Draft law implementing ATAD 2 published in Luxembourg

On 08 August 2019, the draft law implementing into Luxembourg domestic law the EU Directive 2017/952 of 29 May 2017 was published (the Draft Law). Such Directive is known as the second Anti-Tax Avoidance Directive (ATAD 2) as it amends the EU Directive 2016/1164 of 12 July 2016 (ATAD 1) and must be transposed by EU members before 31 December 2019. The new provisions should enter into force as from 01 January 2020 apart from the provision regarding reverse hybrid mismatches which should enter into force as from 01 January 2022. This article sets out a high-level summary of the main points addressed in the Draft Law.

Background

As a reminder, ATAD 1 was adopted in Luxembourg by the law of 21 December 2018. For more information regarding the content of such law, please find our elexica article at the following link, here.

The Draft Law

The Draft Law follows ATAD 2 wording and provides useful clarifications on the future application of the law.

Scope of the hybrid mismatches rules

The new provisions should apply to Luxembourg corporate taxpayers including permanent establishments of non-residents entities.

The Draft Law provides that hybrid mismatches exist when there is a mismatch effect occurring either (i) between associated companies, or (ii) between the taxpayer and an associated company, or (iii) between the head office and a permanent establishment, or (iv) between two or more permanent establishments of the same entity, or (v) in the framework of a structured system.

There are different situations where a mismatch effect could arise, in particular the following:

(i) Payment made under a financial instrument:

A payment made in respect of a financial instrument giving rise to a deduction without inclusion. This mismatch effect is due to differences in the qualification of the instrument or the payment made under that instrument and where this payment is not included within a reasonable time.

(ii) Payment made to hybrid entities:

A payment to a hybrid entity giving rise to a deduction without inclusion. This mismatch effect results from differences in the allocation of payments made to the hybrid entity under the laws of the jurisdiction in which the hybrid entity is established or registered and the laws of the jurisdiction of any persons that hold an interest in that hybrid entity.

(iii) Payment made to permanent establishment:

A payment to an entity with one or more permanent establishments giving rise to a deduction without inclusion. This mismatch effect results from differences in the allocation of payments between the head office and the permanent establishment or between two or more permanent establishments of the same entity under the laws of the jurisdictions in which the entity operates.

Outcome of the new rules

The consequences of falling within the scope of the new provisions are the following:

To the extent that a hybrid mismatch leads to a double deduction, then the payment would not be deductible in the investor’s jurisdiction and where the payment would be deductible in the jurisdiction of the investor, the payment would not be deductible in the payer’s jurisdiction.

To the extent that a hybrid mismatch leads to a deduction without inclusion, then the payment would not be deductible in the payer’s jurisdiction, and where the payment is deductible in the payer's jurisdiction, the receipts which would otherwise give rise to a mismatch effect would be taken into account in the total net income of the beneficiary.

Reverse hybrid entities

The Draft Law also addresses the reverse hybrid situation. This situation occurs when an entity is treated as transparent for Luxembourg tax purposes but is viewed as opaque in the jurisdictions of associated investors (explained further below). Such transparent entities would be considered as resident taxpayers and their income subject to Luxembourg corporate income tax to the extent that such net income is not otherwise imposed under Luxembourg law or the laws of any other jurisdiction.

Associated enterprise

The concept of associated enterprise already exists in Luxembourg law. However, the Draft Law provides for an autonomous definition applicable specially to the anti-hybrid rules. For the purpose of such rules, associated enterprise means:

• an entity in which the taxpayer holds, directly or indirectly, a participation of 50 per cent or more of the voting rights or capital, or of which it is entitled to receive 50 percent or more of the profits
• a person or an entity that holds, directly or indirectly, a participation of 50 per cent or more of the taxpayer's voting rights or capital, or who is entitled to receive 50 per cent or more of the taxpayer's profits
• an organisation that is part of the same consolidated group for accounting purposes than the taxpayer, and
• a business in which the taxpayer exercises significant influence over the management of the business or a company that has a significant influence over the management of the taxpayer.

The outcome of such definition is that if a person or an entity holds, directly or indirectly, a 50 per cent or more interest in terms of voting rights or capital in a taxpayer and in one or more entities, all relevant entities, including the taxpayer, should also be considered as associated enterprises.

In the case of a hybrid mismatch involving a payment under a financial instrument, the 50% threshold is replaced by 25%.

Clarifications provided by the Draft Law

The Draft Law provides clarifications concerning the application of the anti-hybrid mismatch rules. The below provides a summary of the main clarifications.

Safe Harbour rule

The Draft Law integrates the "safe harbour rule” as addressed in ATAD 2 which allows the taxpayer to deduct payments under a financial instrument if the payment in question would be included in the recipient's jurisdiction in a tax period that begins within 12 months after the end of the tax period of the payer.

Acting together

The concept of "acting together" is intended to prevent taxpayers from circumventing the related party test by transferring their voting rights or interests in another person who continues to act under their direction with respect to these voting rights or shareholdings. In relation to this concept, a person or an entity which acts together with another person or another entity in respect of voting rights or ownership in the capital of an entity is considered to hold an interest in all voting rights or capital of that organisation, which is held by the other person or other entity. The Draft Law proposes to retain that an investor only holding, directly or indirectly, less than 10% of the securities or units in a fund and less than 10% of the profit-sharing rights of this investment fund, should not, unless proven otherwise, be considered as acting together with another investor in the same investment fund.

Non-inclusion due to the status of the recipient

Based on the commentary to the Draft Law the hybrid mismatch rules should not apply when the non-inclusion happens at the level of the recipient because of its tax status in its jurisdiction (eg an exempt fund).

Carve-out for reverse hybrid rules

The new provisions on reverse hybrid mismatch rules should not apply to Luxembourg collective investment vehicles meaning companies or funds that are widely held with a diversified portfolio of securities subject to the rules of investors protection in the State where they are established. As specified by the commentary to the Draft Law, this should refer to collective investment funds as defined in the law of 17 December 2010, to specialized investment funds as defined in the law of 13 February 2007, to reserved alternative investment funds as defined in the law of 23 July 2016 and to alternative investment funds as defined in the law of 12 July 2013.

Burden of proof

On demand from the Luxembourg tax authorities, the taxpayer must be able to provide any relevant documentation (eg tax returns) in order to evidence that the anti-hybrid rules contained in the Draft Law are not applicable.

Next steps

The Draft Law will go through parliamentary process before being adopted into Luxembourg law which can be expected at the end of the year.

For further information please contact any member of the Luxembourg tax team.