Background
As a reminder, the reverse hybrid rule was part of a set of measures implemented by the Luxembourg law of 20 December 2019 transposing Council Directive (EU) 2017/952 of 29 May 2017 amending Directive (EU) 2016/1164 (ATAD I and II), which was aimed at circumventing situations of double non-taxation resulting from hybrid mismatches.
Since the 2022 tax year, a Luxembourg entity that is considered transparent from a Luxembourg tax perspective (such as a common limited partnership (CLP) or a special limited partnership (SLP)) may be subject to the reverse hybrid rule if it is treated as tax-opaque in the jurisdiction(s) of its nonresident associated enterprises that hold, in aggregate, directly or indirectly, 50% or more of the voting rights, capital interests or rights to a share of profit in the Luxembourg tax-transparent entity. Consequently, the Luxembourg tax-transparent entity, which is not, in principle, taxable in Luxembourg, becomes subject to Luxembourg corporate income tax on its net income to the extent that this income is not taxed in Luxembourg or in any other jurisdiction and where this non-taxation results from a difference of the Luxembourg entity’s tax qualification.
However, certain Luxembourg tax-transparent entities can benefit from an exception (the CIV carve-out) and, thus, are not subject to the reverse hybrid rule if they meet certain conditions.
Since 2022, professionals have raised practical concerns and have sought clarifications from the LTA. While the LTA provided initial guidance on 9 June 2023 concerning the consequences of the reverse hybrid entity’s tax status and the determination of the reverse hybrid entity’s net income and tax due, the new circular clarifies under which conditions CIVs are excluded from the reverse hybrid rule’s scope of application.
Key clarifications
Luxembourg UCIs, SIFs and RAIFs are considered CIVs in themselves
It is now clear that Luxembourg investment funds subject to (i) the Luxembourg amended law of 17 December 2010 relating to undertakings for collective investment (UCI), (ii) the Luxembourg amended law of 13 February 2007 relating to specialized investment funds (SIF) and (iii) the Luxembourg amended law of 23 July 2016 on reserved alternative investment funds (RAIF) are considered CIVs in themselves. Therefore, they are excluded from the reverse hybrid rule (without needing to check whether they meet other conditions).
Other Luxembourg investment funds are considered CIVs if they meet three conditions
The other Luxembourg investment funds (such as a CLP or SLP qualifying as an alternative investment fund (AIF) within the meaning of the Luxembourg amended law of 12 July 2013 on alternative investment fund managers (AIFM)) may also benefit from the CIV carve-out (and thus be excluded from the reverse hybrid rule’s scope of application). However, this is only if they meet the three conditions foreseen in the law, i.e., they are widely held, hold a diversified portfolio of securities and are subject to investor-protection regulation in the country in which they are established.
The circular provides welcome clarifications on each of these criteria.
Being "widely held"
According to the circular, an investment fund is considered widely held if its shares or units are marketed for distribution to several unrelated investors. More precisely, the circular specifies the following:
The broad participation condition may still be met even with a limited number of investors (particularly during the investment fund’s launch or liquidation phase), depending on factual and intentional circumstances.
In a master-feeder structure, the condition is assessed at the level of the investors of the feeder fund(s).
Investors are related if one holds, directly or indirectly, 50% or more of the voting rights or capital of the other; if an individual or an entity holds, directly or indirectly, such a stake in both; if they are family members; or, taking into account all the relevant facts and circumstances, if one controls the other or both are controlled by the same individual or entity.
In any case, broad participation is presumed where no individual investor, directly or indirectly, owns more than 25% of the investment fund’s voting rights or capital or controls it by other means. In this respect, the LTA may rely on the information published in the register of beneficial owners.
Holding a "diversified portfolio of securities"
To assess whether an investment fund has a diversified portfolio of securities, the circular specifies the following:
The term "securities" must be understood in its broadest sense, including various types of assets: shares and other securities that give access to the capital of a legal entity, beneficiary shares, bonds and other debt securities, fund’s units, deposits with credit institutions, and derivative financial instruments if the underlying asset consists of securities.
Diversification is assessed based on the investment fund’s investment policy and market risk exposure.
Furthermore, in terms of risk spreading (and in line with the requirements for SIFs), an investment fund is not considered diversified, in principle, (i) if it invests more than 30% of its assets or commitments in securities from a single issuer, unless it provides adequate justification for departing from this rule, or (ii) if its use of derivatives lacks appropriate diversification of underlying assets.
Being "subject to investor-protection rules in the country where it is established"
According to the circular, this condition is presumed to be met if the investment fund is subject to prudential supervision by the Commission de Surveillance du Secteur Financier (such as SICARs) or if the AIF is managed by an AIFM duly authorized in accordance with the AIFM Directive.
For further information, and to assess the potential implications of this development — including support with reviewing fund structure and documentation — please get in touch with your usual Baker McKenzie contact.
