handbook-tb

Protecting the tax base of developing countriesThis “hybrid” nature of the transaction may result in income escapingtaxation in both jurisdictions. It may arise in a number of ways,with respect to the overall treatment of the transaction or just of someparticular elements. For example, one country may view a payment ashaving taken place, whereas the other country may not find a payment,or there may be a difference of view as to which taxpayers have made orreceived a payment. Similarly, an entity may be treated as transparentin one jurisdiction and as a separate entity in the other jurisdiction. Asa result, the overall tax revenues that the two countries were expectingfrom a transaction may be reduced. The transaction may have resultedin “stateless” income that is not taxed in any jurisdiction. In addition,situations can arise in which the same amount is deducted twice, dueto the differing treatment of a legal entity or disagreement as to whois the owner of an asset, with both countries granting a depreciationdeduction for the same asset. These “hybrid” results can come aboutbecause of differences in domestic law or differences in the applicationof tax treaties.2.2 Hybrid situationsOne of the most common forms of hybrid transaction involves aninstrument that is treated differently in two jurisdictions with respectto the payments on the instrument. Typically, the country of the issuerof the instrument treats the instrument as debt and payments on thedebt as deductible interest, while the country of the investor treats theinstrument as equity and the payments as dividends that qualify forsome kind of participation exemption.Example: Company B, resident in Country B, issues an instrumentto Company A, resident in Country A. Under the lawsof Country B the instrument is treated as debt and the paymentson the instrument are deductible by Company B. Underthe laws of Country A the instrument is treated as a share ofstock of Company B and the payments are treated as dividends.Under Country A’s tax system, dividends are given a participationexemption.The result may be the same where the instrument itself has thesame character in the two jurisdictions but certain features are treateddifferently. For example, a debt instrument may be convertible into a9