Final regs implement anti-hybrid provisions


The IRS issued final regulations (T.D. 9896) on April 7 implementing anti-hybrid provisions enacted by the Tax Cuts and Jobs Act (TCJA) while concurrently releasing proposed regulations (REG-106013-19) under Sections 245A(e), 951A, and 881.

The final regulations adopt the general structure and approach of proposed regulations issued in December 2018, which exercised a broad grant of authority provided under Sections 267A and 245A(e) to implement far-reaching rules targeting hybrid dividends, hybrid transactions and other transactions with hybrid entities. They also make several helpful clarifications and changes in response to many comments received by taxpayers. The final regulations generally apply to tax years which begin after Dec. 31, 2017, and end on or after Dec. 20, 2018. However, some provisions are subject to a special applicability date (i.e. tax years beginning on or after Dec. 20, 2018).

The new proposed regulations expand current anti-conduit rules under Section 881 and create new rules related to adjustments to hybrid deduction accounts (HDA) and the deductibility of certain pre-payments made in the global intangible low tax income (GILTI) gap period. The new proposed regulations have varying applicability dates, which are described in detail later in this article.

Taxpayers should carefully analyze the changes made in the final regulations to determine whether they affect any positions taken under the 2018 proposed regulations. The 2020 proposed regulations also create homework for taxpayers. Taxpayers should re-evaluate existing financing arrangements to ensure they are not subject to the new proposed rules. Payments between controlled foreign corporations (CFC) during the GILTI gap period should also be reviewed to determine if they may fall under the 2020 proposed regulations.





The TCJA enacted two new provisions targeting so-called “hybrid arrangements,” which generally look to exploit differences in the tax treatment of a transaction or entity under the laws of two or more tax jurisdictions to achieve double non-taxation, double deductions, or other tax benefits resulting from inconsistent treatment between local law and U.S. law.

The TCJA amendments came on the heels of an international response to hybrid arrangements in Action 2 of the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Project that addressed hybrid and branch mismatch arrangements. The new provisions include Section 245A(e), which denies the dividends received deduction under Section 245A with respect to hybrid dividends, and Section 267A, which denies certain interest or royalty deductions involving hybrid transactions or hybrid entities.




Final regulations under Section 245A(e)


The 2018 proposed regulations generally implemented the Section 245A(e) provisions that deny a dividends received deduction (DRD) with respect to a hybrid dividend received by a domestic corporation from a CFC. The rules provide that if a U.S. shareholder of a CFC receives a “hybrid dividend” the recipient is not allowed a DRD and foreign tax credits and deductions are also disallowed with respect to the dividend.

In general, a dividend is a “hybrid dividend” if it would otherwise qualify for the Section 245A DRD, and the CFC (or a related person) paying the dividend is or was allowed a hybrid deduction or other tax benefit under relevant foreign tax law with respect to such dividend. The proposed regulations defined hybrid deductions and provided operating rules that require a connection between the hybrid deduction or other tax benefits under the relevant foreign tax law and the instrument that is stock for U.S. tax purposes.

The 2018 proposed regulations also provided rules related to hybrid dividends of tiered corporations and require an inclusion under Section 951(a) with respect to a hybrid dividend received by a CFC from another CFC in a tiered structure to the extent that the amount would be a hybrid dividend if the receiving CFC were a domestic corporation. If a CFC receives a tiered hybrid dividend from another CFC, then the tiered hybrid dividend is treated as Subpart F income by the CFC receiving it and the U.S. shareholder must include in income its pro rata share of the Subpart F inclusion.

To address situations where a dividend and a hybrid deduction are recognized in different taxable years, the 2018 proposed regulations instituted a tracking system. The tracking system requires maintenance of an HDA by either the domestic corporation or the CFC receiving the dividend. A dividend paid by a CFC to a shareholder that has an HDA is generally treated as a hybrid dividend or a tiered hybrid dividend to the extent of the shareholder’s balance in all its HDAs with respect to the CFC.

