Background
Reverse Hybrid Entity Rule introduced in Luxembourg by the law of 20 December 2019 (hereafter the “ATAD II Law”) implementing Council Directive (EU) 2017/952 of 29 May 2017, regarding hybrid mismatches with third countries (hereafter “ATAD II Directive”) will apply as of 1 January 2022.
Scope of application
The Reverse Hybrid Entity Rule shall apply to an arrangement involving an entity (i.e., the Reverse Hybrid Entity) that is incorporated or established in Luxembourg and that Luxembourg considers transparent for its tax purposes, if one or more associated entities holding (directly or indirectly) at least 50% of the entity’s voting rights, capital, or profits; are established in a jurisdiction that considers the entity as opaque for its own tax purposes.
The Reverse Hybrid Entity Rule refers to tax transparent entities (i.e. partnerships) incorporated or established in Luxembourg.
“Collective investment vehicle” carve-out
The Reverse Hybrid Entity Rule shall not apply to a “collective investment vehicle” which is defined, pursuant to the ATAD II Law and the ATAD II Directive, as 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.
The commentaries to the ATAD II Law provide additional details, by confirming that various types of Luxembourg regulated investment funds (SIF, RAIFs, UCIs covered by the law of 17 December 2010 etc.) are to be covered as well as other types of alternative investment funds not specifically mentioned or covered by the law of 12 July 2013 related to AIFMs, as long as such vehicles meet the widely held criteria, that they have a portfolio of securities that is diversified in order to limit exposure to market risks and are subject to obligations related to investors protection.
General rule
An entity deemed to be a Reverse Hybrid Entity shall be considered as a resident taxpayer in Luxembourg. Therefore, its net income is subject to corporate income tax and contribution to the unemployment fund (i.e., currently at the rate of 18.19%) to the extent that its net income is not otherwise taxed under the laws of Luxembourg or any other jurisdiction. The tax liability of the Reverse Hybrid Entity is limited to corporate income tax and does not consequently extend to municipal business tax or to net wealth tax.
Associated entities test and acting together concept
An “associated entity” for the application of the Reverse Hybrid Entity Rule is defined as including (i) any individual or entity holding directly or indirectly a participation in terms of voting rights or capital ownership in a Luxembourg taxpayer of 50% or more or is entitled to receive 50% or more of the profits of the taxpayer, (ii) an enterprise that has significant influence on the management of the Luxembourg taxpayer or (iii) an entity that is part of the same consolidated group for financial accounting purposes as the Luxembourg taxpayer.
In certain circumstances, entities and/or individuals may be considered as “acting together” for the purpose of the “associated enterprise test” which shall result in the aggregation of the voting rights or capital ownership held by different persons in the same entity, even though the above detailed criteria are not met. More particularly, as stated in the comments to the ATAD II Law, 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. As a result, the position is generally taken that all investors in a partnership could be considered as acting together. However, to provide relief from the far-reaching concept of acting together, the Luxembourg legislator decided to include a non-acting together presumption (which does not derive from the ATAD II Directive or the OECD BEPS reports). Under this presumption, all investors holding directly or indirectly less than 10% of the interests in an investment fund, and who are entitled to receive less than 10% of the profits from the investment fund, are considered, unless proven otherwise (by the Luxembourg tax authorities) to not be acting together with any other investor in said investment fund. Although the ATAD II Law remains silent on the definition of investment fund, the commentary to the law specifies that an investment fund needs to be understood as a collective investment vehicle that raises capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors.