On 9 June 2023, the Luxembourg Tax Authorities (the “LTA”) issued the administrative circular L.I.R. n°168 quater/1 (the “Circular”). The Circular clarifies the Luxembourg tax status of a reverse hybrid entity together with applicable taxation rules and compliance obligations. A new Form 205 has been issued in that respect with an FAQ to provide guidance.
Background on the reverse hybrid rule
Since fiscal year 2022, under Article 168quater of the Luxembourg Tax Law (“LITL”), Luxembourg tax transparent entities (e.g., limited partnerships, special limited partnerships, mutual funds) may become liable to corporate income tax (“CIT”) in relation to their net income which is not otherwise taxed under Luxembourg domestic tax law or the law of any other jurisdiction, provided one or more non-resident associated enterprises (i) are holding in aggregate a direct or indirect interest of 50% or more of the voting rights, capital interests or profit entitlements in the Luxembourg partnership and (ii) are in a jurisdiction that considers the Luxembourg entity as a taxable person and do no tax the income attributable to associated enterprise solely because of such difference in qualification.
More details on the reverse hybrid rule in our previous newsflash.
Key aspects of the Circular
The Circular provides some clarifications concerning the reverse hybrid entities:
Specific tax status: A reverse hybrid entity will not be deemed as a tax resident corporate entity within the meaning of Article 159 LITL.
Provisions of the LITL explicitly not applicable to reverse hybrid entities: The following tax provisions are not applicable to a reverse hybrid entity:
Article 164ter LITL: Controlled foreign companies rules;
Article 166 LITL: Participation exemption regime (the partial exemption of certain dividends is however available);
Article 168bis LITL: Interest deduction limitation rules; and
Article 168ter LITL: Anti-hybrid rules.
Net income category: The taxable basis of reverse hybrid entities will be determined based on each category of income realized by the entity, as it would be the case for individuals or non-residents. Such entities should realize income falling within the last three income categories listed in Article 10 LITL, i.e., net income from transferrable securities (Article 97 LITL including notably interest and dividends), net rental income (Article 98 LITL) and other net income (Article 99 LITL including notably capital gains). The Circular reminds that only income not otherwise taxed in Luxembourg or abroad can be subject to CIT at the level of the reverse hybrid entity.
Computation of the net income: The net income must be determined by the subtraction of operating expenses (Article 105 LITL) from gross income (Article 104 LITL) based on a cash accounting method.
Applicable fiscal year: Regardless of the taxpayer’s accounting year, the taxable basis of the reverse hybrid entity will follow the calendar year.
Conversion of foreign currency: Taxpayer’s income received or expenses paid in a foreign currency must, in principle, be converted into Euro at the exchange rate of the day the income is received or the expense paid. However, an administrative tolerance will apply allowing the conversion into Euro either on the year-end exchange rate or on the average exchange rate for the tax year.
Absence of step-up upon becoming a reverse hybrid: When an entity acquires the reverse hybrid entity status, it is not granted the benefit of the step-up in value on assets and liabilities provided by Article 102§4a LITL. As a result, any capital gain realised on the disposal will be calculated on the basis of the historical acquisition cost.
Absence of realization event upon losing the reverse hybrid status: Losing the reverse hybrid status is not a realization event, hence no taxation of latent gains will occur upon the entity’s status change.
Availability of the 50% exemption of eligible dividends: A reverse hybrid entity can claim the benefits of Article 115§15 a) LITL providing for the partial exemption of certain distributions.
Absence of withholding tax on distributions: Distributions by a reverse hybrid entity remain free of withholding taxes in Luxembourg.
Elimination of double taxation: Standard tax credit and deduction rules for domestic and foreign taxes will apply in proportion to the income subject to CIT at the level of the reverse hybrid entity.
Tax return: In order to comply with their tax return obligations, taxpayers must complete a new tax form, i.e., Form 205, issued by the LTA.
Relevant information from the FAQ on the Form 205
The FAQ provides further details on (i) who should file Form 205, (ii) distinction with other tax forms applicable to tax transparent Luxembourg entities and (iii) information to be reported in the Form 205.
Who must file Form 205?
Luxembourg tax transparent entities whose income mainly falls within the categories of income from transferrable securities (Article 97 LITL) and other net income (Article 99 LITL which covers capital gains);
Luxembourg tax transparent entities that have received an invitation to file Form 205 from the LTA; and Luxembourg tax transparent entities falling with the scope of CIT, even if they have not been invited to file Form 205 by the LTA.
Luxembourg tax transparent entities: Form 200, 205 or 300?
The FAQ clarifies that Luxembourg tax transparent entities must file only one tax form and file the form requested by the LTA. Form 205 must filed online and within the standard deadline (31 December N+1 for tax year N).
Form 200 remains relevant for tax transparent Luxembourg entities realizing business profits (Article 14 LITL) without being liable to municipal business tax, agricultural and forestry benefits, capital gains on Luxembourg real estate or entities with ancillary revenue falling within the category of income from transferrable securities and capital gains on assets other than Luxembourg real estate assets.
Form 300 remains relevant for tax transparent Luxembourg entities realizing business income (Article 14 LITL) and being liable to municipal business tax.
Information to be reported in Form 205
First part is to report income taxable in Luxembourg without application of the reverse hybrid rule (i.e., income attributable to Luxembourg resident investors and attributable to non-resident investors where the right to tax such income is attributable to Luxembourg);
Second part is to report income subject to CIT. The net income reported in the first part of the form is not to be reported in the second part;
A final part must contain the list of limited partners and investors in the reverse hybrid entity, with the percentage held and result allocated to each investor according to the accounting result of the Luxembourg entity. The FAQ mentions that such information must be provided for verification purposes.
Conclusion
Luxembourg tax transparent entities will need to take their first reporting position with respect to the reverse hybrid rule before 31 December 2023. The Circular and FAQ provides timely and useful guidance in that respect.