of information that are expected to be shared under the CbC reporting rules, there is an expectation that some jurisdictions will want to assert a level of tax based on sales or other factors in its jurisdiction, and will therefore do so directly or deploy aggressive arm’s length theories to reach that result. What are the BEPS Project recommendations on hybrid entities and instruments? A hybrid mismatch is an arrangement that exploits differences between tax jurisdictions, often through the use of a hybrid entity or instrument. A hybrid entity is an entity that is treated differently under the rules of different tax jurisdictions (for example, a partnership which may be treated as a taxable entity in one jurisdiction and transparent in another). Similarly, a hybrid instrument is one that is characterized differently by two tax jurisdictions (for example, an instrument that is considered debt in one country and equity in another). The BEPS report on hybrid mismatch arrangements sets out recommendations to neutralize the tax effects of these mismatches in two ways. First, the BEPS report recommends changes to domestic law and sets forth a series of linking rules that aim to align the tax treatment of a hybrid entity or instrument with the treatment in the counterparty’s jurisdiction (for example, by denying the payer an interest deduction when the recipient is not subject to tax on the interest).

Second, the BEPS report recommends changes to tax treaties and aims to ensure that the benefits of tax treaties are only granted in appropriate cases to the income of hybrid entities. income can be repatriated for only a small amount of additional US tax (under the US foreign tax credit system). To maximize this effect, some US MNEs may seek to restructure their non-US businesses to keep previously low-taxed non-US income offshore while repatriating future high-taxed non-US income that will bring along foreign tax credits. Who will oversee the implementation of the BEPS Project recommendations? The OECD and G20 countries have agreed to monitor the implementation of the BEPS Project recommendations. This will consist of reports describing what countries have done to implement the recommendations and adhere to the minimum standards.

The OECD has indicated that there will need to be some form of peer review, so that no country or jurisdiction gains unfair competitive advantages. The contributors gratefully acknowledge the assistance of Ashwin Pillay, a Trainee Solicitor in Sullivan & Cromwell LLP’s London office, in preparing these responses. The recommendations aim to put an end to, among other things, multiple deductions for a single expense, and deductions in one country without corresponding taxation in another. The recommendations are also intended to neutralize hybrid mismatch effects of what is commonly known as check the box planning. How will the BEPS report on hybrid mismatch arrangements affect international tax planning? While the full impact will depend on how each country implements these recommendations, and on what changes are made to treaties, it is expected that it will become more difficult to aggressively “interest strip” from high-tax jurisdictions (meaning to strip income from an entity located in a high-tax jurisdiction through interest payments made to an entity located in a lowtax jurisdiction). Many MNEs have already begun to wind down their use of hybrid structures. The effects on US planning remain unclear.

Currently, many US MNEs focus their international tax planning on reducing non-US tax and deferring US tax on income earned outside the US. With respect to deferral, a critical aspect is using hybrid entities to ensure that non-US income is treated as active, and that the royalties or interest used to reduce non-US tax are ignored for US tax purposes. However, to the extent that higher non-US taxes must be paid as a result of the BEPS Project recommendations, US MNEs may decide that deferral is unnecessary because high-taxed non-US © 2016 Thomson Reuters. All rights reserved.

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