On June 9 2023, the Luxembourg tax authorities released an
initial administrative Circular1 regarding the taxation
of Luxembourg reverse hybrid entities, which includes tax
transparent entities and arrangements that meet the conditions
specified in Article 168quater of the Luxembourg Income Tax Law
("LITL"), along with a Q&A document2
concerning the corresponding annual return (Form 205) that was
published earlier this year. Additional administrative guidelines
are anticipated, particularly regarding the collective investment
vehicle exemption and the hybrid mismatch rules.
This update summarises the key points.
Tax Status and Regime of the Reverse Hybrid
Entity
The Luxembourg tax authorities have confirmed that a Luxembourg
reverse hybrid entity will be subject to Luxembourg corporate
income tax as a resident taxpayer, rather than as a resident
corporation (resident collective entity within the meaning of
Article 159 LITL). This will impact the determination of its
taxable profit and limit the applicable tax provisions
thereof.
The income of a reverse hybrid entity is therefore not classified
as commercial income and can only fall into three categories: (i)
income from movable capital (Article 97 LITL); (ii) rental income
(Article 98 LITL); and (iii) miscellaneous income (Article 99
LITL).
The tax base of a reverse hybrid will be determined by considering
the total net income earned during the calendar year, using a cash
accounting method (income received minus expenses paid), regardless
of the reverse hybrid's financial year.
A reverse hybrid entity will be subject to a maximum tax rate of
18.19% (including the 7% contribution to the employment fund) for
taxable income exceeding EUR 200,000.
Distributions of income by a reverse hybrid entity to its partners
are not subject to Luxembourg withholding tax.
The following tax rules will not apply to a reverse hybrid entity:
CFC rules (Article 164ter LITL), participation exemption regime
(Article 166 LITL for dividends and liquidation proceeds, and the
Grand Ducal Decree implementing Article 166(9) LITL for capital
gains), interest limitation rules (Article 168bis LITL) and
anti-hybrid rules (Article 168ter LITL).
The 50% exemption for dividends provided by Article 115(15a) LITL
is applicable under certain conditions and certain capital gains on
movable assets may not be taxable under certain conditions.
The historical acquisition value of the assets held by a reverse
hybrid entity will be maintained, even if those assets were
acquired prior to the entity becoming a reverse hybrid. This means
that the step-up in value rule for shares, as outlined in Article
102(4a), will not be applicable. Furthermore, when a reverse hybrid
entity is no longer subject to corporate income tax, there will be
no deemed realisation of its assets and liabilities.
Foreign taxes, as well as domestic withholding tax, may be credited
against the Luxembourg corporate income tax of the reverse hybrid
entity in proportion to the percentage of income subject to
corporate taxes at the reverse hybrid level.
Finally, the conversion of foreign currency income or expenses of
the reverse hybrid into Euro is generally made at the exchange rate
applicable on the day the income is received or the expense is
incurred. However, the conversion of these amounts will be
permitted at the year-end exchange rate or at the average exchange
rate for the year.
Annual Tax Return of the Reverse Hybrid Entity (Form
205)
Form 205 will replace Form 200 for transparent entities that
primarily generate income from movable capital (Article 97 of the
LITL) or miscellaneous net income (Article 99, numbers 1 and 2 of
the LITL), as well as for other tax transparent entities or
arrangements that qualify as reverse hybrids. The Form 200 and 300
will continue to exist for certain transparent3.
Form 205 must be submitted by any transparent entity (or
arrangement) under the following circumstances: (i) when requested
by mail to do so; (ii) upon formal request from the Luxembourg tax
authorities, or (iii) if identified as a reverse hybrid entity
according to the conditions outlined in Article 168quater (1)
LITL.
Form 205 is divided into two parts. The first part aims to report
the net income of the transparent entity that is subject to
taxation in Luxembourg, considering both resident and non-resident
investors. The second part of Form 205 is dedicated to the
reporting of the net taxable income of the reverse hybrid entity,
categorised by income types and (non-resident) investors. This
taxable income will be subject to Luxembourg corporate income tax
at the level of the reverse hybrid.
Finally, a list of all direct and / or indirect investors, i.e.
those invested through another tax transparent entity, in the
transparent entity must be attached to Form 205. This list should
indicate the percentage of ownership and corresponding allocated
amount of profits. By examining this list, the Luxembourg tax
authorities can verify the accuracy of the application of Article
168quater.
Footnotes
2 https://impotsdirects.public.lu/dam-assets/fr/echanges-electroniques/decl-coll/faq-modele-205.pdf
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.
