handbook-tb

Protecting the tax base of developing countries2.4 OECD Action 2 — 2014 DeliverableThe scope of the OECD Action 2 — 2014 Deliverable 10 on neutralizingthe effects of hybrid mismatch arrangements is more limited than theapproaches discussed above, dealing only with specifically defined“hybrid instruments” and “hybrid entities.” Its basic approach withrespect to instruments is to have as a primary domestic rule the denialof the deduction of a hybrid payment that is not taxed in the otherjurisdiction. This of course requires the payer country to have adequateinformation with respect to the treatment of the payment in the recipientcountry. In cases where the payer country does not have domesticlegislation denying the deduction, it is recommended that the recipientcountry deny an otherwise applicable exemption regime. Similar principlesare suggested in the case of other hybrid transactions.3. Limiting the deduction of interest and other financingexpenses3.1 GeneralThe use of borrowing (leverage) was identified in both the OECD Reporton Addressing BEPS and Action 4 in the OECD Action Plan on BEPSas a technique that facilitated base erosion and profit shifting. The issuecomes up because most jurisdictions recognize interest expense onborrowing (the “rental” cost of money) as a deductible expense. Whenapplied to corporations, this basic rule encourages the use of debt financingrather than equity financing for corporate structures, as interestdeductions reduce the tax base while distributions of corporate profits inthe form of dividends do not. In addition, it gives an incentive to “load”debt into companies operating in high-tax countries and arrange for theinterest payments to be received by an entity in a low- or no-tax jurisdiction.This problem is especially troublesome where the loan is providedby a related shareholder or a related finance company organized in alow-tax jurisdiction. Furthermore, not only can the amount of the loan10OECD/G20 Base Erosion and Profit Shifting Project: Neutralisingthe Effects of Hybrid Mismatch Arrangements — Action 2: 2014 Deliverable(Paris: OECD, 2014), available at http://www.oecd.org/tax/beps-2014-deliverables.htm.11