handbook-tb

Neutralizing effects of hybrid mismatch arrangementsIf the reduction in the debt is looked at in isolation, there is amismatch that gives rise to a cross-border tax benefit (deductionin Country B) with no pick-up in Country A (no income). Inmany cases, such a scenario is not abusive, presuming that Z hasunrelieved (or cancelled) losses in Country A. However, the mismatchcan result in untaxed funds if, from a tax perspective, Z hasmanaged to set off all of the negative results that gave rise to thearrangement against income. This income might be in CountryA or elsewhere, for example, through carry back of losses or settinglosses against income from other activities, including those ofrelated parties.In this example, Country B (country of creditor) sees valuepassing from Y (creditor) to Z (debtor) when Y forgives part of thedebt. Country B also sees this “payment” as having a sufficient businesspurpose and grants a deduction for it. By contrast, Country A(country of debtor) does not recognize the payment received by Z inthe form of a reduction in liability. The result is a cross-border mismatch.This example focuses on countries disagreeing as to the verynature of whether there is a bestowal of value (payment) that shouldbe recognized for tax purposes. This case should not be confused withsimilar examples that focus on other income tax fundamentals, suchas where both countries recognize a payment but characterize it differently,for example, Country A characterizes the forgiven debt as apayment of capital and does not tax it because Country A does not taxcapital gains.Example 2 is a simple illustration of a mismatch between twocountries that recognize a payment, but disagree as to who (whichperson) should be treated as receiving it.Example 2Mismatch in recipient of payment — No incomeZ, a resident of Country A, makes a payment that is deductible forCountry A tax purposes. Country A considers that the payment ismade to Y, a resident of Country B. Country B considers that thepayment is made to X, a resident of Country A.197