As a reminder, the reverse hybrid provisions were part of a set of measures implemented by the Law of 20 December 2019 ("Law") transposing the amended (EU) Directive 2016/1164 (ATAD I) regarding hybrid mismatches with third countries (ATAD II)2 aimed at circumventing situations of double nontaxation resulting from those hybrid mismatches. By application of the implemented provisions, Luxembourg transparent partnerships may qualify as resident taxpayer and become liable to corporate income tax on their net income, to the extent that it is not otherwise taxed under Luxembourg domestic tax law or the law of any other jurisdiction. This rule applies provided that one or more associated nonresident entities (i) are holding in aggregate a direct or indirect interest in 50% or more of the voting rights, capital interests or profit entitlements in the Luxembourg partnership and (ii) consider the Luxembourg partnership as a taxable person (opaque entity). The reverse hybrid rules are applicable as of 1 January 2022.
Since its entry into force, many practical issues have been raised by tax professionals requesting clarifications from the legislator and the Luxembourg tax authorities (LTA).
The 2023 Budget Bill (Law of 23 December 2022) amended Article 168quater LITL, clarifying the conditions in which the reverse hybrid provisions apply. Indeed, the legislator confirmed that the reverse hybrid rule only applies when the nontaxation of the income paid by the payor to the entity results from the difference of tax qualification of an entity seen as tax-transparent in the country of establishment (e.g., Luxembourg) and tax-opaque in the jurisdiction of the investors. In accordance with the legislator's intention, the reverse hybrid provisions should not apply where the nontaxation of the income is due to the investor's tax-exempt status.
The Circular therefore provides necessary clarifications on the consequences of reverse hybrid's tax status in the meaning of Article 168quater LITL, as well as clarification on the determination of the reverse hybrid entity's net income and tax due. The Circular finally includes some useful guidance regarding tax filing and reporting.
- The participation exemption regime, the Controlled Foreign Companies (CFC) provision, the interest deduction limitations rule as well as the anti-hybrid provision do not apply to reverse hybrids.
- Luxembourg income tax law provisions in connection with the determination of the taxable income, capital gain or liquidation proceeds, for instance are applicable to reverse hybrids.
- The only categories of income subject to tax as a result of the application of the reverse hybrid rule are dividend and interest, rental income and royalties and o capital gains to the extent that they are not taxed under the Luxembourg income tax law provisions or under the laws of other jurisdictions.
- The net income of the reverse hybrid should be determined after deduction of relevant expenses from the income.
- If the income or the expenses of the reverse hybrid are denominated in another currency, the foreign exchange rate applicable is the one retained on the day of the payment. A tolerance is granted for using the foreign exchange rate applicable as of 31 December of the fiscal year.
- No step-up of the reverse hybrid's assets and liabilities is granted by virtue the entity becoming a resident taxpayer subject to corporate income tax.
- No withholding tax should be levied on distribution made by reverse hybrids.
- Certain qualifying dividend and interest income derived by the reverse hybrid may benefit from a partial tax exemption (50%).
- Foreign taxes may be credited against the taxes due by the reverse hybrid entity in proportion to income that is subject to tax at its level.
- A new Form 205 dedicated to reverse hybrid entities has been released and must be submitted annually to the LTA by reverse hybrid entities.
For further information and to discuss what this development might mean for you, please get in touch with your usual Baker McKenzie contact.
1 Circulaire du directeur des contributions L.I.R. n°168quater/1 du 9 juin 2023.
2 European Union (EU) Directive 2017/952 of 29 May 2017 amending (EU) Directive 2016/1164.