In 2020, the EU’s Anti-Tax Avoidance Directive II (“ATAD II“) came into force.
This led to EU Member States being required to implement into domestic law a suite of so-called “anti-hybrid” laws.
What are anti-hybrid rules?
The aim of the anti-hybrid rules is, unsurprisingly, to eliminate the potential to exploit ‘hybrid features’ in a structure.
For example, the rules might address a hybrid instrument that is treated as debt in one jurisdiction but equity in another jurisdiction. Alternatively, they might target a hybrid entity which is treated as tax transparent in one jurisdiction and tax opaque in another jurisdiction.
One such anti-hybrid rule is the “reverse hybrid” rule.
This was introduced in a number of countries including Luxembourg.
The purpose of the “reverse hybrid” rule is to counteract “double non-taxation outcomes”.
Such an outcome might arise where an entity, e.g. a Luxembourg fund partnership, is treated as tax transparent in Luxembourg but tax opaque in the jurisdiction of one of its investors.
Why might this lead to ‘double non-taxation?’
Running with the example above, the Luxembourg fund partnership is not taxed in Luxembourg because it transparent for tax purposes. In other words, the entity does not pay tax, only the partners in the partnership.
However, that same income is also untaxed in that investor’s jurisdiction as a result of that jurisdiction deeming the income to have been paid by an opaque entity.
Triggering the Luxembourg reverse hybrid rule
The rule may be triggered if:
- investors treat the Luxembourg fund partnership as tax opaque in their home country; and
- they hold 50% or more of the voting rights, capital interests or rights to a share of profit in that fund partnership.
This is subject to certain aggregation or “acting together” rules.
Effect of the reverse hybrid rule
Where it is engaged, our fund partnership would be treated as a corporate for tax purposes in Luxembourg. As such, it becomes subject to Luxembourg corporate income tax.
Luxembourg amended its “reverse hybrid” on 23 December 2022.
This was to clarify certain conditions that must be satisfied in order for it to be engaged.
The conditions can be summarised as follows:
- there is an entity established in Luxembourg that is treated as tax transparent under Luxembourg domestic law;
- one or more investors in the relevant entity are located in a jurisdiction that treats the Entity as opaque for tax purposes;
- income allocable to such investor or investors is not subject to tax as a result;
- the hybrid Investors hold at least 50% of the relevant entity’s voting rights, capital, or profits; and
- the income of the relevant entity is not otherwise taxed under the laws of Luxembourg (or any other jurisdiction).
The reason for the amendment was that they overreached and counteracted certain mismatches that were not caused by hybridity - but rather as a result of an investor’s tax exempt status.
The amendment has retrospective effect from 1 January 2022.
If you have any queries relating to Luxembourg’s Reverse Hybrid Rule Amendments or tax matters in the Luxembourg more generally, then please do not hesitate to get in touch.
The content of this article is provided for educational and information purposes only. It is not intended, and should not be construed, as tax or legal advice. We recommend you seek formal tax and legal advice before taking, or refraining from, any action based on the contents of this article.