OECD consults on branch mismatch structures to curb profit shifting

The OECD is consulting on the mechanics of dealing with branch mismatch structures under Base Erosion & Profit Shifting (BEPS) Action 2, designed to neutralise the effects of hybrid mismatch arrangements as part of the wider anti-avoidance action plan

The BEPs project has already released a report on Action 2, which sets out recommendations for domestic rules designed to neutralise mismatches in tax outcomes that arise in respect of payments under a hybrid mismatch arrangement. The report included specific recommendations for improvements to domestic law intended to reduce the frequency of such mismatches as well as targeted hybrid mismatch rules which adjust the tax consequences in either the payer or payee jurisdiction in order to neutralise the hybrid mismatch without disturbing any of the other tax, commercial or regulatory outcomes.

This discussion draft now applies the analysis and recommendations set out in that report to mismatches that can arise through the use of branch structures.

These branch mismatches occur where the residence and the branch jurisdictions (i.e. the jurisdictions in which the head office and branch are located) take a different view as to the allocation of income and expenditure between the branch and head office and include situations where the branch jurisdiction does not treat the taxpayer as having a taxable presence in that jurisdiction.

The discussion draft identifies five basic types of branch mismatch arrangements. These include:

• disregarded branch structures where the branch does not give rise to a permanent establishment (PE) or other taxable presence in the branch jurisdiction;
• and diverted branch payments where the branch jurisdiction recognises the existence of the branch but the payment made to the branch is treated by the branch jurisdiction as attributable to the head office, while the residence jurisdiction exempts the payment from taxation on the grounds that the payment was made to the branch;
• deemed branch payments where the branch is treated as making a notional payment to the head office that results in a mismatch in tax outcomes under the laws of the residence and branch jurisdictions;
• DD branch payments where the same item of expenditure gives rise to a deduction under the laws of both the residence and branch jurisdictions;
• and imported branch mismatches where the payee offsets the income from a deductible payment against a deduction arising under a branch mismatch arrangement.

The consultation sets out preliminary recommendations for domestic rules, based on those already agreed in the Action 2 report, which would neutralise the resulting mismatch in tax outcomes.

The earlier recommendations target mismatches that are attributable to differences in the legal characterisation of instruments and entities. However, the OECD says that in the case of branch mismatches, the trigger for the application of the rules is different.

Branch mismatches do not generally result from differences between the branch and residence jurisdictions in their interpretation of the legal structure adopted by the taxpayer; rather they are the result of differences in the way the branch and head office account for a payment made under that structure.

Because branch mismatches turn on differences in tax accounting rather than legal characterisation, the same basic branch structure may call for the application of different branch mismatch rules, depending on the accounting treatment adopted by the branch and head office.

Despite this, the OECD states that, as for the recommendations under the action 2 report, the intention of these rules is to comprehensively neutralise any mismatch in tax outcomes arising from the use of branch structures (regardless of the accounting treatment applied in the branch or head office) while avoiding the risk of economic double taxation or disturbing any of the other tax, commercial or regulatory outcomes.

The deadline for comments on the discussion draft is 19 September.

The consultation on OECD BEPS action 2 branch mismatch structures is here