The final regulations under Section 245A(e) largely adopt the structure discussed above but do make several revisions. The most significant clarifications, changes and departures made are highlighted below.:


Hybrid Deductions

  • There is a partial elimination of the ordering rule for hybrid mismatch payments from the 2018 proposed regulations under which foreign tax law hybrid mismatch rules are applied before the determination of hybrid deduction status under Section 245A(e). Under the final regulations, a taxpayer will not apply a foreign hybrid mismatch rule prior to applying Section 245A(e) if the amount gives rise to an amount treated as a dividend for U.S. tax purposes that will be paid within 12 months after the taxable period in which the deduction or other tax benefit would otherwise be allowed. This more closely aligns with the OECD approach under BEPS Action 2.
  • The final regulations confirm that notional interest deductions (NIDs) give rise to a hybrid deduction and delays the effective date of the provision which treats NIDs as hybrid dividends. The final rules provide that a NID of a CFC is only treated as a hybrid dividend for tax years beginning on or after Dec. 20, 2018.
  • The final regulations provide that a deduction or other tax benefit may be a hybrid deduction regardless of whether under relevant foreign tax law the deduction or other tax benefit is disallowed under a thin capitalization rule or a rule similar to Section 163(j). Specifically, the rules clarify that the determination of whether a deduction or other tax benefit is allowed is made without regard to a rule that disallows or suspends deductions if a certain ratio or percentage is exceeded.
  • Under the final regulations “subnational” taxes (e.g. taxes imposed by a state, province, or canton) are now considered when determining if a CFC or related person was allowed a deduction or other benefit in the context of hybrid deductions so long as the tax is a covered tax in the applicable U.S. income tax treaty.
  • The final regulations provided that the “tiered dividend rule” (described above) no longer applies to non-corporate U.S. shareholders as they are not eligible for the Section 245A deduction.

Hybrid deduction accounts


The final regulations make several changes and clarifications with respect to HDAs following a stock transfer:

  • The final regulations confirm that when a Section 338(g) election is made with respect to a CFC target, the shareholder of the “new” target does not succeed to the HDA of the old target.
  • A general “anti-duplication rule” is implemented by the final regulations which is designed to ensure that when deductions or other tax benefits under a relevant foreign tax law are in effect duplicated at different tiers, the deductions or other tax benefits only give rise to a hybrid deduction of the higher-tier CFC. This may occur when a lower-tier CFC liquidates into an upper-tier CFC, and the two parties have mirror hybrid instruments in place.
  • The final regulations provide that HDAs will be allocated in the same manner as earnings and profits (E&P) in a Section 355 transaction.
  • Following a mid-year transaction, HDAs are adjusted proportionately between a seller and buyer based on the number of days in a tax year in which the shares were owned.

Generally, the HDA rules apply to distributions made after Dec. 31, 2017, during tax years ending on or after Dec. 20, 2018.

Grant Thornton Insight:

Post-TCJA, taxpayers have numerous attributes to track with respect to both domestic and foreign corporations. HDAs will need to be continually tracked and monitored. The final regulations provide helpful guidance surrounding the treatment of HDAs following a stock transfer. These attributes should be considered in the M&A context when conducting due diligence.


Regulations under Section 267A The 2018 proposed regulations implemented the provisions of Section 267A by disallowing deductions of “specified parties” for certain interest and royalty payments made to related parties. A specified party is defined to be either a tax resident of the United States, a CFC with at least one U.S. shareholder (i.e., a U.S. person that owns at least 10% directly or indirectly by vote or value of the stock of the CFC), or a U.S. taxable branch of a foreign corporation.

The 2018 proposed regulations generally disallow deductions only where there was a deduction without a corresponding income inclusion (referred to as “D/NI”). Additionally, the 2018 proposed regulations provided that a deduction is disallowed only to the extent that the no-inclusion portion of the D/NI outcome is a result of hybridity.

The deduction disallowed under Section 267A is limited to the amount of the no-inclusion aspect of a D/NI situation. The 2018 proposed regulations provide that only “tax residents” or “taxable branches” are considered to include an amount in income. A payment is included in income of a tax resident or taxable branch to the extent that under its local tax law it is included in the tax base and taxed at the full marginal tax rate imposed on ordinary income and not reduced or offset by exemptions, credits or other preferential regimes. Additionally, income that is deferred beyond 36 months is treated as a no-inclusion outcome under a “long-term deferral” provision.

