On 19 December 2019, the Luxembourg Parliament passed the 2020 Budget bill covering the expiry of pre-2015 advance tax agreements as well as bill 7466 on the transposition of the EU Anti-Tax Avoidance Directive 2 (ATAD 2) into Luxembourg domestic tax law. A request to dispense with the second vote has been filed with the State Council.

The main tax measure relates to the expiry of advance tax agreements (ATAs) issued by direct tax authorities before 1 January 2015. Those ATAs will no longer be valid after tax year 2019 (no change made to the initial bill in this respect), but taxpayers will be allowed to request a new ATA under the procedure applicable since 2015. 

On 3 December 2019, the tax administration issued a newsletter, clarifying the process for obtaining a new ATA:

• A new ATA may be requested if it has not yet produced all its effects at the date of expiry of the old ATA;
• Taxpayers with a diverging year-end must file the ATA request prior to the end of their 2020 tax year (e.g. 31 March 2020 if the year-end is 31 March) for the new ATA to apply as from 2020 tax year. 

The Law largely reflects the wording of the ATAD 2 and, compared to the text of bill 7466 issued on 8 August 2019, a few (minor) amendments have been made as a result of the State Council’s opinion, including a clarification on the reverse hybrid provision as described below.

The Law extends the scope of existing anti-hybrid rules to additional categories of mismatches and to mismatches with third countries. These new measures will apply to financial years starting on or after 1 January 2020, except for reverse hybrid provisions that will apply as from tax year 2022.

The Law applies to Luxembourg corporate taxpayers (including Luxembourg permanent establishments of foreign entities) and primarily targets payments triggering a “deduction without inclusion” or “double deduction” mismatch outcome between associated enterprises or in the context of structured arrangements, as a result of hybrid mismatches involving hybrid instruments, hybrid entities, permanent establishments, as well as imported mismatches. The Law also contains specific provisions addressing hybrid transfers and residency mismatches.

Payment

The Commentaries of bill 7466, which reflect the recitals of the ATAD 2, specify that differences in the value ascribed to a payment, including transfer pricing adjustment, are not targeted by the anti-hybrid rules. 

Associated enterprise

An entity or individual qualifies as ‘associated enterprise’ of the taxpayer in the following cases:

• Direct or indirect participation of minimum 50% (25% for payments under hybrid financial instruments) of voting rights, or capital or profit entitlement, held by (i) the taxpayer in an entity or (ii) an entity or individual in the taxpayer or (iii) an entity or individual in the taxpayer and other entities, or 
• Entity part of the same consolidated group as the taxpayer for financial accounting purposes, or
• Significant influence of an enterprise in the management of the taxpayer, or significant influence of the taxpayer in the management of an enterprise.

For the purpose of the 50% or 25% threshold, any entity or individual acting together with another entity or individual in respect of the voting rights or capital ownership of an entity, is deemed to hold the rights/capital held by the other individual/entity in such entity. Unless otherwise demonstrated, an individual or entity holding, directly or indirectly, less than 10% in the shares/units of an investment fund, and who is entitled to receive less than 10% of the profit of this investment fund, is not treated as acting together with the other investors, as it is deemed not to control the investments made by the investment fund. The State Council considers this rebuttable presumption consistent with the spirit of the ATAD 2.

Mismatch outcome

To the extent the mismatch outcome takes the form of:

• a deduction of a payment (in the payer jurisdiction) without a corresponding inclusion (D/NI) for tax purposes (in the payee jurisdiction): the deduction shall be denied for the Luxembourg payer, and as a secondary rule if the payment is deductible for the foreign payer, the payment shall be included in the taxable income of the Luxembourg payee (subject to some exceptions); or
• a double deduction (DD) of a payment, expense or loss in the payer jurisdiction and in another jurisdiction (investor jurisdiction): the deduction shall be denied for the Luxembourg investor, and as a secondary rule if the deduction is not denied for the foreign investor, the deduction shall be denied for the Luxembourg payer. No tax adjustment is required if the deduction is granted to the payer against income that is dual inclusion income.
  
  

Targeted hybrid mismatches

The Law targets the following categories of hybrid mismatches giving rise to D/NI:

• Payment under a financial instrument: the D/NI is solely attributable to differences in the characterization of the instrument or the payment made under it (for example, instruments that are treated as debt in the payer jurisdiction and as equity in the payee jurisdiction).
  Payments that are included within a reasonable period of time are not caught. Instruments issued with the sole purpose of satisfying loss absorbing capacity requirements applicable to the banking sector are out of scope until 31 December 2022. 
• Payment to a hybrid entity: the D/NI results from differences in the attribution of the payment under the laws of the jurisdiction where the hybrid entity is established and under the laws of the jurisdiction of any person with a participation in the hybrid entity (this typically addresses payments made to an entity that is transparent in its jurisdiction – such as a Luxembourg partnership - but treated as opaque by its foreign investors).
  As from tax year 2022, under the reverse hybrid rule, Luxembourg partnerships (such as a SCS or SCSp) shall be liable to corporate income tax (but not net wealth tax) for the portion of their net income that is not otherwise taxed under Luxembourg or foreign tax law, if non-resident associated enterprises holding in aggregate a direct or indirect interest of 50% or more consider the partnership as opaque, meaning that the tax transparency will be maintained for the other investors. Collective Investment Vehicles as defined in the Law shall not be caught.  
• Payment by a hybrid entity: the D/NI results from the fact that the payment is disregarded under the laws of the payee jurisdiction (for example, payments made by a Luxembourg opaque company that is treated as transparent or disregarded in the jurisdiction of its shareholder). No hybrid mismatch arises if the deduction is granted against income that is dual inclusion income. 
• Payment or deemed payment involving permanent establishments, including payment to a disregarded permanent establishment (where the Law confirms the preeminence of double tax treaties with third countries over the ATAD 2 for the purpose of this provision).  

In line with the recitals of ATAD 2, the commentaries of bill 7466 clarify that payments to tax exempt payees (e.g. tax-exempt investment funds or sovereign wealth funds) do not trigger any hybrid mismatch. The State Council further considers that the same conclusion should apply to payments made to payees established in zero tax, low tax or territorial tax jurisdictions.

Burden of proof and documentation

If the taxpayer considers that the hybrid mismatch rules are not applicable, such taxpayer must be able to prove this upon request from the tax authorities and provide the latter with reasonable proof. 

Given the complexity of the ATAD 2 and the lack of detailed guidance provided so far in the Law, its implementation in Luxembourg and, especially, the issuance of a circular by the Luxembourg tax authorities will need to be closely monitored.

Do you own an entity that is treated differently in its jurisdiction and the investor jurisdiction? Do you own an entity funded by financial instruments that are treated differently in the payer and payee jurisdictions? KPMG Luxembourg’s tax experts are ready to help. Get in touch now!