Luxembourg Tax Alert 2023-06

On 9 June 2023, the Luxembourg Tax Authorities (“LTA”) issued Circular L.I.R. n° 168quater/1 (“the Circular” – available here) in relation to so-called “reverse hybrid rules” of ATAD 2 (as transposed into article 168quater of the Luxembourg Income Tax Law – “LITL”). On the same day, they also published a Frequently Asked Questions (“FAQ”) to address tax compliance obligations of all types of Luxembourg partnerships (SCS(p)s) and, in particular, the tax forms 200/300 and the new 205 tax form.

Please find hereafter a summary of the key considerations at stake. 

Under article 168quater Luxembourg entities or arrangements that are in principle tax transparent for Luxembourg tax purposes (i.e., not subject to Luxembourg corporate income tax) could become subject to Luxembourg corporate income tax (“impôt sur le revenu des collectivités”, hereinafter “CIT”) on their income in Luxembourg when certain conditions are met. These rules are already applicable since the beginning of fiscal year 2022 and were already amended by the 2023 budget law (please refer to our Tax Alert 2022-13 for more details in this respect).

These guidelines provide interesting clarifications, such as their tax status, the determination of total net income, the calculation of tax due, and other related matters.

1 -  Tax Status of a Reverse Hybrid (“RH”) Entity

•  As expected by the Luxembourg marketplace, according to the LTA, RH entities should not qualify as tax resident undertakings within the meaning of article 159 LITL
• As a result, RH entities should not be comparable to regular tax resident undertakings and should therefore not be subject to the following specific provisions of the LITL:
  • Controlled foreign companies (“CFC”) rules (article 164ter LITL)
  • Interest limitation rules (article 168bis LITL)
  • Anti-hybrid rules (article 168ter LITL) and
  • The participation exemption (article 166 LITL - which is not helpful)
• As regards the latter, please note that the LTA confirmed that the 50% exemption on dividend income should, however, be available (article 115 (15) a LITL) under certain conditions

2 - Determination of taxable income

• The LTA emphasizes that the categories of income that could be subject to tax at the level of a RH entity only includes income from movable property (article 97 LITL), rental income (article 98 LITL) and miscellaneous income (article 99 LITL). Other income would therefore not be subject to tax
• Unlike regular tax resident companies, the taxable basis of RH entities would be determined based on “revenues” (“recette”) minus “expenses” (“frais d’obtention”), on a cash basis
• This is a rather paramount point brought by the LTA: in a typical alternative investments structure, it would mean that up until cash is actually received (e.g., interest on a debt instrument held by a Luxembourg partnership), no taxation would be triggered at the level of the Luxembourg RH entity. This raises the question on whether tax would be triggered in Luxembourg in the case where there is a distribution from the reverse hybrid to its partners at the exact same time where cash is received by the partnership. This is not addressed by the LTA
• Unfortunately, the fiscal year of RH entities should always correspond to the calendar year irrespective of a potential diverging financial year. This creates an additional burden for these particular cases. To be seen how divergent financial years starting in 2021 will be handled and specifically, cash income received before 1 January 2022. This remains unclear
• The LTA confirmed that they accept that RH entities can convert their non-EUR denominated net income into EUR using either the year-end exchange rate or the average exchange rate for the tax year (instead of converting each income/expense separately on a cash-basis). The LTA does not refer to any specific upfront filing requirement in that respect (such as a request to use foreign functional currency to calculate the taxable result)
• Based on the Circular, RH entities should retain the historical acquisition costs to determine their net income when they become subject to the reverse hybrid rules, hence no fiscal step-up is required. This would lead to the recognition of a higher gain upon disposal of the assets of the RH entity. This would require particular attention in practice when it comes to assessing the quantum of tax triggered and allocation of tax liability to the investors causing the RH entity treatment, based on the tax indemnity in the fund documentation, given that one could expect that only those investors should bear the additional tax burden. However, the fact that RH entities stop being subject to the reverse hybrid rules (e.g., where one of the conditions is no longer met) should not be considered as a deemed disposal of the assets of the entity. This should not lead to any “exit” taxation, even in case of latent gains
• Any tax withheld on payments received by the RH entity on a cash-basis is creditable against CIT charge, subject to certain limitations

3 - Withholding tax treatment

• Distributions made by RH entities should not be subject to withholding tax, as they should not qualify as income from movable capital within the meaning of Article 97 LITL. This is a helpful clarification from the LTA

4 - Tax Compliance Obligations

• Entities falling within the scope of Article 168quater should file Form 205. Although the Circular does not provide specific information on this form, the LTA also issued a specific FAQ in this respect on the same day

As explained above, the FAQ (available here) aims to provide additional information related to the compliance obligations of all types of Luxembourg partnerships (SCS(p)s) and in particular the tax forms 200/300 and the new 205 tax form.

We will focus here on the new form 205 (“Déclaration pour l’établissement en commun des revenus d’entreprises collectives et Déclaration pour l’impôt sur le revenu des collectivités”), which should be filed electronically by all SCS(p)s registered at office number 6.

1 - Who should file the 205 form?

The 205 form is an electronic procedure that must be filed through the MyGuichet.lu platform (no PDF version is available):

• Due to their specific nature, RH entities should file the 205 form
• The 205 form should also be filed by all Luxembourg tax transparent entities mainly generating income from movable property (article 97 LITL), miscellaneous income not in relation to immovable property (article 99 LITL) and where the net income should be determined and allocated at the level of each resident or non-resident partner
•  All the above-mentioned entities should file the first part of the 205 form (“Déclaration pour l’établissement en commun des revenus”)
• However, the second part of the 205 form (“Déclaration pour l’impôt sur le revenu des collectivités”) is specifically dedicated to compliance obligations of RH entities generating a type of income that triggers CIT based on article 168quarter LITL, as interpreted by the LTA (see above). Based on the FAQ, we expect that RH entities would likely have to file the second part of the form 205 even if they do not have to report any eligible income
• The LTA also confirmed that the 205 form must be filed by all relevant entities which were requested to do so, irrespective of the position taken by the person or service provider involved in said tax returns. We recommend that you discuss with your advisers in case you received any letters from the LTA, especially considering that we’ve seen historically different positions taken by specific tax offices. Hopefully the FAQ will align the position taken by the tax inspectors of any relevant tax office
• It goes without saying that the 205 form must be filed by entities not been invited to do so, but who meet the criteria for being subject to CIT based on article 168quater LITL

2 - Who should file the 200 form?

• In the FAQ, the LTA are listing all the relevant cases where the 200 form has to be filed or not
• As an example, any tax transparent entities realizing commercial profits based on article 14 LITL but not triggering Municipal Business Tax (“MBT”) or mainly generating income from immovable property should file the 200 form (" Déclaration pour l’établissement en commun des revenus d’entreprises collectives et de copropriétés")
• However, the LTA made it clear that the 200 form is not intended to cover Luxembourg tax transparent entities that are not RH, but that are mainly generating income from movable property (article 97 LITL) and miscellaneous income not in relation to immovable property (article 99 LITL)
• Note that 200 form and 205 form are mutually exclusive

3 -  Who should file the 300 form?

• The FAQ also covers the 300 form ("Déclaration pour l’établissement en commun du bénéfice commercial et déclaration pour l’impôt commercial"). The LTA reminds taxpayers that this specific form is solely reserved for tax transparent entities that generate commercial profits subject to MBT in accordance with article 14 LITL
• Note that 300 form and 205 form are mutually exclusive

Should you have any further questions or require assistance with your tax declarations, please do not hesitate to contact us.