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Chapter 7: Debt/equity hybrids and synthetic arrangements

Current arrangements

Current tax law often fails to tax debt/equity hybrids and synthetic arrangements according to their economic substance. This failure can result in uncertainty, tax arbitrage and compliance costs.

A strategy for reform

To develop a tax framework which does not distort normal commercial activity and provides greater certainty, while balancing compliance and administration costs against the need to protect the revenue.

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Key policy issues How should debt/equity hybrids be treated? How should synthetic arrangements be treated?
Debt/equity features could be identified by a number of factors or a single determinative factor. Anti-avoidance rules may be required, but would need to be considered in context of general anti-avoidance provisions. (Chapter 24) Instruments could be bifurcated into separate debt and equity components and taxed accordingly; alternatively a blanket debt or equity treatment could be applied to the combined (hybrid) instrument. Tax timing considerations of debt/equity hybrids could be addressed by applying the timing adjustment framework. The tax treatment of synthetic arrangements could more closely reflect economic substance,
rather than legal form.