Summary: Why this new figure? Applications and cases in which they operate. Non-subjection and exemption. Double deductibility (DD). Understanding an example.
Index
Hybrid Asymmetries in Costa Rica: New Fiscal Limitation
Law 9635 ( Law for the Strengthening of Public Finances ) established a series of new limitations to the deductibility of certain expenses for purposes of determining the taxable income tax base. I refer immediately to "Hybrid Asymmetries", a concept extensively developed by the European Union's Board of Directors since 2016. Undoubtedly, the inclusion of hybrid asymmetries in our positive order is the result of the drive of a public policy that seems to intend to harmonize our local rules with those of our commercial and political partners . We are undoubtedly before the normative development tending to avoid what is known as "infra-taxation".
What are Hybrid Asymmetries?
Why this new figure? On hybrid asymmetries, the ninth commentary of the European Council Directive of May 2017, allows to understand the broad spectrum covered by this conceptual figure:
"The rules on hybrid mismatches should deal with mismatch situations arising from double deductions, from conflicts in the qualification of financial instruments, payments and entities, or from the attribution of payments. Since hybrid mismatches could result in a double deduction or a deduction without inclusion, it is necessary to establish rules under which the Member State concerned refuses to deduct a payment, expenses or losses, or obliges the taxpayer to include the payment in its taxable income, as appropriate. However, such rules apply only to deductible payments and should not affect the general characteristics of tax systems, whether classical or imputation systems."
And why it is important to Europeans:
"our objective is to address one of the main practices that multinational companies have introduced to reduce their tax obligations."
Legal Framework in Costa Rica
Costa Rica, as if it were a member of the Union, has adopted them. Thus, the new paragraph m) of Article 9 of Law 7092, as amended by Law 9635 (Law for the Strengthening of Public Finances) reads as follows:
"Expenses associated with hybrid mismatches incurred by the taxpayer to related parties abroad, when such expenses do not generate taxable income or generate exempt income for such related party, or when such expenses are also deductible for the related party domiciled abroad.
The term "hybrid asymmetries" refers to those divergences existing as to the classification or tax treatment of an entity or a financial instrument under the Costa Rican legal system and that of the other jurisdictions involved, from which situations of double non-taxation are generated".
This new article, at the request of the deputies of the Republic, required clarification by its drafters in the Ministry of Finance, who then introduced the second paragraph of the clause in the text as a didactic rule:
"The term "hybrid asymmetries" refers to those divergences existing as to the classification or tax treatment of an entity or a financial instrument under the Costa Rican legal system and that of the other jurisdictions involved, from which situations of double non-taxation are generated."
Applications and cases in which hybrid asymmetries operate
We recognize several situations to which the "term" can be applied:
Financial Instruments
First: those resulting from payments under a financial instrument.
Attribution of Payments
Second: those resulting from differences in the attribution of payments made to a hybrid entity or a permanent establishment, also as a result of payments to a permanent establishment not taken into account.
Payments between Hybrid Entities
Third: those resulting from payments made by a hybrid entity to its owner or deemed payments made between the head office and the permanent establishment or between two or more permanent establishments.
Double Deductions
Fourth: double deductions resulting from payments made by a hybrid entity or a permanent establishment.
Therefore, it is important to understand that this limitation is only applicable to those payments to related parties abroad, which makes immediate reference to the concept of related parties in our income tax regulations.
Expense Reimbursement Requirements
And to disallow an expense made to a related party abroad under the limitation of the new subsection m) requires that such expenses made by the Costa Rican taxpayer :
A. Do not generate taxable income for the recipient of the payment, or .....
B. ....generate exempt income for the related party even though they are considered a deductible expense in Costa Rica, or...
C. ... when they are also deductible for the foreign related party.
At this point it is essential to ask ourselves what we should understand by entity and by financial instrument, since the second paragraph of the new standard establishes that hybrid asymmetries refer to those divergences with respect to the classification or tax treatment of an entity or a financial instrument.
Key Definitions
These are the definitions that the Directive 6661 - 17 of the Directive Council of the European Union amending the EU Directive 1164 of 2016 and that it seems to me, we can assume would be adopted as interpretative criteria or criteria of science and technique, given its conceptual clarity and obvious application to what is regulated:
Hybrid Entities
"Hybrid entity": any entity or arrangement that is considered a taxable entity under the laws of one jurisdiction and whose income or expenses are considered income or expenses of another subject or subjects under the laws of another jurisdiction;
Financial Instruments
"Financial instrument": any instrument to the extent that it produces a financial or capital return subject to tax under the rules for the taxation of debt, equity or derivatives under the law of the jurisdiction of the recipient or originator and includes a hybrid transfer;
Thus, in accordance with our regulations and with respect to the amendment of the second article of the Income Tax Law ( LIR ):
"(a) All legally constituted legal entities, regardless of whether or not they carry out a lucrative activity, de facto companies, professional activity companies, State enterprises, collective entities without legal personality and joint ventures existing in the country."
