ATAD 2 - Luxembourg Bill for implementation is published

In brief

On 8 August 2019, the Luxembourg Government tabled a Bill (n°7466) before the Luxembourg Parliament setting out draft legislation (the “Draft Law”) that will implement the EU Anti Tax Avoidance Directive regarding hybrid mismatches with third countries (“ATAD 2”) as Luxembourg domestic law. EU Member States have until 31 December 2019 to transpose most of the measures in ATAD 2 into their domestic laws, and must apply those provisions from 1 January 2020.

This Draft Law now needs to go through the Luxembourg legislative process, and may be subject to amendments before final voting by the Luxembourg Parliament. As is usual in Luxembourg the Bill sets out, in addition to the Draft Law, a detailed commentary (the “Commentary”), which in places gives guidance on how the Draft Law should be interpreted.

The Draft Law generally follows the text of ATAD 2 rather closely, adapting it mainly to integrate with the structure and terminology used in the Luxembourg Income Tax Law (“LITL”).

As anticipated by ATAD 2, the Draft Law will in general apply as from the tax years starting as from 1 January 2020, with the additional “reverse hybrid” measures that comprise Article 9a of ATAD 2 applying from the 2022 tax year.

In detail

Scope

Entities

The Draft Law applies to any Luxembourg corporate income taxpayer, including foreign entities that have a permanent establishment in Luxembourg as defined by the domestic legislation. As from the 2022 tax year, the scope is also extended to Luxembourg entities that are regarded under Art. 175 LITL as being tax transparent for Luxembourg tax purposes, effectively, in some cases, turning such entities into Luxembourg taxpayers for all or part of their income.

Parties giving rise to a “hybrid mismatch”

The provisions of the Draft Law apply whenever there is a “hybrid mismatch” under

(i) a “structured arrangement”; or

(ii) between “associated enterprises”; or

(iii) between a head office of an entity and a permanent establishment; or

(iv) between two or more permanent establishments of the same entity; or

(v) in cases of dual tax residence.

Essentially any link, where there is a 50% or more right to votes, capital ownership or profits, causes two entities, or an individual and an entity, to be associated enterprises (except in relation to payments under a financial instrument - here a threshold of 25% is sufficient to create an associated relationship).

In relation to the “acting together” concept, the Draft Law deals specifically with investors (either physical persons or entities) in an investment fund that own, directly or indirectly, less than 10% of the shares or units of the fund and are entitled to less than 10% of the profits of that fund. Unless demonstrated otherwise (for example, where two investors agree with each other to each invest and to take a common position in dealings with the fund manager), any such investor in a fund is not to be regarded as “acting together” with any other investor. This means that in these circumstances any such "less than 10%" investor should not be “associated” with the fund vehicle, and as a consequence also not be "associated" with the entities the fund vehicle controls.

Mismatch effect

The Draft Law and/or the Commentary clarifies that:

  • If the payment is included as ordinary income in at least one jurisdiction, then there will be no mismatch for the rule to apply to (through reference to paragraph 89 of the OECD/G20 BEPS Action 2 Final Report of 2015);
  • In respect of payments under a financial instrument, there is no mismatch when the tax relief granted in the payee jurisdiction is solely due to the tax status of the payee, or to the fact that the instrument is held subject to the terms of a special regime (reference to recital 16 of ATAD 2). Based on our reading, payments to non-transparent entities that are exempt in their countries of incorporation (for example, some sovereign wealth funds), or that are not subject to tax because they are resident in a zero tax rate jurisdiction, or that benefit from some specific exemption (territorial tax regime, REITs, etc.) should each normally not trigger a hybrid mismatch effect;
  • The application of the provisions of the Draft Law is limited to the extent that there is a  hybrid mismatch (i.e. application in due proportion only to the amount giving rise to a deduction without inclusion / double deduction).

Hybrid mismatch definition

Deductions without inclusion

To the extent that a hybrid mismatch results in a deduction without inclusion, the deduction shall be denied for the Luxembourg payer or, as a secondary rule if the deduction is granted to the foreign payer, the amount of the payment shall be included as taxable income in the hands of the Luxembourg payee. The Draft Law however adopts the option of article 9(4)(a) of ATAD 2, such that a Luxembourg taxpayer does not have to apply the secondary rule (i.e., taxation) in cases b), c), d) or f) listed below.

The Draft Law also adopts the option of article 9(4)(b) of ATAD 2, applicable to the banking sector. Until 31 December 2022, hybrid mismatches resulting from intra-group instruments issued with the sole purpose of meeting the issuer’s loss-absorbing capacity requirements (i.e. regulatory hybrid capital) are excluded from the scope of application of the above rules.

