Luxembourg Tax Authorities issue guidance on reverse hybrid rules

LU Law

On 9 June 2023, the Luxembourg Tax Authorities (“LTA") published a circular letter concerning the application of the reverse hybrid rules (the “Circular"). The Circular provides guidance on the determination of tax owed by Luxembourg reverse hybrid entities.

As per article 168quater of the Luxembourg Income Tax law (the “LITL"), a Luxembourg entity considered as transparent for Luxembourg tax purposes and whose income is not taxed in Luxembourg or abroad, will be considered as a reverse hybrid entity if one or more associated enterprises, holding directly or indirectly a minimum of 50% of the entity's voting rights, capital, or rights to profits, are located in a jurisdiction that views the entity as opaque and, consequently, do not tax the income attributable to the relevant associated enterprise due to the hybrid mismatch.

The Circular1 offers some guidance on the implications of being classified as a reverse hybrid entity.

1. Tax status of a reverse hybrid entity

Specific tax status

The Circular specifies that a reverse hybrid entity does not qualify as a tax resident collective entity (organisme à caractère collectif") within the meaning of article 159 of the LITL per se.

It is however subject to corporate income tax (“CIT") rules in relation to certain categories of income attributable to the relevant investor. This entails that certain provisions of the LITL will be applicable to the income of a reverse hybrid entity, while those specifically applicable to collective entities are to be excluded.

LITL provisions that are applicable

According to the Circular, the following CIT provisions apply to reverse hybrid entities:

  • Articles 158 and 163(1) of the LITL: a reverse hybrid entity is subject to CIT annually based on the calendar year.
  • Article 162(1) of the LITL: as a rule, the provisions of Title 1 of the LITL applicable to natural persons apply to reverse hybrid entities. In practice, only certain categories of income are likely to be taxed at the level of reverse hybrid entities.
  • Article 115 15a of the LITL: a reverse hybrid entity may claim a 50% exemption on dividends from certain participations.
  • Articles 13, 134bis and 134ter of the LITL: a reverse hybrid entity may claim relief from CIT regarding foreign and/or local withholding tax levied on income received.
  • Articles 168(2) and 168(4): certain categories of expenses are not deductible from a reverse hybrid entity's income such as taxes, as well as charitable or religious expenses.
  • Articles 173 and 174(1) of the LITL: reverse hybrid entities are subject to the same CIT rates as a corporate resident taxpayer.

LITL provisions that are not applicable

The Circular explicitly lists the following LITL provisions as being inapplicable to reverse hybrid entities:

  • Article 164ter of the LITL: controlled foreign corporation (CFC) rules.
  • Article 166 of the LITL: the Luxembourg participation exemption regime on income received (although, as mentioned above, a 50% exemption may be available as per article 115 15a of the LITL).
  • Article 168bis of the LITL: interest deduction limitation rules.
  • Article 168ter of the LITL: hybrid mismatch rules.

2. Determination of the total net income and the tax due in respect of a reverse hybrid entity

The Circular indicates that income from capital within the meaning of article 97 of the LITL, rental income within the meaning of article 98 of the LITL and capital gains within the meaning of article 99 of the LITL would be taxable at the level of the reverse hybrid entity, provided that such income is not otherwise taxed in Luxembourg or abroad.

Net income would be obtained by subtracting operating expenses from the gross income.

A reverse hybrid entity would also be annually subject to CIT (cf. art. 158 of the LITL) on its net income realized during the calendar year (cf. art. 163 al. 1 of the LITL) at standard CIT rates (cf. art. 174 al. 1 of the LITL).

Should income or expenses be denominated in a foreign currency, the conversion of such currency into euros is in principle to be performed at the date of the receipt of income or the date at which the expense was incurred. However, the Circular provides for a simplification measure allowing to convert the amounts either at the year-end exchange rate or at the average exchange rate of the year.

The Circular further indicates that distributions made by a reverse hybrid entity will not be subject to Luxembourg withholding tax given that such distributions would not qualify as income from capital within the meaning of article 97 of the LITL.

As previously mentioned, a reverse hybrid entity may benefit from a 50% exemption on dividends from a qualifying participation within the meaning of article 115 15a of the LITL.

Moreover, if capital income received by the reverse hybrid entity suffered domestic or foreign withholding tax, to the extent final, those should be proportionally deductible from the income subject to CIT at the level of the reverse hybrid entity.

3. Reporting obligations

Together with the Circular, the LTA published on its website information regarding reporting obligations imposed on a reverse hybrid entity2 , including a FAQ document (the “FAQ"3 ).

The Circular indicates that a new form (form 205) will have to be filed by Luxembourg reverse hybrid entities. The FAQ specifies notably that form 205 should be filed as from tax year 2022 and contains other relevant information regarding reporting that will need to be taken into consideration for compliance purposes.

How we can help you

Our tax team is available to assist you with the application of these rules.