Hybrid Mismatch Arrangement, Anti-Tax Avoidance Instrument in Government Regulation 55/2022

Every profit-oriented corporation will seek to maximize revenue and minimize profits in various ways. For example, through a tax avoidance scheme, aka Tax Avoidance.

Tax Avoidance is the effort of a person or corporation in utilizing the weaknesses or loopholes of the tax provisions in a country. The goal is to pay less tax liability than it should be.

In addition, it is also possible to take advantage of the differences in taxation rules that apply between one country and another, through transaction modifications. This method is often referred to as Hybrid Mismatch Arrangement, which is regulated legally because no rules are violated.

The problem is that this Hybrid Mismatch Arrangement is considered to erode a country's tax revenue. Thus, many countries, including Indonesia, are trying to close the loopholes of regulatory differences that are often used to avoid taxes.

Read: Preventing Tax Avoidance, PP 55/2022 Adopts New Borrowing Cost Provisions

Best Practice OECD

Actually, the effort to limit the practice of Hybrid Mismatch Arrangement has been initiated by the Organization for Economic Co-operation and Development (OECD), through 15 action plans on tax base erosion and profit shifting or Base Erosion and Profit Shifting (BEPS) Action Plan.

In particular, through the action plan called Neutralizing the Effects of Hybrid Mismatch Arrangements contained in the 2nd BEPS Action Plan.

According to the OECD, a Hybrid Mismatch Arrangement is a rule that utilizes differences in the tax treatment of instruments, entities, or transfers between two or more countries.

In detail, the Hybrid Mismatch Arrangement consists of several elements. First, Hybrid Entities, where an entity is treated as a transparent entity for tax purposes in one country, and a non-transparent entity in another country.

Second, Dual Resident Entities, which is an entity that is resident in two different countries for tax purposes.

Third, Hybrid Instruments, which is an instrument that has different treatments in the countries involved. For example, an instrument is considered debt in one country but capital in another.

Fourth, Hybrid Transfers, which are different arrangements relating to the transfer of asset ownership in one country, but are considered debt guarantees in other countries.

Read: Confirmation of Secondary Transfer Pricing Adjustment as Dividend

The OECD mentions that there are several impacts resulting from the use of this Hybrid Mismatch Arrangement. First, it creates double deduction schemes, where an income deduction for tax purposes is claimed in two different countries.

Second, deduction/no inclusion schemes or deduction and non-inclusion recognition schemes. This occurs because the tax provisions in a country cause an expense to be recognized in that country, usually a deduction for interest expense, but is not considered income in another country.

Third, foreign tax credit generators, which is an arrangement where an entity generates foreign tax credits that would not otherwise be available, at least not to the same extent, or not without more appropriate taxable foreign income.

Read: Through PP 55/2022, Advance Pricing Agreements Can Be Made Multilaterally

Indonesia's response

Indonesia, in its latest regulation, Government Regulation (PP) Number 55 of 2022, which came into effect on 12 December 2022, seeks to minimize the practice of Hybrid Mismatch Arrangement.

Article 32 paragraph (2) letter h of the regulation states that the Minister of Finance is authorized to recalculate the amount of tax that should be owed by taxpayers who take advantage of differences in tax treatment, on an instrument or entity in the country or jurisdiction where it is domiciled.

Based on Article 43 paragraph (1), any payment transactions made by domestic taxpayers to foreign taxpayers will not be charged as expenses that reduce income if two conditions are met.
First, if the payment is not taken into account as income of the foreign taxpayer taxed in the jurisdiction where the foreign taxpayer is domiciled or deduction-noninclusion.

Second, if the payment is charged as a deduction from the foreign taxpayer's income in the jurisdiction where the foreign taxpayer is domiciled or double deduction.

In other words, payments that are not taxable either in Indonesia or abroad cannot be charged as a deduction from taxable income. The purpose is so that payments made can be taxed in Indonesia as they should be.

For example, the difference in the tax treatment of convertible bonds or bonds that can be converted into shares which, according to domestic regulations, are considered as debt, where interest payments on the debt can be a deduction from income.

Meanwhile, in other countries, convertible bonds can be considered as the capital where the income received from the capital will be treated as dividends.

Thus, if under the provisions of the country, dividends are not taxable, taxpayers will obtain tax benefits, in the form of income deduction on the cost of interest payments as well as the benefit of tax exemption on dividends.

Without Hybrid Mismatch Arrangements, domestic taxpayers will receive both benefits.

With the Hybrid Mismatch Arrangements provision, the cost of paying interest on a hybrid instrument (convertible bonds) in Indonesia cannot be an income deduction, because it has received the benefit of not being taxed in the other country.

However, in order to be effective, the provisions of Hybrid Mismatch Arrangements in Government Regulation Number 55 of 2022 require technical rules outlined in the Minister of Finance Regulation (PMK). We will wait. (ASP/KEN)