The Hybrid Nature of Hybrid Financial Instruments and EU Steps Towards a Solution

Abstract

For the last few years, aggressive tax planning, tax avoidance, tax fraud and their various manifestations have been dominating the public and private sector. Issues raised by numerous forms of base erosion and profit shifting are listed as top priorities for EU and non-EU countries. Logically, states want to optimize the levy of taxes and obtain the corresponding revenues attributable to their jurisdiction. At the same time, companies want to increase the profit margins through the optimization of all the costs concerned, including optimal taxation. The opposing interests involved might seem irreconcilable having in mind the stakes at hand. In the quest to achieve at least a certain level of balance, the parties engaged are required to adopt solutions that take into account the long-term objectives, the legal certainty behind the rules and potential ramifications of the latter. This article focuses on a particular set of arrangements through which companies attempt to obtain the most favourable taxation and increase the yield on their investments. The aforesaid are carried out by means of exploitation of complex hybrid financial instrument schemes. The significant impact of these sophisticated instruments on the taxing rights of countries has raised various questions but still no concrete answers. The inner logic behind a hybrid instrument is to utilize the differences between the divergent tax systems. The EU, along with the OECD’s work on base erosion and profit shifting and in the context of combating the negative effects of hybrid mismatches, decided to propose an amendment to the Parent-Subsidiary Directive by conditioning the tax relief provided by a home Member State to the deductibility at the level of a host Member State. This approach addresses only one possible solution to the problem and leaves aside other significant ones.