The rules implemented in the 2018 proposed regulations generally only apply to one of three categories of payments consisting of disqualified hybrid amounts, disqualified imported mismatch amounts and specified payments satisfying anti-abuse requirements. A disqualified hybrid amount is a payment that produces a D/NI outcome as a result of a hybrid or branch arrangement. These would include payments with differing characterizations by the payor and the payee (e.g., payments treated as interest expense by payor, but as equity by payee) and payments that are disregarded under the payee’s tax law but regarded by the payors. A disqualified imported mismatch amount is a payment that produces an indirect D/NI outcome as a result of the effects of an offshore hybrid or branch arrangement being imported into the United States. These would include non-hybrid payments to a foreign recipient for which the income is offset by a hybrid deduction. Finally, the anti-abuse requirements would be satisfied by any payment made pursuant to a transaction the principal purpose of which was to avoid the purposes of the regulations and that produces a D/NI outcome. Examples may include certain structured transactions and use of intermediaries to avoid the purposes of Section 267A.

The final regulations under Section 267A largely implement the 2018 proposed regulations, with some notable departures in response to taxpayer comments. The most significant clarifications, changes and departures made by the final regulations are highlighted below.:



Hybrid or branch arrangements

  • In several places, the 2018 proposed regulations address “long-term deferral,” which is the deferral of income resulting from a specified payment for more than 36 months. The final regulations retained the long-term deferral provisions but provide that a determination as to whether long-term deferral exists is made by establishing when the payment is “reasonably expected” to be included in income. This is discerned at the time the specified payment is made. Further, the regulations clarify that if a specified payment will never be recognized under the tax law of the specified recipient (e.g. because the tax law does not impose an income tax) the long-term deferral rule does not apply.
  • The final regulations provide that hybrid sale/lease transactions should not be subject to the hybrid transaction rule. An example of one of these transactions is when a specified payment is treated as a royalty for U.S. tax purposes, and a contingent payment of consideration for the purchase of intangible property under the foreign tax law of the recipient. The IRS determined that these transactions should be exempt as there may be little difference between the results occurring under a hybrid sale/license transaction and the results that would occur where both the recipient’s tax law and U.S. tax law view the transaction as a license and the specified payment as a royalty.
  • The final regulations clarify that D/NI outcomes resulting from imputed interest on interest free loans (IFLs) may result in a deduction disallowance under the disqualified hybrid amount or disqualified imported mismatch rules. While this is not consistent with the treatment of IFLs under the OECD’s BEPS Action 2 report, the preamble to the final regulations provides that imputed interest can create D/NI outcomes that are no different than those produced by other hybrid and branch arrangements. The rules which address IFLs apply to tax years beginning after Dec. 20, 2018.
  • Generally, under the 2018 proposed regulations, a deduction for a disregarded payment is disallowed to the extent it exceeds the specified party’s “dual inclusion income.” Dual inclusion income is defined for this purpose as income included in both the income of the specified party and the tax resident or branch to which the payment is provided. A change was made in the final regulations such that items of income that are not included in the income of a tax resident or taxable branch as a result of a participation exemption or similar relief (e.g. DRD) should be treated as dual inclusion income.
  • The final regulations make a favorable change with respect to the treatment of payments to reverse hybrids. To the extent that an investor includes a current year distribution in its income, the investor is treated as including in income a corresponding portion of a specified payment made to the reverse hybrid during the year.
  • The final regulations make a clarification with respect to the determination of a disqualified hybrid amount in cases where there are multiple investors in a reverse hybrid, and an investor or investors do not include in income a specified payment made to the reverse hybrid. In such a case, only the no-inclusion of the investor(s) that occurs for its portion of the payment may give rise to a disqualified hybrid amount.
  • The 2018 proposed regulations provide rules that are designed to ensure that a specified payment is not a disqualified hybrid amount to the extent it is included in the income of a U.S tax resident or a U.S. taxable branch, or is taken into account by a U.S. shareholder under the Subpart F or GILTI rules. The final regulations make several clarifications with respect to these rules. For example, an amount is treated as included in Subpart F income without regard to the application of the E&P limitation under Section 952. Additionally, an exception has been provided for specified payments received by a qualified electing fund (QEF) which are taken into account by a tax resident of the United States.
  • The final regulations maintain the position in the 2018 proposed regulations with respect to withholding taxes. Despite numerous comments from taxpayers stating that the application of Section 267A to specified payments on which a withholding was imposed could result in double taxation, there is no exception provided with respect to such payments of U.S. withholding taxes.

