Private equity players and alternative investors will likely be familiar with the acronym ATAD, but it might not be the case for those in Luxembourg's banking sector. It is time, however, for them to get to grips with these four letters which stand for Anti-Tax Avoidance Directive. Why? Well, despite these new tax measures focusing primarily on unregulated multinational enterprises, they could have a significant impact on more traditional investment industries.

What are ATAD 1 & ATAD 2?

ATAD arose from the OECD's ambitious Base Erosion and Profit Shifting (BEPS) project launched back in 2015.

It is designed to equip governments with the appropriate domestic and international instruments needed to ensure that tax is paid where income is generated and/or value is created, ultimately restoring trust in the fairness of tax systems.

Effective in Luxembourg since 1 January 2019 (with the exception of the amended exit taxation rules applicable only as from 1 January 2020), ATAD 1 addresses the following:

  1. Exit taxation
  2. Hybrid mismatches within the EU
  3. Controlled foreign companies (CFC)
  4. Interest limitation rules
  5. General anti-abuse rules (GAAR)

While some of these provisions only imply slight modifications to the existing domestic tax framework, others bring more significant changes.

On 8 August 2019, the Luxembourg government issued bill n°7466, transposing ATAD 2. The main purpose of ATAD 2 (effective from 1 January 2020, except the "reverse hybrid" measures applicable as from 1 January 2022) is to broaden the scope of hybrid mismatches outside of the EU.

ATAD 1's impact on banks

Given the specific nature of the banking industry, not all of the tax measures put forward by ATAD 1 are relevant.

For instance, CFC rules have little impact given that banks face regulatory restrictions when it comes to equity investments and, generally speaking, do not hold participations/shareholdings in low tax jurisdictions with no substance requirements.

Banks are advised, however, to review their potential exposure to interest limitation rules if they are a member of a fiscal unity.

Under the Luxembourg rules, banks are not generally affected by the interest limitation rules, except indirectly, when part of a fiscal unity. Indeed, interest limitation rules may apply at the level of the other members of the fiscal unity and could thus impact the fiscal unities' consolidated taxable basis.

In addition, the anti-abuse provisions should also be taken into consideration by banks when carrying out various operations including restructuring. Indeed, the genuine commercial character of any operation needs to be demonstrated in case it is challenged under the anti-abuse provisions.

We mustn't forget that Luxembourg securitization vehicles that do not fulfil the requirements of Article 2 (2) Regulation (EU) 2017/2402 may also be impacted by the new interest limitation rules, potentially resulting in significant additional tax exposure as from 2019.

ATAD 2 – What banks need to know

ATAD 2 mainly extends the hybrid mismatch provisions to non-EU scenarios by targeting financial derivatives, foreign/domestic tax credits and specific instruments satisfying loss-absorbing capacity requirements applicable to banks.

The bill considers the following situations as hybrid mismatches subject to tax adjustments in Luxembourg:

  • Securities lending or repo transactions where the securities lender/repo seller continues to qualify as economic owner of the transferred underlying asset
  • Payments giving rise to multiple tax credits on withheld taxes

The bill also states that common financial instruments aimed at satisfying banks' loss-absorbing capacity, should not lead to a hybrid mismatch situation, and therefore do not require tax adjustments by Luxembourg banks. This will only remain applicable until 31 December 2022.

Three actions banks need to take

  1. If in a fiscal unity, review their potential interest limitations exposure
  2. Ensure that operations have been reviewed from an anti-abuse perspective
  3. Review their derivatives transactions to spot potential hybrid mismatches

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.