In December 2022, the Luxembourg Parliament passed the 2023 Budget Law, which amended Article 168quater of the Luxembourg Income Tax Law (LITL) in relation to the so-called “anti-reverse hybrid rules” of the EU’s second Anti-Tax Avoidance Directive (ATAD 2)1.
On 9 June 2023, the LTA issued Circular L.I.R. n° 168quater/1 (“the Circular”) regarding these anti-reverse hybrid rules, alongside an FAQ to address the tax compliance obligations of all types of Luxembourg SCS(p)s, in particular the 200/300 tax forms and the new 205 tax form.
This survey once again finds that SCSps are the most commonly used vehicles for private debt funds in Luxembourg, and anti-reverse hybrid rules’ impact on these vehicles has remained a hot topic since the publication of ATAD 2 in December 2019.
Anti-hybrid rules applicable in Luxembourg
Under Article 168quater LITL, Luxembourg entities or arrangements that are, in principle, tax transparent in Luxembourg, such as SCSps that are not subject to Luxembourg corporate income tax (CIT), could become subject to CIT on their income when certain conditions are met.
One of these conditions is when the jurisdiction(s) of the investor(s) consider(s) the Luxembourg entity or arrangement as a taxable (i.e. tax opaque) person in Luxembourg. This difference in qualification and the resulting income allocation would mean the Luxembourg entity or arrangement is regarded as a reverse hybrid.
Notably, these anti-reverse hybrid rules do not apply to collective investment vehicles (CIVs). This exemption defines CIVs as investment funds or vehicles that are (based on article 168 quarter LITL) “widely held, hold diversified portfolio of securities and are subject to investor-protection regulations in the country in which they are established”. Therefore, each AIF should assess whether this CIV exemption applies to them.
These rules have applied since the beginning of fiscal year 2022.
2023 Budget Law retrospective amendment
The 2023 Budget Law amending Article 168quater LITL clarifies that the lack of taxation of the income realized by the investor(s) through the Luxembourg tax transparent entity or arrangement must be due to the difference in the Luxembourg vehicle’s qualification, and not the investor’s subjective tax exemption. In other words, when income is not taxed at the investor level above the SCSp due to these investors’ subjective tax exemption in their respective jurisdictions (e.g. certain pension funds or sovereign wealth funds), anti-hybrid rules should not apply in Luxembourg.
In addition, the lawmakers clarified that, if Article 168quater LITL applies, only the portion of income attributable to associated enterprises that triggers its application should be subject to Luxembourg CIT. For example, investors who do not qualify as associated enterprises or who benefit from a subjective tax exemption should not be impacted by these rules.
As this amendment applies retrospectively from tax year 2022, entities or arrangements in scope of former rules may retroactively benefit from this new rule.
The Circular and FAQ
The LTA’s guidelines in the Circular offer important clarifications regarding the practicalities of the reverse-hybrid rules in Luxembourg. These include the reverse hybrid entity’s tax status, determining its total net income, and calculating the tax due.
The LTA confirmed that, unlike regular tax resident companies, the taxable basis of a reverse-hybrid Luxembourg SCSp would be determined based on revenues” (“recette”) minus expenses” (“frais d’obtention”), on a cash basis. In a typical alternative investment structure, this means that 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 reverse hybrid entity. This raises the question of whether tax would be triggered in Luxembourg if the reverse hybrid makes a distribution to its partners at the exact same time that the partnership receives the cash.
The LTA also provided the helpful clarification that distributions made by reverse-hybrid 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.
In its associated FAQ, the LTA provided additional information regarding the compliance obligations of all types of Luxembourg SCS(p)s. The new 205 form should be filed by all Luxembourg tax transparent entities that mainly generate income from movable property (Article 97 LITL), miscellaneous income not regarding immovable property (Article 99 LITL) and where the net income should be determined and allocated at each resident or non-resident partner’s level.
The second part of the 205 form (“Déclaration pour l’impôt sur le revenu des collectivités”) is regarding the compliance obligations of reverse hybrid entities that generate income triggering CIT, based on Article 168quarter LITL and as interpreted by the LTA.
New Luxembourg-UK double tax treaty
A positive development for Luxembourg private debt funds