Imported mismatch rules The general approach taken in the 2018 proposed regulations with respect to the imported mismatch rule has been retained by Treasury and the IRS, however changes have been made to reduce complexity and help facilitate compliance with the rule:

  • The final regulations narrow the definition of an imported mismatch payment to provide that a specified payment is an imported mismatch to the extent it is neither a disqualified payment nor included in income in the United States.
  • For purposes of determining if a deduction allowed to a tax resident or taxable branch under its tax law is a hybrid deduction, the IRS replaced its requirement that the deduction be “substantially similar” to a deduction that would be disallowed under the 2018 proposed regulations. Instead, the final regulations provide an exclusive list of deductions that constitute hybrid deductions with respect to a tax resident or a taxable branch in the tax law of which contains hybrid mismatch rules.
  • Under the final regulations, the dual-income inclusion standard applies in the imported mismatch context in cases in which the tax law of the taxable branch permits a loss of the taxable branch to be shared with a tax resident or another taxable branch.
  • The final regulations continue to treat NIDs as hybrid deductions in the context of an imported mismatch, but only to the extent that they are permitted for a tax resident under its tax law for accounting periods beginning on or after Dec. 20, 2018.
  • Clarification is provided in the final regulations that for a payment to be considered a funded taxable payment, it must be included in income of a tax resident or taxable branch.
  • The final regulations now provide that CFCs can incur hybrid deductions and make funded taxable payments.
  • Several clarifications are made with respect to the offset rule where there are multiple imported mismatch payments. First, the final regulations clarify that an imported mismatch payment is a factually related imported mismatch payment only if a design of the series of related transactions pursuant to which the hybrid deduction is incurred was for the hybrid deduction to offset income attributable to the payment. Second, the final regulations clarify that when there are multiple imported mismatch payments that are indirectly connected to the tax resident or taxable branch that incurs the hybrid deduction, the hybrid deduction is first considered to offset income attributable to an imported mismatch payment that is connected, through the fewest number of funded taxable payments, to the tax resident or taxable branch that incurs the hybrid deduction.
  • The 2018 proposed regulations contain the “deemed IMP rule,” which coordinates the U.S. imported mismatch rule with foreign imported mismatch rules to ensure that the same hybrid deduction will not be disallowed by imported mismatch rules in multiple jurisdictions. The deemed IMP rule has been modified to ensure that the U.S. rule is not overridden by the foreign imported mismatch rule where the foreign rule might not apply to disallow the deduction in question.

Other issues addressed in the final regulation package

  • The definition of interest has been pared back for purposes of Section 267A, possibly to align with the impending final regulations under Section 163(j). The regulations also provide clarification that Section 267A is applied prior to Section 163(j). Additionally, Section 163(j) carryforwards are not re-tested under Section 267A.
  • It is clarified under the final regulations that structured payments are treated identical to interest for purposes to Section 267A. Additionally, the definition of a structured payment is modified to provide that any expense or loss that is economically equivalent to interest is treated as a structured payment if a principal purpose of structuring the transaction is to reduce an amount that would have otherwise been treated as a structured payment. The final regulations also clarify that to the extent a deduction is disallowed as a disqualified hybrid amount, an imported mismatch or subject to a Section 267A anti-avoidance rule, such payment is permanently disallowed for all purposes of the Internal Revenue Code (IRC), and thus cannot be capitalized and recovered in any other manner (e.g. COGS, depreciation or amortization).
  • Under the 2018 proposed regulations, an arrangement is a structured arrangement if either (i) a pricing test is satisfied, meaning that a hybrid mismatch is priced into the terms of the arrangement, or (ii) a principal purpose test is satisfied. The final regulations modify the requirements of a structured arrangement by replacing the “principal purpose” standard with an objective test analyzing whether the arrangement was designed to produce the hybrid mismatch and reason to know standard.
  • Subnational taxes are considered under the final regulations when determining if a specified recipient included an item of income under the tax law of the foreign jurisdiction.
  • The final regulations maintain that a specified party’s E&P are not affected by operation of the rules under Section 267A but add the principal purpose of a transaction must not be to reduce or limit a CFC’s Subpart F income.
  • A modification has been made to the general anti-avoidance rule under Section 267A to focus on the plan or arrangement’s terms or structure, instead of requiring that a principal purpose of the plan or arrangement is avoiding the regulations under Section 267A.
Grant Thornton Insight:

Although the final Section 267A regulations follow many of the provisions contained in the proposed regulations, they do contain numerous changes and modifications. Intercompany interest and royalty arrangements should be reviewed to assess the impact of these final regulations.


