An FAQ published on the same day (the FAQ) provides clarifications on the new tax form 205, the tax return to be filed by these reverse hybrid entities. The Circular and the FAQ provide valuable guidance in time for the first reporting deadline (i.e. 31 December 2023). However, some important questions remain open, in particular regarding investment funds.
The reverse hybrid rules affect Luxembourg tax transparent entities under certain conditions
Effective as of tax year 2022, article 168quater of the LITL lays down rules to neutralise situations of double non-taxation resulting from Luxembourg tax transparent entities (e.g. common limited partnerships, special limited partnerships, mutual funds) being treated as tax opaque in their investors’ jurisdiction(s). If the rules apply, the Luxembourg tax transparent entity becomes subject to Luxembourg corporate income tax on its net income that is not otherwise subject to taxation pursuant to the LITL or the laws of another jurisdiction.
The rules apply if one or more associated enterprises holding, directly or indirectly, at least 50% of the Luxembourg tax transparent entity (in terms of voting rights, capital ownership or profit distribution rights) are resident in jurisdictions that regard the Luxembourg entity as tax opaque and do not tax the underlying income as a result thereof. They do not apply to collective investment vehicles, i.e. investment funds or vehicles that are widely held, hold a diversified portfolio of securities and are subject to investor-protection regulation.
The reverse hybrid tax regime differs from the standard tax regime for opaque entities
The Circular clarifies that, for tax purposes, reverse hybrid entities are not standard opaque entities (as defined in article 159 of the LITL). Thus, not all provisions of the LITL apply to them.
The main differences between the reverse hybrid tax regime and the standard tax regime for opaque entities may be summarised as follows:
- The tax year corresponds to the calendar year, regardless of the reverse hybrid entity’s accounting year.
- Income and expenses should be recorded according to the cash accounting method, as opposed to the accrual accounting method.
- A reverse hybrid entity is subject to corporate income tax on the following three categories of income:
- net income from movable capital within the meaning of article 97 of the LITL, which includes interest and dividends;
- net income from rental property within the meaning of article 98 of the LITL; and
- miscellaneous net income within the meaning of article 99 of the LITL, which includes capital gains.
- The controlled foreign companies, interest limitation and other hybrid mismatch rules are not applicable to a reverse hybrid entity.
- A reverse hybrid entity cannot rely on the participation exemption regime. For dividends, a reverse hybrid entity should still benefit from the 50% dividend exemption available under certain conditions based on article 115-15a of the LITL. However, capital gains on shares, to the extent taxable, would not benefit from any exemption. In this respect, the Circular specifies that, for tax purposes, the assets of a reverse hybrid entity are to be valued at their historical acquisition cost (i.e. there is no step-up in value upon becoming a reverse hybrid entity).
- There are no tax consequences if an entity ceases to be a reverse hybrid entity.
- Income and expenses denominated in a foreign currency should, in principle, be converted into euros at the exchange rate applicable on the day the income is received or the expense incurred. However, the Circular provides for an administrative tolerance allowing the conversion into euros either on the year-end exchange rate or on the average exchange rate for the tax year.
- Distributions made by a reverse hybrid entity are not subject to withholding taxes in Luxembourg.
Reverse hybrid entities must file tax form 205 on an annual basis
Reverse hybrid entities must file tax form 205 at the latest by 31 December following the relevant tax year, i.e. it is due for the first time by 31 December 2023 with respect to tax year 2022. The tax form must be submitted in electronic form through the MyGuichet portal.
The FAQ clarifies that this form must be filed by any entity established in Luxembourg that is tax transparent by virtue of article 175 of the LITL and that realises primarily income from movable capital under article 97 of the LITL or miscellaneous income under article 99 of the LITL. Furthermore, any tax transparent entity would be required to file this form if it is invited by the LTA to do so or if it otherwise falls within the scope of the Luxembourg corporate income tax.
It is further clarified that an entity required to file tax form 205 would not be required to file tax form 200 or 300, and vice versa.
It should be noted that tax form 205 must be filed even if the net income to be reported is zero for a given tax year. Only the second part of the form concerns the information to be filled out for reverse hybrid entities.
Despite the clarifications brought by the Circular and the FAQ, challenges and questions remain
While the Circular and the FAQ clarify many aspects of the reverse hybrid rules and the related reporting formalities, some questions remain open. In particular, neither the Circular nor the FAQ address the application of the reverse hybrid rules to Luxembourg investment funds subject to a subscription tax. Further, no guidance has been provided regarding the collective investment vehicle exemption.
Depending on the circumstances, the new tax form 205 may cause significant administrative burdens and ongoing monitoring given that it requires the disclosure of the identity and addresses of the entity’s partners or unit holders, regardless of whether the entity is considered a reverse hybrid entity or not.
Finally, a separate set of accounts may need to be established for tax purposes given that the cash basis method needs to be used and that the tax year may differ from the entity’s accounting year.