Special Tax Alert

It’s Time to Unwind the Hybrids: IRS Issues Final and Proposed Hybrid Regulations

Alon Kritzman, Senior Director

akritzman@alvarezandmarsal.com

Kenneth Brewer, Senior Advisor

kbrewer@alvarezandmarsal.com

Nicolaus McBee, Senior Director

nmcbee@alvarezandmarsal.com

April 28, 2020 / North America

On Tuesday, April 7th, the IRS released final and proposed regulations dealing with so-called hybrid mismatches between the U.S. and foreign tax treatment of certain items. All global organizations should immediately review their cross-border tax profiles for the application of these rules. The implication of these regulations, in most cases, is the loss of a deduction, or the inclusion of income. The regulations apply the rules throughout a global structure, applying not only to U.S. entities, but also CFCs.  In certain instances, these rules may even apply to transactions with unrelated parties.

The regulations are organized around three different types of mismatches.  We have outlined those generic mismatches below.  To ensure the applicability to the vast number of structures and transactions, the writers were forced to issue complex and dense regulations in this area.  Many taxpayers will find these regulations difficult to digest and apply. As an assist, we have included a short high-level explanation of the regulations below, a short list of fact patterns that are likely implicated, and a link to a more comprehensive discussion of the regulations for those who may be affected.

For the most part, these regulations are already in effect and may apply to prior periods.  The final regulations dealing with hybrid instruments/entities under section 267 are generally effective for tax years ending on or after December 20, 2018. The final regulations dealing with hybrid dividends under section 245A(e) apply to distributions made after December 31, 2017, provided those distributions occur during tax years ending on or after December 20, 2018.  For the final regulations issued under sections 267A and 245A(e), taxpayers may either apply the final regulations or the 2018 proposed regulations to earlier periods but must apply either set of regulations in their entirety.  Note that the final regulations under both sections have special effective dates for certain rules.

We expect taxpayers will pursue unwind transactions in response to these regulations. We further expect that the unwind transactions themselves will have thorny cross-border tax issues. We will be working with our clients to address these issues and unwind applicable transactions and structures in short order to avoid adverse tax consequences under these regulations. We suggest all global organizations follow suit.

As discussed above, there are generally three different types of mismatches that the regulations address.  These mismatches arise in the following three categories of outcomes:

  • double-nontaxation outcome – Non-inclusion of income under either foreign or U.S. law.  An example of this result may occur when a foreign corporation pays a dividend to its U.S. corporate parent if the foreign corporation is allowed a local country deduction (or other tax benefits) for paying the dividend and the U.S. corporation receives a 100% dividends received deduction (participation exemption deduction).
  • double deduction outcome – Two deductions for the same item (i.e. one in the U.S. and one in a foreign country).  An example of this result may occur when a Foreign parent corporation owns a U.S. group of companies that have a common U.S. parent company that is a reverse hybrid entity (e.g. a U.S. partnership that elected to be classified as a corporation for U.S. tax purposes, but that is a pass-through entity for foreign tax purposes). In the absence of the anti-hybrid provisions, losses incurred by the U.S. parent company would be deductible for U.S. tax purposes, in consolidation, against the income of other U.S. group companies. At the same time, the losses of U.S. parent corporation would pass through under foreign tax law providing a second deduction for the foreign parent corporation…

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