What are called “hybrid mismatch arrangements”, or aggressive tax planning schemes, need to be curbed by nation states through greater co-operation and through more disclosure arrangements, the Paris-based organisation, which represents the world’s wealthiest powers, said.

These arrangements can often lead to unintentional “double non-taxation”, or a deferral in tax that lasts so long as to be almost the same as paying no or little tax, the OECD said.

The OECD’s paper, Hybrid Mismatch Arrangements: Tax Policy and Compliance Issues, is part of a continuing trend of governments trying to stamp out not just what is seen as tax evasion – a crime in almost all nations – but types of tax avoidance as well.

Tax revenue losses from certain practices, even those that are strictly legal, can be large, the OECD said. In 2009, New Zealand settled cases involving four banks for a total of around NZ$2.2 billion (around $1.8 billion); Italy recently settled cases for around €1.5 billion (around $1.98 billion). In the US, the amount of tax at stake in 11 foreign tax credit generator deals is worth $3.5 billion.

“Hybrid mismatch arrangements that arguably comply with the letter of the laws of two countries but that achieve non-taxation in both countries, which result may not be intended by either country, generate significant policy issues in terms of tax revenue, competition, economic efficiency, fairness and transparency,” the OECD said.

Seeking to explain this complex area, the OECD said hybrid mismatch arrangements tended to contain the following elements: entities are treated as transparent for tax purposes in one country and non-transparent in another country; entities are resident in two different countries for tax purposes; and instruments are treated as debt in one country and as equity in another.

To illustrate, a parent firm in country A (A Co) indirectly holds an operating firm in country B (B Co). Inserted between the two companies is a hybrid entity that is treated as tax transparent for country A’s tax purposes and non-transparent in the case of country B’s. A Co holds all or almost all of the equity interest in the hybrid entity, which in turn holds all the equity interests in B Co. The hybrid entity borrows from a third party and uses the loaned money to put into B Co. The hybrid entity then pays interest in the loan but apart from interest, it claims no significant deductions.

For country B tax purposes, the hybrid entity is subject to corporation tax; its interest expenses can be used to offset B Co’s corporate tax. In the case of country A, it treats the hybrid entity as transparent, hence allocating its interest expenses to A Co, where they can be deducted and used to offset unrelated income. As a result, there is a double deduction for tax.

In another example, a hybrid transfer of an equity instrument is made through a sale and repurchase of the shares in one country, while in the other country the transaction is treated as a loan with the shares serving as collateral.