Hybrid mismatch arrangements are cross-border arrangements that exploit differences in the income tax treatment of business entities or financial instruments under the laws of two or more countries.

There are two main forms of hybrid mismatches:

• “Deduction/non-inclusion mismatches”, which occurs when one country allows a deduction in respect of a cross-border payment, the receipt of which is not fully included in income in the other country.
• “Double deduction mismatches”, which occurs where a tax deduction is available in two or more countries in respect of a single economic expense.

These schemes can significantly reduce overall tax paid and decrease tax revenues for Canada and other countries. The hybrid mismatch rules address these issues. A first set of rules has already been implemented.

The purpose of the first set of rules is to neutralize the effects of:

• Payments under deduction/non-inclusion mismatches, and
• Dividends received from a foreign affiliate in respect of which a deduction is available for foreign income tax purposes.

The rules are in line with the Organisation for Economic Cooperation and Development recommendations for Action 2 of the Base Erosion and Profit Shifting project.

Other rules are expected to be introduced at a later date to address other forms of hybrid mismatches.

On this page

• Who the rules affect
• What are the rules
• Legislation
• What to report
• When to report
• How to report

Who the rules affect

The rules apply to corporations, trusts, individuals and partnerships that make or receive cross-border payments that result in hybrid mismatches under the tax laws of two or more countries.

What are the rules

The rules target deduction/non-inclusion mismatches that arise in relation to three types of hybrid mismatch arrangements briefly described below:

1. Hybrid financial instrument arrangement
   A hybrid financial instrument arrangement gives rise to a deduction/non-inclusion mismatch because its terms or conditions are such that payments under this arrangement are treated differently under the tax laws of different countries (subsection 18.4(10) of the Act).
2. Hybrid transfer arrangement
   A hybrid transfer arrangement refers to the transfer of a financial instrument that gives rise to a deduction/non-inclusion mismatch because the tax laws of different countries view different entities as the recipient of the returns under the transferred financial instrument (subsection 18.4(12) of the Act).
3. Substitute payment arrangement
   A substitute payment arrangement undermines the integrity of the rules by creating a deduction/non-inclusion mismatch without the use of hybrid financial instruments or hybrid transfer arrangements. Under such arrangement, payments for the transfer of a financial instrument are engineered to function as a substitute for the returns under the transferred instrument (subsection 18.4(14) of the Act).

The rules restrict the deduction available to a taxpayer for payments made under these arrangements (the “primary rule”, subsection 18.4(4) of the Act) or include in the taxpayer’s income a payment received under these arrangements (the “secondary rule”, subsection 12.7(3) of the Act). The secondary rule can also apply to certain situations involving hybrid mismatches between foreign affiliates (paragraph 95(2)(f.11) of the Act).

The rules also restrict the deduction under section 113 of the Act in respect of dividends received by a taxpayer that is a corporation from a foreign affiliate when the dividend is deductible for foreign income tax purposes (the “deduction restriction rule”, subsection 113(5) of the Act).

A comparable rule applies to inter-foreign affiliate dividends which includes such dividends in FAPI when certain conditions are met (paragraph (b) of variable A of the definition of FAPI in subsection 95(1) of the Act).

For more information, please see the links below.

Legislation

The Income Tax Act (Revised Statutes Canada, 1985, c. 1 (5^th Supp.))

The Explanatory Notes Relating to the Income Tax Act and Income Tax Regulations published by the Department of Finance

What to report

The hybrid mismatch arrangement rules contain two filing requirements in respect of a payment that arises or a dividend received after June 30, 2023:

• A taxpayer is required to provide the prescribed information if a deduction is restricted under the primary rule in subsection 18.4(4) of the Act (subsection 18.4(21) of the Act).
• A taxpayer is required to provide the prescribed information if an amount is included in income under the secondary rule in subsection 12.7(3) of the Act (subsection 18.4(21) of the Act).
• A taxpayer that is a corporation resident in Canada is required to provide the prescribed information if the deduction restriction rule in subsection 113(5) of the Act applies in respect of a dividend received from a foreign affiliate (subsection 113(7) of the Act).

When to report

The information described below has to be reported for each taxation year of a taxpayer, if applicable, with the taxpayer’s income tax return, before the relevant filing due date.

How to report

To report prescribed information, follow the instructions below. For updated information, visit this web page regularly.

If the application of the rules to a taxpayer in a given taxation year results in the requirement to file one or multiple prescribed forms, the CRA will accept a letter and you can include your information in a single communication.

If the primary rule applies

Adjust any appropriate line in your return by the relevant amount and attach a letter that includes the following information:

• the name, country, and taxpayer identification number, if applicable, of the payment recipient
• the relationship between the recipient and the taxpayer
• the amount that is deductible in respect of the payment in computing the income from a business or property of a taxpayer in Canada
• the amount , if any, in respect of the payment that is foreign ordinary income
• the amount , if any, in respect of the payment that is Canadian ordinary income
• the hybrid mismatch amount
• the type of hybrid mismatch arrangement involved

If the secondary rule applies

Adjust any appropriate line in your return by the relevant amount and attach a letter that includes the following information:

• the name, foreign taxation year, country, and taxpayer identification number, if applicable, of the payer
• the relationship between the payer and the taxpayer
• the amount that is deductible in respect of the payment in computing foreign income or profits
• the amount , if any, in respect of the payment that is foreign ordinary income
• the amount, if any, in respect of the payment that is Canadian ordinary income
• the hybrid mismatch amount
• the type of hybrid mismatch arrangement involved

If you are a corporation resident in Canada and the deduction restriction rule applies in respect of a dividend received from a foreign affiliate

Adjust any appropriate line in your return by the relevant amount and attach a letter containing the following information:

• the identity of the payer foreign affiliate
• the amount of dividend received from the foreign affiliate
• the amount deducted in respect of the dividend in computing foreign income or profits of the foreign affiliate or another entity described in subsection 113(5) of the Act
• the portion of the dividend deemed not received under subsection 113(5) of the Act

Attaching a letter

If you are filing a corporate income tax return using certified tax preparation software, you can use the T2 Attach-a-doc service to submit your letter if the software has that functionality.

You can also submit your letter through one of the CRA secure portals using the Submit documents feature.

Keeping records

Remember to keep all documents supporting amounts determined under the rules. For more information on your responsibility to keep records and on the related requirements, go to Keeping records.