On 8 August 2019, the Luxembourg government filed a draft law implementing the Council Directive (EU) 2017/952 of 29 May 2017 amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries (hereafter the “ATAD 2 Directive”) into Luxembourg domestic law. The ATAD 2 Directive introduces additional forms of hybrid mismatches, not yet encompassed by the currently applicable rules, and expands their territorial scope to situations involving third states.
As expected, the draft law largely follows the original wording of the ATAD 2 Directive and only provides for occasional clarifications. It still needs to go through the legislative process and may be subject to amendments before the final vote by the Luxembourg Parliament (Chambre des Députés).
The draft law applies to all corporate taxpayers, including foreign entities having a permanent establishment (hereafter “PE”) in Luxembourg. The scope of the draft law is limited to hybrid mismatches arising:
(i) between a taxpayer and his associated enterprise(s) or between associated enterprises;
(ii) between an entity’s head office and a PE;
(iii) between two or more PEs of the same entity; or
(iv) under a structured arrangement.
As regards the definition of an “associated enterprise”, the draft law notably proposes to introduce an autonomous concept for the sole purpose of the anti-hybrid mismatch rules, aiming notably at:
(i) an entity in which the taxpayer holds directly or indirectly a participation in terms of voting rights or capital ownership of 50% or more or is entitled to receive 50% or more of the profits of that entity;
(ii) an individual or entity which holds directly or indirectly a participation in terms of voting rights or capital ownership in a taxpayer of 50% or more or is entitled to receive 50% or more of the profits of the taxpayer
(iii) an entity that is part of the same consolidated group for financial accounting purposes as the taxpayer ; or
(iv) an entity in which the taxpayer has significant influence in the management of the taxpayer or an entity that has a significant influence in the management of the taxpayer.
Furthermore, in line with the ATAD 2 Directive, the draw law introduces a new rule stating that an individual or entity acting together with another individual or entity in respect of the voting rights or capital ownership of an entity is considered as holding a participation in all of the voting rights or capital ownership of that entity that are held by the other individual or entity. Interestingly, the draft law specifies that, unless proven otherwise by the tax authorities, an individual or entity holding directly or indirectly less than 10% in, and entitled to receive less than 10% of the profits of, an investment fund is not be treated as acting together with any other individual or entity holding an interest in the same investment fund. As mentioned in the government’s comments to the relevant provision, the investors in an investment funds generally do not have effective control over the investments made by the fund and should thus not be impacted by the anti-hybrid mismatch rules. The term investment fund is in this context understood as any collective investment vehicle raising funds from a number of investors in order to invest them in accordance with a defined investment policy to the benefit of the investors.
Hybrid mismatch scenarios
The draft law extends the hybrid mismatch scenarios to four main categories:
- hybrid mismatches resulting from payments under a financial instrument ;
- hybrid mismatches resulting from the differences in the attribution of a payment made to a hybrid entity or a PE (including payments to a disregarded PE) ;
- hybrid mismatches resulting from payments made by a hybrid entity to its owner or payments made between the head office and the PE or between two or more PEs ;
- double deduction outcomes resulting from payments made by a hybrid entity or a PE.
In the presence of a hybrid mismatch giving rise to a deduction / non-inclusion outcome, Luxembourg will in the future either deny the deduction of the payment (under the primary rule, in case Luxembourg is the payer jurisdiction) or oblige the taxpayer to include the payment in its tax base (under the defensive rule, in case Luxembourg is the payee jurisdiction and the hybrid mismatch is not neutralised by the payer jurisdiction). The comments to the draft law seem to clarify that the denial of the deduction / inclusion in the tax base will only be applied in proportion to the amount giving rise to a double deduction or deduction without inclusion.
In the presence of a hybrid mismatch giving rise to a double deduction outcome, Luxembourg will deny the deduction of the payment (i) in case Luxembourg is the investor jurisdiction and (ii) in case Luxembourg is the payer jurisdiction but the investor jurisdiction allows for deduction.
Imported hybrid mismatches
Payments made by an entity or individual, which directly or indirectly fund deductible expenses giving rise to a hybrid mismatch between associated enterprises or in a structured arrangement, shall not be deductible in Luxembourg, unless an equivalent adjustment has already been made by one of the jurisdictions involved in the transaction.
Tax residency mismatches
Where a taxpayer is considered resident in two or more jurisdictions, the payments, expenses or losses which would usually be tax deductible, are denied where otherwise a double deduction would occur. Luxembourg will nonetheless allow the deduction where it has concluded a double tax convention with the other jurisdiction(s) and according to which the taxpayer is considered a resident in Luxembourg.
The draft law will also cover hybrid transfers constituting arrangements whereby a financial instrument is transferred and the underlying return is treated for tax purposes as deriving from more than one of the parties to the arrangement.
The hybrid transfer rule notably targets securities lending and/or repo arrangements. In case a hybrid transfer gives rise to a deduction without inclusion outcome, the primary and defensive rules described above would apply.
Reverse hybrid mismatches
Reverse hybrid entities are entities established in Luxembourg, which are considered transparent for Luxembourg tax purposes, but treated as taxable entities by one or more non-resident associated enterprise(s) holding directly or indirectly in terms of voting rights, capital ownership or share of profits at least 50% in such a hybrid entity.
According to the draft law, an entity established in Luxembourg is considered as resident in Luxembourg and its income is subject to corporate income tax to the extent that this income would not otherwise be taxed in Luxembourg or any other jurisdiction. Such entity would however not be subject to municipal business tax or to net worth tax. This rule does however not apply to investment funds, defined as widely-held vehicles, which hold a diversified portfolio of securities and are subject to investor-protection regulation in the country in which they are established.
While the provisions of the draft law will apply as of 1st January 2020, the reverse hybrid mismatch rule would only apply as of 2022.
Documentation and evidence
The draft law finally provides that, upon request by the Luxembourg tax authorities, taxpayers must be able to provide documentary evidence of the non-application of the anti-hybrid mismatch provisions, for instance in the form of a declaration by the counterparty, tax returns, assessments or certificates issued by foreign tax authorities.