In line with ATAD 2, six categories of deduction without inclusion are recognised as potentially causing a “hybrid mismatch” to arise, as follows:

a)    A payment under a financial instrument that is attributable to differences between tax regimes in the way the instrument or the payment are characterised. Mismatch outcomes that reverse in a “reasonable period” of time are not caught. As a safe harbour rule, inclusion by the recipient in a tax period starting within 12 months of the end of the payer’s tax period in which the deduction is taken is considered as causing the mismatch to be reversed in a reasonable period of time. Payments outside of the safe harbour rule may also not be caught provided that it is reasonable to expect an inclusion of the payment by the jurisdiction of the payee in a future tax period when the terms of the payment are at arm’s length;

b)    A payment to a “hybrid entity”, where the mismatch outcome is the result of differences in the allocation of payments made to the hybrid entity under the laws of the jurisdiction where the hybrid entity is established or registered, and the jurisdiction of any person with a participation in that hybrid entity (“reverse hybrid”) ;

c)    A “diverted branch payment”;

d)    A payment to an entity with a “disregarded permanent establishment”. The Draft Law confirms however the primacy of Double Tax Treaty (DTTs) with third countries over ATAD 2. In other words, disregarded PE income would not be included at the level of the Luxembourg head office when a DTT with a third country requires exemption of the income, as also provided by article 9(5) of ATAD 2;

e)    A “hybrid entity payment”, where the payment is disregarded under the laws of the payee jurisdiction.

f)     A “deemed branch payment”.

Notwithstanding the above, a “hybrid mismatch” will only arise under categories e) or f) listed above to the extent that the deduction in the payer jurisdiction is not offset against dual inclusion income.

Double deductions

To the extent that a hybrid mismatch results in a double deduction, the deduction shall be denied for the taxpayer that is the investor. If the deduction is granted in the jurisdiction of the investor, the deduction shall then be denied for the taxpayer that is the payer. Nevertheless, any deduction shall remain deductible to the extent that there is dual inclusion income of that tax year. Furthermore, payments, expenses or losses which may not have been deductible in a given year may still be deductible subsequently, to the extent that dual inclusion income arises in a future tax year.

Imported mismatches, hybrid transfer and tax residency mismatches

The Draft Law reproduces almost without change the wording of ATAD 2 in relation to these three situations.

As such:

  • A deduction for a payment will be denied to the extent that it gives rise to an “imported mismatch”. The Draft Law uses the exact same definition of an imported mismatch as that in ATAD 2;
  • To the extent a hybrid transfer is designed to produce a relief from withholding tax on a payment derived from a transferred financial instrument to more than one of the parties involved, the relief will be limited in proportion to the net taxable income regarding the payment. Contrary to the general rule, the portion of a withholding tax that may not be creditable shall in this specific case not be deductible for Luxembourg tax purposes;
  • The deduction will be denied to the extent dual residency results in double deduction. The payment, expense or loss will however remain deductible when the other jurisdiction involved is a  Member State with a DTT in force with Luxembourg and provided the taxpayer is considered as a Luxembourg resident under that DTT.

Post 2021 reverse hybrid mismatches

With effect as from the 2022 tax year, Luxembourg transparent partnerships will become liable to corporate income tax in relation to net income to the extent that such income is not otherwise taxed under the Luxembourg domestic tax law or the laws of any other jurisdiction, provided one or more associated non-resident entities (i) holding in aggregate a direct or indirect interest in 50% or more of the voting rights, capital interests or rights to a share of profit in the Luxembourg partnership (ii) consider the Luxembourg partnership to be a taxable person.

In such a situation, the Draft Law confirms that, while the Luxembourg partnership will be considered as a tax resident for corporate income tax purposes, it will be exempt from Net Wealth Tax.

In line with the exclusion provided for in ATAD 2, collective investment vehicles are out of the scope of this provision. For the purpose of this rule, collective investment vehicles are defined as an investment fund or vehicle that is widely-held, holds a diversified portfolio of securities and is subject to investor-protection regulation in the country in which it is established. The Commentary clarifies that this definition includes undertakings for collective investment in the sense of the Law of 17 December 2010, specialised investment funds (“SIFs”) covered by the Law of 13 February 2007, reserved alternative investment funds (“RAIFs”) covered by the Law of 23 July 2016, and other alternative investment funds (“AIFs”) not falling within the above categories but covered by the Law of 12 July 2013 (implementing the EU AIFM Directive) relating to managers of alternative investment funds although only to the extent that such AIFs are widely-held, hold a diversified portfolio of securities and are subject to investor-protection regulations.

Documentation

At the request of the tax authorities, the taxpayer must be able to provide any relevant information such as tax returns, other tax documents or certificates issued by the tax authorities of another State, in order to prove that the provisions of the Draft Law are not applicable.

In conclusion

Groups and investment funds now have to assess their situation considering the potential impact of the precise wording of  the Draft Law applying these “hybrid mismatch” measures, most of which will begin to take effect from as soon as 1 January 2020 onwards.

Luxembourg has a long-standing reputation for timely and strict implementation of EU Directives. The Draft Law is one more set of measures that justifies this reputation. 

Contact us

Alina Macovei

Tax Partner, Alternative Investments, PwC Luxembourg

Tel: + 352 49 48 48 3122

Fabien Hautier

Tax Partner, Alternative Investments, PwC Luxembourg

Tel: +352 49 48 48 3004

Iryna Sansonnet-Matsukevich

Tax Partner, Alternative Investments, PwC Luxembourg

Tel: +352 49 48 48 3185

Sami Douénias

Tax Partner, Industry and Public Sector, PwC Luxembourg

Tel: +352 49 48 48 3060

Anthony Husianycia

Tax Partner, Industry and Public Sector, PwC Luxembourg

Tel: +352 49 48 48 3239

Murielle Filipucci

Tax Partner, Bank/Insurance, PwC Luxembourg

Tel: +352 49 48 48 3118

Géraud de Borman

Tax Partner, Bank/Insurance, PwC Luxembourg

Tel: +352 49 48 48 3161