As we welcome the new year, we would like to highlight two major developments that can have a significant impact on developers and investors with Luxembourg investment structures.

1. ATAD 2: Entry into force of the rules on reverse hybrid devices

January 1, 2022 marks the entry into force of the rules relating to reverse hybrid devices, the last part of the rules relating to hybrid devices introduced by the law of December 20, 2019 transposing Council Directive (EU) 2017/952 of May 29, 2017 amending Directive (EU) 2016/1164 (ATAD) concerning hybrid arrangements with third countries (ATAD 2), as transposed in article 168 quarter of Luxembourg income tax law.

In summary, these rules aim to eliminate cases of double non-taxation which may arise when entities or arrangements considered in Luxembourg to be fiscally transparent (for example, simple limited partnerships (SCS) or special limited partnerships (SCSP) are considered fiscally opaque in the jurisdiction (s) of their shareholder (s) (i.e. a reverse hybrid entity).

As a result, reverse hybrid entities may, under certain conditions, be subject to Luxembourg corporation tax (CIT).

The rules on reverse hybrid arrangements only apply in situations where non-resident associates hold in total a direct or indirect holding of at least 50% of the voting rights, holdings or rights in entities or companies. agreements located in jurisdictions which consider such entities or agreements to be opaque.

The aforementioned tax treatment does not apply to Luxembourg entities deemed to be collective investment vehicles, such as UCITS, SIFs, RAIFs and AIFs, which are widely held, hold a diversified portfolio of securities and are subject to investor protection requirements.

Thus, if you are a promoter or investor of tax transparent entities in Luxembourg, we strongly encourage you to carefully assess this new rule in relation to your investment structures.

To assist taxpayers in this endeavor, Dentons has developed a tax diagnostic tool that provides taxpayers with an easy “first look” into whether the Reverse Hybrid Mismatch Rule may apply to your investment structure. Our fiscal diagnostic tool can be found here: Dentons Diagnostics – Reverse Hybrid Rules for Partnerships (LU).

2. ATAD 3 (Unpack) proposal

The proposal for a directive of the Council of the European Commission (Directive) laying down rules to discourage the misuse of so-called “shell” entities was unveiled on December 22, 2021 (the Proposal). The proposal is expected to be adopted in the first quarter of 2022. The aim is for Member States to transpose the directive into domestic law by June 30, 2023, with the rules applying from January 1, 2024.

The proposal introduces new reporting requirements which may result in the denial of tax benefits to EU entities that are deemed to have no or minimum substance. In particular, such a qualification may lead to the refusal of the double taxation agreement (TNT), the elimination of access to advantageous European directives such as the parent-subsidiary directive or the directive on interest charges as well as a reallocation of taxing rights.

As a welcome development for Luxembourg funds and financial sectors, the proposal intends to provide for explicit exclusions from reporting obligations for companies listed on a regular stock exchange and regulated financial companies, such as UCITS and AIFs.

Companies operating only on national territory and companies with more than five employees involved in the operations are also excluded.

Businesses that meet the following cumulative “gateways” are considered to be at-risk businesses:

I. Companies that derive most (over 75%) of their income from passive sources, such as rents, royalties, interest (including from crypto assets), dividends, etc. ;

II. Companies which are mainly (more than 60%) engaged in cross-border activities; and

III. Companies that outsource most of their operations / administration and do not have adequate resources to perform basic management activities.

As a result, a company that cumulatively fulfills the three aforementioned gateways will be subject to reporting obligations.

A risky enterprise may request an exemption from the reporting obligation if it can prove that it does not reduce the tax liability of its beneficial owner (s) or of its group. This exemption will first be granted for one year with the possibility of extension, on request, to five years.

Businesses crossing all gateways will have to report in their annual tax return information relating to “substance indicators”, i.e. whether a business has:

1. Its own premises for its exclusive use

2. An active bank account in the EU

3. At least one suitably qualified and licensed local manager, or full-time local staff.

A risk case will be presumed to be a shell company if it fails at least one of the above substance indicators. A business presumed to be a shell may be able to rebut this presumption if it can prove that it controls its activities and bears the risks of the activities which generated the relevant income or, in the absence of income, of its assets.

  • Automatic exchange of information

The proposal also provides for the automatic exchange of information communicated between Member States through existing mechanisms for administrative cooperation.

Companies considered to be fictitious entities will be refused access to TNT or EU directives (in particular parent-subsidiary and interest-royalty directives) by any other Member State.

In practice, this can lead to withholding taxes on payments made to shell entities and taxation of the shell company (s) on a transparent basis, as if it had been acquired directly from the shareholder (s). ).