Transfer Pricing – “Misalignment” from hybrids

As is well known, on Jan. 26, 2022, the full-bodied Circular No. 2/E was published, in which the Agency took stock of the regulation of “misalignments from hybrids” under the ATAD decree, giving guidance on the implementation of the rules that provide for forms of reaction to misalignments from hybrids.


In essence, the “ATAD”[1] decree contains a series of measures aimed at preventing multinational companies from evading tax by im-peding them from exploiting differences between tax jurisdictions for the purpose of eroding tax bases.

Specifically, ATAD Directive 1 provided for enforcement measures with respect to certain hybrid mismatches arising from the interaction between the tax regimes of Member States, but did not address mismatches arising from interactions between a Member State and third countries, as well as other types of hybrid mismatches (such as those involving permanent establishments). These areas were regulated by ATAD Directive 2, which also addressed hybrid transfers, misalignments from imported hybrids, and additional types concerning double deduction phenomena.

Furthermore, misalignments from hybrids could theoretically occur even within a single state, although the phenomenon is typically a transnational one. In this regard, it is specified that the rules to combat misalignments from hybrids introduced by the ATAD Decree are aimed exclusively at misalignments arising from interactions between the Italian tax system and one or more foreign tax systems and, therefore, with respect to facts-species occurring between entities resident or located in Italy and entities resident or located in another foreign state (whether Member State or third party).

Concept of tax hybrid misalignment

Hybrid misalignments arise from asymmetric tax treatment by two or more tax systems in relation to entities, permanent establishments, legal transactions (particularly financial instruments or involving financial instruments), income components suitable for generating tax effects (the “misalignments” precisely) incoe-rent (and, therefore, “hybrid“) at the international level, such as those attributable to the phenomena of deduction without inclusion (“deduction/no inclusion” or D/NI) and double deduction (double deduction or DD).

The elements in relation to which, at the international level, the greatest tax asymmetries have been recorded and which have, for a long time, been the basis of aggressive tax planning schemes appear to be prin-cipally hybrid financial instruments; hybrid transfers; hybrid entities (direct and inverse); and permanent establishments (both in relation to configurability and income attribution).

Imported hybrids

This definition refers to a case in which the effects of a hybrid mismatch originated between two jurisdictions and not neutralized (first-tier hybrid) reverberate in another jurisdiction (second-tier hybrid).

The case of imported hybrid concerns “composite” transactions through which a deduction-without-inclusion or double-deduction effect, generated in jurisdictions where anti-hybrid mismatch rules have either not been introduced or have been introduced in a manner that differs from the minimum standard, is transferred (imported) to jurisdictions that have adopted them and therefore would have reacted to the direct generation of the hybrid effect.

In order to neutralize misalignments from imported hybrids, a single reaction is provided that denies the deductibility of the negative income component incurred or deemed incurred by a taxpayer to the extent that it finances, directly or indirectly, deductible expenses that generate a misalignment from hybrids me-through a transaction or series of transactions between associated enterprises or that are parties to a structured arrangement.

The rule therefore requires that a “nexus” be re-discounted between the expense in the Italian company and the hybrid misalignment abroad, i.e., that the income corresponding to the negative Italian-source component be offset-directly or indirectly-by a deduction that results in a hybrid effect.


The previously mentioned Circular highlights the emergence of “implicit documentation burdens” on the taxpayer (part of Italian or foreign matrix groups, thus including Italian subsidiaries of nonresident groups).

The provision regarding imported hybrids must also be adequately considered because of the profiles related to the assessment, which must be preceded by the notification of a request for clarification with an appropriate at-to indicating the reasons on the basis of which it considers a violation configurable, to which the taxpayer is required to respond within 60 days.

Failure to respond or incomplete response to the request for clarification means that the documents and information not produced cannot be used in administrative and litigation proceedings. Moreover, as recalled by the Tax Administration, in case of dispute, administrative sanctions and, where the conditions are met, criminal and tax sanctions apply.

It is also pointed out that the new rules do not introduce an automatism, whereby intercompany costs become deductible only if they are supported by comprehensive documentation proving the absence of hybrid misalignments.

In fact, the technical complexity and possible difficulties in finding and processing relevant information within multinational groups (particularly if they are of a certain size) within the aforementioned 60-day ter-mine must be taken into account, together with the penalty provisions that entail a substantial obligation for the Italian company to perform an annual analysis at the group level aimed at excluding the existence of non-neutralized hybrid misalignments (at any level) that could be “imported” into Italy by ef-fect of any intercompany payment.

This analysis should allow the foreign parent company to certify annually, by means of a suitable file, to the Italian company the non-existence of relevant cases, by means of a formal communication, to be received before the signing of the tax return by its legal representative.


[1]The provisions of the ATAD Decree, shall apply as of the tax period following the one in progress as of December 31, 2019. The exception is the provisions in Article 9 of the ATAD Decree, which relate to the general rules regarding misalignments arising from reverse hybrid entities, which apply from the tax period following the one in progress on December 31, 2021.

[2] Permanent establishments can give rise to hybrid misalignments when two jurisdictions have different tax views about the allocation of income or expenses between the permanent establishment and the head office of the same entity. Consider the case where, the permanent establishment, records a negative income component that generates a tax loss that com-pensates, through tax consolidation, with the income of the said other company in the same group. In that circumstance, from a tax standpoint, it could be the case that the permanent establishment’s loss is deducted in both the stabi-le’s state of location and the parent’s state of residence.

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