Moran Harari ■ New report: ‘Hybrid Mismatches in Israel’


Tax Justice Network Israel (TJN IL), in cooperation with Friedrich Ebert Stiftung, has published a new report on ‘Hybrid Mismatches in Israel’. The term “hybrid mismatches” refers to discrepancies in the tax laws of two or more independent tax jurisdictions or territories in relation to the classification of a legal entity or financial instruments for tax purposes. The hybrid component refers, for example, to the classification of a legal entity as a partnership in one country and as a company in another country, or the classification of a financial instrument such as Profit Participation Loans as a capital investment in one country and a debt in another country. A tax planning which involves the use of hybrid mismatches takes advantage of the tax discrepancies between jurisdictions in order to reduce the tax rate, which then erodes the tax base of at least one of the two countries.

The main reasons that hybrid mismatches are one of the most common and problematic elements of tax planning are the variety of combinations they include and the difficulty in identifying whether and under what circumstances they are used to evade tax. The expertise for understanding the various forms and designs of hybrid mismatches requires time, experience and knowledge, all of which are considered valuable resources for the tax authorities.

Not only does the use of hybrid mismatch for tax reduction lead to base erosion and profit shifting but it also increases tax competition between jurisdictions for attracting foreign investment, and thus poses a risk regarding destructive race to the bottom policies. In addition, compared with medium and small businesses, tax schemes which involve hybrid mismatches for tax reduction are used far more by international companies whose business operations dominate several countries. This advantage undermines fair competition between businesses and harms economic efficiency. Finally, the use of hybrid mismatches creates an unfair advantage for taxpayers whose income is mainly from capital (compared with taxpayers whose income is mainly from employment) and who can pay for professional financial service providers to design their tax schemes. 

In this report we look at

  • the different types of hybrid mismatches

  • recent developments – both in Israel and abroad – on hybrid mismatches, including Action 2 of the OECD’s BEPS project, the EU Anti- Tax Avoidance Directive (ATAD) and the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI).

  • the various ways they are often used by corporations

  • the risks to society as a result of their use for the purpose of tax reduction

  • policy recommendations for the Israeli government 

Among various other policy recommendations this report suggests Israel should determine general rules for non-recognition of a deduction for tax purposes insofar as the use of hybrid financial instruments and hybrid entities leads to a result of a deduction/ non-inclusion or double deduction. Another recommendation is to determine the criteria for classifying financial instruments as debt or as equity so that it will be more difficult for tax avoids to take and vice versa. In addition the report highlights the need for rules classifying hybrid entities as transparent or opaque.

The report was presented by TJN IL at a roundtable meeting with representatives from the Israeli Tax Authority, scholars and practitioners from the big four accountancy firms and law firms. One of the concerns raised by practitioners was the lack of clarity regarding the tax authority’s approach towards hybrid mismatches and the way it intends to implement Action 2. It appears that all participants agreed on the necessity for better regulation to address hybrid mismatches in Israel. While the tax authority acknowledged it is still in the middle of a learning process, it seemed positive towards adopting some of the report’s recommendations in the future, subject to available resources. 

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Comments • 1

  • Jürgen Maier
    January 3, 2018 - 5:54 pm

    what about an English translation?

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