Luxembourg tax authorities clarify the "CIV carve-out" under the reverse hybrid rules

Background and context

Since January 2022, further to the implementation of ATAD 2, reverse hybrid rules can subject Luxembourg transparent partnerships to corporate income tax where associated non-resident entities holding 50% or more of interests treat the partnership as a taxable person whilst the income remains otherwise untaxed. However, CIVs benefit from a specific carve-out from these rules.

For the purposes of Article 168quater, paragraph 2 LITL, a CIV is defined as an investment vehicle that (i) has broad investor participation, (ii) holds a diversified portfolio of securities, and (iii) is subject to investor-protection regulation in the country in which it is established.

The clarifications of the Circular

The Circular confirms that the following Luxembourg vehicles automatically qualify as CIVs: 

• Undertakings for Collective Investments (UCIs) under the amended law of 17 December 2010,
• Specialised Investment Funds (SIFs) under the amended law of 13 February 2007 (the “2007 SIF Law”), and
• Reserved Alternative Investment Funds (RAIFs) under the amended law of 23 July 2016.

In relation to entities other than those referred to above, the Circular provides the following clarification on the interpretation of the conditions set out in Article 168quater, paragraph 2 LITL:

1. Broad investor participation

The broad participation condition targets investment vehicles whose shares or units are marketed for distribution to several unrelated investors. The Circular provides welcome flexibility by recognising that a restricted circle of investors does not necessarily constitute a breach of the broad participation condition. 

Funds in their launch phase may comply with the broad participation condition even with limited initial investors, provided broader participation is reasonably expected within 36 months of authorisation or establishment. Similarly, during the liquidation phase, non-compliance with this condition is acceptable where the failure is attributable to the liquidation process.

In master-feeder structures, the Circular clarifies that a transparency approach applies, meaning the criterion is assessed based on the investors in the relevant feeder fund.

For the purpose of determining whether there is broad participation among "several unrelated investors", the Circular provides that investors are considered related where: one holds 50% or more of voting rights or capital in the other; they are under common control of 50% or more; they are family members (including spouses, civil partners, relatives, and adopted persons); or one controls the other based on all relevant facts and circumstances.

In addition, the Circular provides that the broad participation condition is satisfied where no individual natural person holds or controls, directly or indirectly, more than 25% of capital participations or voting rights, or controls the fund by other means. For verification purposes, tax authorities may rely on information from the Register of Beneficial Owners to confirm the absence of such controlling individual investors.

2. Diversified securities portfolio

The Circular adopts a broad interpretation of "securities" including shares and similar instruments giving access to capital, beneficiary shares, bonds and other receivables, CIV units, credit institution deposits, and financial derivatives where the underlying consists of securities.

The diversification is assessed based on the investment policy as set out in management regulations or constitutional documents, as well as market risk exposure (including direct and indirect counterparty risk) considering the investment policy followed.

The Circular also offers a negative test, meaning that a fund lacks diversification if risk spreading does not comply with SIF requirements under the 2007 SIF Law, particularly if it invests more than 30% of assets or commitments in securities from a single issuer without adequate justification, or if derivative use lacks comparable risk diversification.

3. Investor protection compliance

This condition is presumed fulfilled for investment vehicles authorised and subject to prudential supervision by the CSSF, or alternative investment funds managed by duly authorised AIFMs under Directive 2011/61/EU.

Conclusion 

The Circular provides essential clarification and confirmation for the Luxembourg fund industry, enhancing Luxembourg's competitive position whilst providing greater legal certainty for fund managers and investors navigating the reverse hybrid rules.