Could the BEPS work on hybrid financing be just the tip of the iceberg?

By Mike Cooper

When the OECD delivered their agreed paper addressing hybrid mismatch arrangements in September there will have been many groups acknowledging the potentially significant effects of the proposals that it contained, but not many can have been surprised. 

The Hybrids paper focusses on arrangements which are probably one of the most obvious targets of the BEPS project. It proposes domestic rules, intended to prevent groups implementing financing structures which allow for interest payments to be made which give tax deductions for the paying territory while the recipient doesn't pay tax on the receipt. While a good many points of detail remain to be debated on the implementation of these proposals, any objections to the fundamental policy aims were overrun some time ago and few must now doubt the inevitability of law change in this area. But will the OECD go further?

There are still 8 of the 15 actions of the OECD's BEPS project where we’re yet to see any formal output. One of these is Action 4, ‘Limit base erosion via interest deductions and financial payments’, where we expect a discussion paper in anytime now. When the action plan was first published in July of 2013 there was an expectation that this action would look at recommendations for a more rigorous approach to the transfer pricing of intra group financing arrangements and suggestions for some form of limit on the levels of debt that can be introduced into a territory. We may well still get that.  After all, there are a wide variety of existing regimes to consider and compare (US earnings stripping, Australian debt equity, UK debt cap, etc). 

But there’s increasingly an expectation that the OECD will be more radical than just reviewing what’s already out there. Options may extend to imposing an absolute limit on aggregate global interest deductions by reference to the actual external interest cost incurred by a group. This approach would have a massive impact on the treasury strategies of multinational groups and would be fraught with practical problems. But the superficial simplicity and logic of such a rule may nevertheless appeal to policy makers. 

We’ll have to wait until the publication of the paper later this month to see what happens with respect to interest deductions.  In the meantime this video provides a useful summary of the proposals to date.