2020 proposed regulations

Anti-conduit proposed regulations under Section 881 Generally, Section 7701(l) authorizes the Treasury Secretary to prescribe regulations re-characterizing any multiple-party financing transaction as a transaction directly among any two or more of such parties where determined to be appropriate to prevent the avoidance of tax. Existing regulations define a financing arrangement to mean a series of transactions by which a financing entity advances money or other property, and the financed property receives money or other property, if the advance and receipt are put into effect through one or more intermediate entities. The current regulations only apply if financing transactions link the financing entity, the intermediary entities and the financed entity. Generally, if it is determined that an intermediate entity is participating as a conduit entity in a conduit financing arrangement, the financing arrangement may be recharacterized as a transaction directly between the financing entity and the financed entity.

Under existing conduit financing regulations, an instrument that is treated as equity for U.S. tax purposes generally will not be characterized as a financing transaction, even though the instrument gives rise to a deduction or other benefit under the tax laws of the issuer’s jurisdiction. The 2020 proposed regulations under Section 881 expand the current rules related to conduit financing arrangements. Under existing regulations, an instrument that was treated as equity for U.S. tax purposes would not be treated as a financing transaction unless it contains provisions that provide the holder with significant redemption and other rights under the existing regulations.

The 2020 proposed regulations include two new situations in which financial instruments would be treated as a financing transaction: 1. financial instruments are treated as financing transactions if a deduction or other tax benefit is allowed to the issuer on amounts paid, accrued or deemed to be paid (including notional interest deductions) under the laws of the issuer’s country, or 2. a person related to the issuer that is under the issuer’s country of residence allowed a refund or tax credit for taxes paid by the issuer on amounts paid, accrued, or distributed without regard to the related person’s tax liability in the tax laws of the issuer.

The anti-conduit proposed regulations are proposed to apply to payments made on or after the date that the final regulations are published in the Federal Register.

Grant Thornton Insight:

The proposed anti-conduit regulations could impact a number of financing arrangements that previously were not subject to the conduit rules. Equity instruments that generate tax deductions or refunds would become subject to the conduit rules upon finalization of these rules. Existing financing structures should be reviewed in light of these rules and the Section 267A final regulations for applicability and impact.


Proposed rules under Section 245A(e) related to HDAs The 2020 proposed regulations provide a new rule that reduces the HDA by three categories of amounts included in the gross income of a domestic corporation as part of its end-of-the-year adjustments. The first category relates to a Subpart F inclusion with respect to a share of stock of the CFC, the second relates to a GILTI inclusion amount with respect to a share of stock of a CFC and the third category is for inclusions under Section 956 with respect to the share of stock of a CFC.

The 2020 proposed rules under Section 245A(e) are proposed to apply to tax years ending on or after the related final regulation is published in the Federal Register, although they may be relied on by taxpayers if applied consistently.

Proposed rules under Section 951A The GILTI final regulations include a rule that provides that a deduction attributable to basis created by the transfer of property from a CFC to a related CFC during the period after Dec. 31, 2017, the final date for measuring E&P for purposes of Section 965, and before the date on which Section 951A first applies with respect to the transferor CFC’s income (i.e. the “GILTI gap period), is allocated and apportioned solely to residual CFC gross income. The purpose of the rule is to ensure that taxpayers cannot take advantage of the GILTI gap period to enter into transaction that would have the effect of reducing their tested income or increasing their tested loss over time, without resulting in any current tax cost.

The 2020 proposed regulations expand the aforementioned rule to address other transactions in the GILTI gap period that may create a similar benefit, such as deductions attributable to pre-payments such as prepaid rents and royalties. Accordingly, a deduction by a CFC related to a deductible payment to a related recipient CFC during the GILTI gap period is treated as allocated and apportioned solely to residual CFC gross income.

This rule is proposed to apply to taxable years of foreign corporations ending on or after April 8, 2020, and to taxable years of United States shareholders in which or with which such taxable years end.

Next steps While retaining the overall character and structure of the 2018 proposed regulations, the final regulations provide a number of meaningful changes and clarifications. Taxpayers are advised to inventory the various changes made in the final regulations and make a determination as to whether they affect any positions taken under prior application of the 2018 proposed regulations. The 2020 proposed regulations also create homework for taxpayers. The anti-conduit provisions found within the 2020 proposed regulations may expose financing arrangements not previously subject to the rules. Taxpayers should re-evaluate existing financing arrangements. Finally, payments between CFCs during the GILTI gap period should be reviewed to determine if they may be captured by the 2020 proposed regulations.



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