And permanent establishments understood as
"b) (...) any place or fixed place of business in which the essential activity of the non-domiciled person is developed, totally or partially", whose payments to a related entity generate a divergence in tax classification or treatment, and of course, produce a situation of "double non-taxation" by virtue of the fact that in the country that receives the payments, the legal nature of the same differs with respect to the Costa Rican one, the assumption that allows the rejection of the expense would be given. The same applies for any type of financial income deductible here.
In future installments of this column, I will also be referring to the jurisprudential development since its adoption 5 years ago.
Receipt is acknowledged: Criminal Court of Finance orders the suspension of the president of the CCSS, Marta Esquivel Rodríguez, for six months. South Korean writer Han Kang receives the Nobel Prize in Literature for her work "La Vegetariana". Rafael Nadal, Spanish tennis player, announces his retirement. The Japanese organization Nihon Hidankyo, formed by survivors of the atomic bombing of Hiroshima and Nagasaki in 1945, wins the 2024 Nobel Peace Prize. Spanish research based on DNA taken from Columbus' tomb and led by forensic expert Miguel Lorente, establishes that Christopher Columbus was a Sephardic Jew. Elon Musk endorses Trump in US elections and actively participates in campaign.
Non-Subjection and Exemption
Non-subject and exemption. We are facing cases of non-taxation or exemption and double deductibility (DD). Thus, it seems that when a Costa Rican company pays to one of its permanent establishments or a related entity, for example professional services, royalties or interests considered expenses in Costa Rica and these are not considered income either because in the country where the payment is received the person who receives it is subject to a regime that does not subject foreign income or that is exempt (for example by a special incentive regime such as free trade zone) these payments could be considered non-deductible in Costa Rica.
Double Deductibility: A Practical Analysis
Double Deductibility (DD). According to the comments to BEPS Action II, a case of double deductibility arises when the same expense is deductible under the rules of more than one jurisdiction. These types of "mismatches", the comments state, produce the need to regulate that what is deductible in one country is taxable in the other.
Mexican law, for example, establishes that interest, royalties and technical assistance payments made to nonresident related parties are not deductible under any of the following circumstances:
1. a) That the recipient of the income is a transparent entity whose members are not subject to taxation in that jurisdiction;
2. b) That the jurisdiction in which the recipient resides is unaware of the payment; or
3. c) That the payment is not considered taxable for the recipient in accordance with the applicable tax provisions.
In addition, and in accordance with such limitation of the regulations of our commercial partner, payments made to related parties are not deductible when such payments are also deductible for the related person or entity, unless the related person or entity includes the income in the taxable income of the same or a subsequent year.
This could occur if, for example, in Costa Rica an interest or royalty is paid that in the country receiving such payments is not considered taxable, either due to provisions of national law (for example, the entity receiving the interest considers that the interest is not taxable but rather a non-taxable dividend) or if the local entity's payments are used by the receiving entity to amortize its losses.
Understanding an example. A company in country A, has established both a branch and a subsidiary in country B. Country B allows the subsidiary of A and its branch in country B to be consolidated for tax purposes, which allows the interest expense incurred by the branch to be utilized by the subsidiary.
If the branch in country B is considered a taxable entity under the laws of country A, then its interest expense would generate deductibility in both country A and country B. Since the country B branch and the subsidiary in B are part of the same group, the interest will also be utilized in country B in the results of the country B subsidiary. Thus, the structure makes it possible to deduct the interest in both countries.
Receipt is acknowledged: In response to Iranian attacks, Israel launches offensive against military targets. Third Chamber rejects cassation appeal filed by Ofelia Tatenblaum. Canada cuts the number of immigrants it will admit in its territory. Government proposes to finance with public funds insurance for hierarchs in case they are denounced. The editor of the Whashington Post resigns after the owner of the media outlet prevents him from endorsing Harris. Trump holds political rally at Madison Square Garden. Baseball final series between two mythical teams: LA Dodgers and NY Yankees. Teatralia presents its annual Class Concert at the Children's Museum.