handbook-tb

Neutralizing effects of hybrid mismatch arrangementsand Country B will quarantine and potentially deny a deduction forwhat both believe to be a foreign expense, which will resolve anymismatch. It is conceivable that the interest expense is not incurredthrough a PE anywhere, or Country A and Country B each considerthe expense to be incurred through a PE situated in their jurisdiction.Comprehensive withholding in Country A will largely address its taxbase erosion. The risk is in Country B if X is granted a deduction andthe tax liability of Y is offset with a foreign tax credit granted in respectof Country A withholding tax. a Country B could deny a deduction toX in such a case, but perhaps this approach is overly prescriptive anddependent upon the treatment in Country A.A.1.5 A more straightforward rule would be to presume, for thepurposes of quarantining expenses but not withholding tax, that apayment made by a resident that is not attributable to a local PE isconsidered to be a foreign expense and so quarantined. The risk in thisversion of example 3 is that both Country A and Country B quarantinethe expense. Tax planners should be able to ensure that such a scenariodoes not arise. The chance that both Country A and Country B simultaneouslypresume that the expense is attributable to a PE in their ownjurisdiction is quite remote and can be left for general anti-abuse rules.Either country may also take the position that the expense has beengranted relief to another person and deny the deduction on that basis.Again, the risk of the expense not being deducted anywhere is remoteand can be discounted.A.1.6 The mismatch in example 4 would have to be addressed byCountry A changing its domestic law. Country A has let a gain escapeits jurisdiction without taxation, perhaps by presuming that CountryB will tax, which it will not. Perhaps Country A should treat Z asreceiving full market value for the sale even if domestically it has ano gain/no loss rule for related-party transfers. Sales to non-residentswould always be treated as made at market value, unless the purchasedasset is included in the assets of a domestic PE.aSome countries may take the view that where they are Country B, theywill not grant a foreign tax credit for foreign tax on a payment that they consideris made by a resident of Country B. This is a well-grounded position. However,there is at least some risk that as a matter of law the relief from the double taxationarticle in a tax treaty (Article 23) requires that a foreign tax credit be granted.261