Research on the Hybrid Mismatch Arrangementsin China /Huang Min

Research on the Hybrid Mismatch Arrangementsin China /Huang Min

1.Current Situation of Hybrid MismatchArrangements

In 2009, the tax bureau issued the Notice on "Implementation Measures for Special Tax Adjustment (Trial)", according to which hybrid mismatch arrangements should be classified as general anti-abuse management. The tax authorities should reclassify the hybrid mismatcharrangements of enterprises and cancel the tax benefits obtained by enterprises.

Meanwhile, for hybrid financial instruments, tax authorities have  some policies:

The Notice on the Treatment of CorporateIncome Tax for Hybrid Investment Business of Enterprises regulates the tax treatment of hybridfinancial instruments.It defines investment business with dual characteristics of equity and debt as hybrid investment business, and meets five conditions specified to consider hybridinvestment as debt nature.

It is also stipulated that residents of the contracting party shall enjoy treaty treatment when receiving dividends from China. However, arrangements with the main objective of obtaining preferential tax status shall not apply.

And the notice on the issue of corporate income tax policy for perpetual bonds clarifies the judgment of the equity or debt nature of perpetual bonds in hybrid financial instruments, which can avoid enterprises from implementing hybrid mismatch arrangements due to vague identification of the nature of perpetual bonds.

In addition,There are related provisions in tax treaty policies.In 2017, China released a complete list of final reservations and notifications to the MLI, with Chapter 2 of the Convention being a hybrid mismatch and fully reserving the tax transparency entity rules.China does not recognize income obtained through transparency entity as income obtained by residents of the contracting jurisdiction, as consent would reduce China's tax benefits. Therefore, a reservation is made.

2.Problems with Hybrid Mismatch Arrangements in China

Firstly,there is currently no official definition of hybrid mismatch arrangements in China's tax policy. Therefore, it is difficult for China to determine whether there is a substantial hybrid mismatch arrangement after discovering tax base erosion. The substantive determination depends on whether the taxpayer has a reasonable business purpose, which lacks proof basis and judgment process, and the practical operation is relatively vague.

Secondly, China lacks a systematic policy to eliminate hybrid mismatch, which has not been included in the special tax adjustment measures. With regard to hybrid financial instruments, although it is stipulated that hybrid investments are debt based after meeting certain conditions.After human operation, the substantive characteristics are easily inconsistent with the form. In addition, China considers partnership established under Chinese law as transparent entities, while partnership established under foreign law are considered non transparent entities. If a foreign country considers a partnership as a transparent entity, it will result in inconsistent recognition and lead to hybrid mismatch risks.

Thirdly, China's tax treaties have covered a wide range of countries and regions, but there is a lack of anti-mismatch clauses in the tax treaties, and no provisions have been made for the applicability of tax transparency.

3.Solutions to the Existing Problems

For the above situation and problems, we can draw on the experience of OECD and developed countries to optimize China's anti tax avoidance rules for hybrid mismatch arrangements.

Firstly, establish standards for the equity and debt nature of hybrid financial instruments, and set criteria for determining the tax transparency or non transparency of hybrid entities.

Secondly, expand the scope of general anti-avoidance to include individuals, partnerships, and hybrid entities, so that mismatches made through hybrid entity can be effectively constrained.

Thirdly, establish linkage rules, including primary and defensive rules. If the primary rule is not implemented, the defensive rule will cause the recipient to tax the income, resulting in a non repeated taxation result where one party deducts and the other party is included in the income.