LRD makes payments to a Swiss principal and the Swiss principal pays a royalty to a (reverse) hybrid entity. Member states could decide to deny the deductibility of a royalty embedded in the payment to the Swiss principal, even though ATAD 2 does not specifically address this issue (see figure 6).
Important: review hybrid entity structures
We advise to review your hybrid entity structures now and consider restructuring when needed. It is important to act prior to the formal January 1, 2020 implementation date - among other things - because certain member states have already introduced hybrid mismatch rules, and probably more will follow.
Beat BaumgartnerPartner Attorney at law, Swiss certified tax expert
Beat Baumgartner, attorney at law and Swiss certified tax expert, is a partner in our Zurich office. He focuses on Swiss and international taxation, M&A, financing and capital market transactions.T: +41 43 434 67 10 M: +41 79 930 63 52 E: firstname.lastname@example.org