Last year I blogged about “hybrid entities” and “reverse hybrid entities.” Unfortunately, these terms are not intuitive. A hybrid entity is an entity that is “fiscally transparent” for U.S. tax purposes but not fiscally transparent for foreign tax purposes, and a reverse hybrid entity is the “reverse” of a hybrid entity in that the entity is fiscally transparent for foreign tax purposes but not fiscally transparent for U.S. tax purposes.
The I.R.S. recently published Notice 2010-62, which deals with Pre-2011 “splitter arrangements” under the new foreign tax credit splitter rules of Code § 909. Splitter arrangements can occur with reverse hybrid entity structures as well as with hybrid instruments.
New Hybrid Instrument Terminology
Interestingly, the Notice creates a new (to me, at least) terminology for hybrid instruments. The Notice refers to an instrument that is treated as equity for U.S. tax purposes and as debt for foreign tax purposes as a “US Equity Hybrid Instrument” (or a “US Equity HI”). Further, the Notice refers to an instrument that is treated as debt for U.S. tax purposes and as equity for foreign tax purposes as a “US Debt Hybrid Instrument” (or a “US Debt HI”).
I really like this new terminology. It is very intuitive. It is easy to remember that a US Debt HI is debt for U.S. tax purposes. If it is a hybrid, therefore, it must be treated as equity for foreign tax purposes. I commend the I.R.S. for this simple but helpful innovation.
Application to Entities
This terminology can also be applied to hybrid entities. For instance, a hybrid entity could be called a “US Fiscally Transparent Hybrid Entity” or “US FT HE” for short. Intuitively, if the entity is fiscally transparent for U.S. tax purposes, then it must be non-fiscally transparent for foreign tax purposes.
Similarly, a reverse hybrid entity could be called a “US Non-Fiscally Transparent Hybrid Entity” or “US NFT HE” for short. The Notice does discuss reverse hybrid entities, but unfortunately, the author of the Notice didn’t suggest the new terminology for entities.
For my charts, I use the triangle pointing upwards to represent a US FT HE and a triangle pointing downwards to represent a US NFT HE. I do not use ovals, as many tax practitioners do, to represent disregarded entities. My reason for avoiding ovals is that it is often unclear whether a nominee shareholder of a foreign entity should be treated as a separate owner, creating a partnership, or whether the nominee should be disregarded under substance principles, resulting in a disregarded entity (see e.g., Rev. Proc. 2010-32).