Background
On 9 June 2023, the Luxembourg tax authorities (the “LTA”) published the long-awaited circular (L.I.R. n° 168quater/1) (the “Circular”) providing clarifications on the Luxembourg reverse hybrid mismatch rules (the “RHMR”) as laid out by Article 168quater of the Luxembourg income tax law (“LITL”). On the same date, the LTA released a frequently asked questions (“FAQ”) in relation to the new Form 205 which should be filed by tax-transparent entities that mainly realize net investment income.
The RHMR targets situations where an undertaking and certain arrangements are treated as tax-transparent in Luxembourg but as tax opaque in the jurisdiction(s) of its investors (“Reverse Hybrid Entity(ies)”) and such situation leads to a non-taxation of the income in any of the jurisdictions involved. Hence, the RHMR aims at hindering double non taxation.
Accordingly, provided certain conditions are observed (i.e., related party tests) a Luxembourg tax-transparent entity falling under the RHMR will become subject to Luxembourg corporate income tax (“CIT”) (including unemployment fund contributions) at a rate of 18.19% for fiscal year 2023 on a portion of its net income that is not taxed in Luxembourg nor elsewhere.
These guidelines follow the legislative clarification issued last year on the conditions for the application of RHMR (see our previous article here).
Tax status of reverse hybrid entities
The Circular specifies that Reverse Hybrid Entities should not qualify as a collective undertaking (“organisme à caractère collectif”) within the meaning of the LITL. However, since a portion of its income is subject to CIT by application of the RHMR, some of the provisions of the LITL applicable to collective entities may apply.
In this respect, the Circular seems to establish a limitative list of Articles of the LITL intended to apply in relation to collective undertakings, that are also applicable to Reverse Hybrid Entities (e.g., provisions dealing with no deduction of specific expenses; portion of taxable result not subject to CIT; applicable CIT rates, etc). Conversely, the Circular also states that certain provisions of the LITL such as the controlled foreign companies’ rules, participation exemption on dividend income and withholding tax rules, exceeding borrowing costs rules, and reverse hybrid mismatch rules are not applicable to the Reverse Hybrid Entities.
Determination of the CIT base and amount of tax due by Reverse Hybrid Entities
The Circular also clarifies how the CIT base and amount of tax due by a Reverse Hybrid Entity should be determined in case the RHMR applies. In this respect, the Circular points out that taxable income according to the RHMR includes only (i) portfolio income, (ii) rental income, and (iii) miscellaneous net income ("revenus net divers"). In this context, only net income that is not otherwise taxed under the LITL or the laws of any other jurisdiction may be taxed at the level of a Reverse Hybrid Entity.
Furthermore, the Circular details how should be determined the taxable result of a Reverse Hybrid Entity. This is calculated by deducting acquisition/procurement costs from income received during a calendar year. Moreover, revenue or acquisition/procurement costs denominated in a foreign currency should be converted into EUR with the possibility of using the end-year exchange rate or a yearly average exchange rate for simplification purposes.
It is also noteworthy that distributions of income made by a Reverse Hybrid Entity will not qualify as capital income and therefore will not be subject to withholding tax in Luxembourg.
On the other hand, a Reverse Hybrid Entity may, under certain conditions, benefit from the 50% exemption on dividend income. Any withholding tax levied at source on capital income may be credited proportionally to the portion of income subject to CIT in Luxembourg under the RHMR. Also, it is expected that certain foreign taxes may be credited proportionally to such a portion of income, provided that certain conditions are met.
Tax compliance obligations of reverse hybrid entities
The Circular explains that Reverse Hybrid Entities must declare their income subject to CIT in a new specific form (“Form 205”) on an annual basis.
FAQ related to the new Form 205
Alongside the release of the Circular, the LTA have released a FAQ in relation to the new Form 205 which should be filed electronically via Myguichet (such filing is not possible in PDF format) as from fiscal year 2022.
According to the FAQ, the Form 205 should be filed by Luxembourg tax transparent undertakings and arrangements which are considered as Reverse Hybrid Entities and generate income subject to CIT
It should be noted that the Form 205 must be filed in any case by undertakings and arrangements which have been requested to do so in a correspondence received from the LTA. Nonetheless, the filing of the Form 205 is also required for undertakings and arrangements which did not receive such a request from the LTA where the criteria for these entities to file Form 205 are met. Hence, it would be required that these potential deemed resident taxpayers undertake their own assessment.
In terms of interaction with other tax compliance obligations, the Circular makes reference to:
- So called, form 200) which is intended for tax transparent entities which generate business income not subject to municipal business tax, income from agriculture and forestry or income from a liberal profession.
- So called, form 300) which is only used by tax transparent entities which generate business income subject to municipal business tax.
The FAQ makes clear that (i) the form 205 and (ii) any of the form 200 or the form 300, are in principle mutually exclusive.
Form 205 should be filed before the relevant tax office (in principle tax office 6) by 31 December of the year following the reporting period. The fact that this filing must be done before the competent tax office and that this reporting is interdependent with the filing of forms 200 and 300 seem in our view to indicate that entities and arrangements which are subject to subscription tax are not concerned by the filing of the Form 205. That being said, it is strongly recommended for any Luxembourg tax transparent entity or arrangement e.g., (special) Limited partnership (SCS(p)) or common contractual fund (“FCP”) to assess on a case-by-case basis whether it is subject to this new tax compliance obligation based on an ongoing yearly assessment.
Take away
The additional guidelines and FAQ on the RHMR are welcome considering the complexity of such rules and their expected non-negligible impact. This seems to indicate that the LTA will start shortly enforcing the RHMR provisions. It is hence key for asset managers and investment fund structures in Luxembourg to continuously monitor these aspects in the next months. We would be pleased to assist you to mitigate any risk of tax audit and sanctions.
