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CA Final · Direct Tax Laws & International Taxation · Fundamentals of BEPS

Gamma Ltd (India) and Delta Inc (Country X) are related. Gamma makes a payment to Delta that Gamma deducts in India, while Country X treats the payment as not includible in Delta's income because it classifies the instrument as equity (a dividend exempt there). Which description and recommended BEPS Action 2 response is correct?

This is a deduction/no-inclusion hybrid mismatch. Under BEPS Action 2, the primary linking rule recommends that the payer's country deny the deduction to the extent the payment is not included in the recipient's ordinary income, with a defensive rule of inclusion if the payer's country does not act.

  1. AIt is a deduction/no-inclusion mismatch; the primary rule recommends denying the payer's deduction to the extent the payment is not included in the recipient's incomeCorrect
  2. BIt is a double deduction mismatch; the primary rule requires the recipient country to tax the payment twice
  3. CIt is a permitted outcome because Action 2 only applies to payments between unrelated parties
  4. DIt is a transfer pricing adjustment under Action 10 that increases the recipient's income

Explanation

This is a deduction/no-inclusion (D/NI) outcome arising from a hybrid financial instrument. Action 2's linking rule says the payer's jurisdiction should deny the deduction to the extent the payment is not included in ordinary income by the recipient. A defensive rule would then require inclusion by the recipient country if the payer's country does not act. The double deduction option is wrong because only one deduction is claimed here.

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