Before P2, mismatches arising from HFAs only concerned differences in treatment for tax purposes. This changed under P2 as HFAs can now also arise due to a mismatch in the accounting treatment or as a result of a mismatch in the treatment for accounting and for tax purposes. An instrument could for instance be treated as debt for accounting purposes and as equity for tax purposes (a 𝐇𝐲𝐛𝐫𝐢𝐝 𝐋𝐨𝐚𝐧).

The effective tax rate (𝐄𝐓𝐑) for P2 purposes is determined by dividing the covered tax (𝐏𝟐 𝐓𝐚𝐱) by the income recognized for P2 (𝐏𝟐 𝐈𝐧𝐜𝐨𝐦𝐞). If a constituent entity is located in a jurisdiction with an ETR < 15%, the ETR can be increased by granting a Hybrid Loan to that entity. The ETR of the low-taxed entity would increase as interest expenses on the Hybrid Loan will be recognized in the financial accounts (decrease of P2 Income) but not in the tax accounts (no decrease of P2 Tax). A simplified example to illustrate this:

As a starting point, ACo has an ETR of 20% as it has P2 Income of 1,000 and P2 Tax of 200. BCo has an ETR of 10% as it has P2 Income of 200 and P2 Tax of 20. ACo grants a Hybrid Loan to BCo with an annual interest accrual of 100. The Hybrid Loan reduces the P2 Income of BCo from 200 to 100, while its P2 Tax remains 20 (no interest deduction for tax purposes). Therefore, the ETR of BCo increases from 10% to 20% (20/100) as a result of the Hybrid Loan. The P2 Income of ACo increases to 1,100 and its P2 Tax remains 200 and, hence, its ETR will slightly decrease from 20% to 18.18% (200/1100). No P2 tax will be due in relation to either ACo or BCo as a result.

Article 3.2.7 of the P2 model rules is an anti-abuse provision aimed at preventing taxpayers from increasing the ETR of a low-tax entity, such as by granting a Hybrid Loan to that entity without a corresponding increase in the taxable income of a high-tax entity. Article 3.2.7 provides that, for purposes of computing P2 Income, interest expenses on a Hybrid Loan are ignored but the corresponding interest income is still included in the P2 Income of the lender.

In the example above, on the basis of article 3.2.7, the interest due by BCo under the Hybrid Loan would be ignored for purposes of computing BCo’s P2 Income and, hence, its ETR would remain 10%. The interest income would still be included in the P2 Income of ACo and its ETR would decrease from 20% to 18.18%.

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