As from tax year 2022, Luxembourg’s Reverse Hybrid Entity Rule introduced by law of 20 December 2019 implementing Council Directive (EU) 2017/952 of 29 May 2017 amending Directive (EU) 2016/1164 (ATAD) regarding hybrid mismatches with third countries (ATAD II) will apply.
Companies with a non-calendar financial year may already be subject to this rule with respect to their financial year that started during calendar year 2021.
This Alert summarizes the key provisions of the Reverse Hybrid Entity Rule.
The Luxembourg law implementing the ATAD II extended, with effect from financial years starting on or after 1 January 2019, the territorial scope of the anti-hybrid mismatch provision to third countries and addressed hybrid permanent establishment mismatches, hybrid transfers, imported mismatches, and dual resident mismatches. It also introduced a provision addressing the taxation of “reverse hybrids” that will apply for the first time in tax year 2022.
Scope and rules
As from tax year 2022, transparent entities or arrangements that are incorporated or established in Luxembourg will, under certain conditions, be treated as corporate taxpayers and will be subject to Luxembourg corporate income tax (CIT).
This rule will only apply to an entity or arrangement (e.g., a partnership such as a limited partnership (société en commandite simple; SCS) or a special limited partnership (société en commandite spéciale; SCSp)) if one or more nonresident associated enterprises holding in aggregate a direct or indirect interest of at least 50% of the voting rights, capital interests or rights to profit in the entity or arrangement are located in one or several jurisdictions that regard the entity or arrangement as opaque (Reverse Hybrid Entity).
Where these conditions are met the Reverse Hybrid Entity will be subject to CIT, but only for that part of its income that is not otherwise taxed in Luxembourg or in another jurisdiction (including that of the investor). The tax liability of the Reverse Hybrid Entity is limited to CIT and does not extend to municipal business tax (MBT) nor to net wealth tax (NWT).
“Associated enterprise” for the application of the Reverse Hybrid Entity Rule is defined as:
Under certain circumstances, entities and/or individuals may be considered as acting together, which results in aggregating the voting rights or capital ownership held by different persons in the same entity. As stated in the comments to the Luxembourg law implementing the Reverse Hybrid Entity Rule, the “acting together” concept targets instances where a number of persons transfer their voting interest or equity interests to another person, who continues to act under their direction in relation to those interests as well as situations where a taxpayer or group of taxpayers that individually hold minority stakes in an entity enter into arrangements that would allow them to act together (or under the direction of a single controlling mind) to enter into a hybrid mismatch arrangement with respect to one of them.
However, a person who, directly or indirectly, owns less than 10% of an investment fund and is entitled to less than 10% of the profits of such investment fund will, unless there is proof to the contrary, not be considered “acting together” with another person participating in the fund. For this purpose, an investment fund is defined as a collective investment undertaking that raises capital from multiple investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors.
Exception to the Reverse Hybrid Entity Rule
The aforementioned tax treatment does not apply to Luxembourg entities that are collective investment vehicles. A collective investment vehicle means an investment fund or vehicle that is widely held, holds a diversified portfolio of securities and is subject to investor-protection regulation in the country in which it is established.
According to the explanatory note to the law that introduced the Reverse Entity Hybrid Rule, this covers:
Burden of proof
To prove that that the Reverse Hybrid Entity Rule is not applicable, the taxpayer must be able to provide, upon simple request by the authorities, any relevant document such as tax returns, other tax documents or certificates issued by the tax authorities of a foreign jurisdiction.
Stakeholders whose financial year closes at any date during calendar year 2022 should carefully analyze their investment structures and be prepared to provide adequate proof that the Reverse Hybrid Entity Rule is not applicable in a particular case.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Tax Advisory Services Sàrl, Luxembourg City
Ernst & Young LLP (United States), Luxembourg Tax Desk, New York
Ernst & Young LLP (United States), Luxembourg Tax Desk, Chicago