Belgian circular letter on hybrid mismatch arrangements has been released

1. Background 

On 22 October 2024, the Belgian tax authorities issued the circular letter nr. 2024/C/66, offering detailed commentary on Belgium’s anti-hybrid rules. These rules, derived from the transposition of EU Directives “ATAD 1” and “ATAD 2” into Belgian tax law, have been in effect since 1 January 2019.

The circular letter is particularly valuable for its numerous examples that illustrate the practical application of these rules.

2. Key aspects of the circular letter

Definitions – The circular letter provides insightful comments on the scope of the ad-hoc tax definition of the key concepts in connection with the application of the anti-hybrid rules, which are the following:

• Hybrid arrangement: a mechanism giving rise to expenses which are tax deductible both at the level of a Belgian resident company (or a Belgian establishment) and a foreign entity (or an establishment of the latter), or solely at the level of one of those participants where there is no corresponding taxable income at the level of the beneficiary.
  
  This definition covers thus mechanisms of both "double deduction" (where the same expense is deducted by two taxpayers) and "deduction without inclusion" (where an expense is deducted without the corresponding income being taxed).
  
  Importantly, the definition of “hybrid arrangement” for tax purposes only encompasses the arrangements in which the participants are “associated entities”, which are “part of the same company” or are acting in the framework of a "structured arrangement".
  
  
• Hybrid entity: an entity or arrangement that is treated as a taxable entity under the laws of one jurisdiction, but whose income and expenses are treated as the income or expenses of one or more other persons under the laws of another jurisdiction.
  
  
• Hybrid transfer: an arrangement allowing the transfer of a financial instrument pursuant to which its underlying return is considered for tax purposes to be obtained simultaneously by more than one of the parties to the arrangement.

Tax adjustment mechanisms – These mismatch arrangements will all be ‘adjusted’ for tax purposes by the three mechanisms foreseen by the anti-hybrid rules (i.e., increase of the taxable profits, denial of the deduction of certain expenses and limitation of the imputation of the foreign tax credit). The circular letter provides for each of them a plethora of examples of application. We will highlight a few of them:

• Increase of the taxable profits – The circular letter gives the example of an arrangement involving a Belgian company and its permanent establishment located in a (tax treaty) EU jurisdiction, where a foreign entity makes a tax-deductible payment to the said establishment (e.g., a royalty for a software licence). A hybrid mismatch would occur if this payment – deducted in the jurisdiction of the foreign entity –  is not included in the permanent establishment’s tax basis because the concerned EU jurisdiction does not recognise it as a permanent establishment (e.g., through a stricter PE definition or interpretation), while the same payment is exempt from tax in Belgium for the Belgian company because the permanent establishment does exist for Belgian tax purposes (e.g., through a broader PE definition or interpretation). 
  
  To counter the base erosion caused by this hybrid mismatch, the first tax adjustment mechanism allows to include the received payment – attributed to the EU permanent establishment in accordance with tax treaty rules – in the taxable basis of the Belgian company. This inclusion would apply insofar as the payment has been deducted by the foreign entity but is not taxed in the jurisdiction of the permanent establishment because it is not deemed to exist there for tax purposes.
  
  Are also targeted by this anti-avoidance rule (i) some payments made to Belgian “reverse” hybrid entities (where the Belgian entity receiving the payment is considered as transparent from a Belgian tax standpoint but as opaque from the perspective of the tax legislation of the jurisdiction of the investor), (ii) payments made in connection with hybrid financial instruments, etc.
  
  
• Denial of the tax deduction of certain expenses – One of the examples given by the circular letter is the payment made by a Belgian company in connection with a financial instrument where this payment has been deducted for Belgian corporate income tax purposes without corresponding income being included in the taxable basis of the foreign recipient of the payment.
  
  The second tax adjustment mechanism allows in that scenario to deny the deductibility of this payment for Belgian corporate income tax purposes insofar as this payment is not included, within a reasonable timeframe, in the foreign beneficiary’s taxable income due to differences in the classification of the financial instrument or the payment made in relation to this instrument (typically, a financial instrument being considered as equity instrument in one jurisdiction and as debt instrument in another jurisdiction).
  
  Are also targeted by this anti-hybrid rule (among others) the “imported” hybrid arrangements, i.e., arrangements put in place between foreign participants (the “double deduction” or the “deduction without inclusion” mechanism takes thus place outside Belgium) the effects of which are extended to Belgium. This could happen when the deduction of some payments in connection with such arrangement is transferred to a Belgian taxpayer through a standard financial instrument, such as a typical loan taken out by the Belgian entity from one of the foreign participants.
  
  
• Limitation of the foreign tax credit – The example mentioned in the circular letter describes a situation where a foreign company lends some bonds to a Belgian company who must remit, as compensation for the ‘loss’ of interest income, each interest payment received in connection therewith (e.g., 100 EUR) to the foreign company, deduction made of the withholding tax retained by the debtor of the payment (e.g., 10% on 100 EUR = 10 EUR). This transfer of bonds qualifies as a hybrid transfer since both companies will be deemed to receive the same interest payment from the perspective of their domestic tax legislation and both will claim a foreign tax credit for the same foreign withholding tax.
  
  By application of this third and last tax adjustment mechanism, the Belgian company will only be allowed to apply the foreign tax credit on the corporate income tax liability pertaining to the portion of the interest payment not remitted to the foreign company (i.e., 100 EUR – 90 EUR = 10 EUR), and not to the full amount of the interest payment received (100 EUR).

3. Implications for Belgian taxpayers

Enhanced legal certainty – The circular letter provides valuable insights into the scope of Belgium's anti-hybrid rules, offering greater legal clarity on the application of these anti-avoidance measures.

Be prepared – The publication of this lengthy circular letter may signal increased scrutiny by the Belgian tax authorities on cross-border investments and transactions in their future tax audits. Belgian companies are therefore advised to closely assess their exposure to these rules in the context of their cross-border arrangements, especially with respect to imported hybrid mismatches, as such arrangements do not require an active involvement of the Belgian entity to fall under the scope of the anti-hybrid rules.