Background 

Pursuant to the reverse hybrid rules, a tax transparent entity nevertheless becomes liable to corporate income tax if associated non-resident investors who see the entity as tax opaque (i.e., as a separate taxpayer) hold more than 50% of the interests, voting rights or rights to profits in that entity and are not taxed on their share of the entity’s income because of the hybrid mismatch. By derogation, CIVs are excluded from the application of the reverse hybrid rules. The law defines a CIV as a vehicle that is (a) widely held, (b) holds a diversified portfolio of securities and (c) is subject to investor-protection regulation in the country in which it is established. The law does not provide for additional clarification on those three conditions. 

The new circular starts by confirming that, in line with the parliamentary documents, UCIs, specialised investment funds (SIFs) and reserved alternative investment funds (RAIFs) are considered CIVs. The main contribution of the circular concerns other investment funds, as the circular now provides useful clarifications on how these conditions apply to them. 

Clarifications on the CIV conditions 

“Widely held” requirement 

The key development is a presumption that the “widely held” condition is met where there is no individual person holding or controlling, directly or indirectly, more than 25% of capital rights or voting rights of the fund or controlling the fund by other means. For assessing the latter, the tax authorities can notably rely on information included in the UBOs register.  In addition, the circular also clarifies that:  

  • the fund must be designed to attract multiple unrelated investors but there may be legitimate cases in which there is only a restricted number of investors, notably the ramp-up phase (36 months) and the liquidation phase;
  • in master-feeder structures, the criterion is to be assessed at the level of the feeder vehicle(s);
  • investors are related if one participates for more than 50% in the capital or voting rights of another, or if they are under common control, or members of a family group, or if effective control is exercised through other means.
“Diversified securities portfolio”

The circular clarifies that “securities” should be understood in its broadest meaning so as to include, among others, shares and similar securities giving access to the capital of an entity, beneficiary units, bonds and other receivables, fund units, deposits with credit institutions, and derivatives if the underlying consist of securities.  

According to the circular, diversification is assessed based on the fund’s investment policy and market risk exposure.  

The circular states that this condition is not met if risk diversification is not in line with the requirements imposed to SIFs and accordingly an investment fund’s portfolio is not considered diversified if a fund invests more than 30% of its assets or commitments in a single issuer, unless there is adequate justification. 

“Investor protection framework”

The fund must be subject to investor protection rules in its jurisdiction of establishment. This condition is presumed met if the fund is supervised by the CSSF or qualifies as an AIF managed by an authorised AIFM under Directive 2011/61/EU. 

Practical implications 

The circular provides welcome clarity for fund managers, tax advisers, and investors assessing whether a fund qualifies as a CIV under Luxembourg tax law. It supports consistent application of tax rules and facilitates compliance with the reverse hybrid provisions. Whilst in practice not many funds were in scope of the reverse hybrid rules, thanks to monitoring of the investor base and choice of adequate fund vehicles, the new circular will allow the very vast majority of alternative investment funds going forward to be excluded from the scope of the reverse hybrid rules under the CIV carve-out, provided that they meet the “diversified securities portfolio” requirement.

In case of any questions, please contact an author of this article or your trusted Loyens & Loeff adviser.