The Luxembourg budget law for 2023 includes a welcome clarification of the reverse hybrid rules, which are relevant for Luxembourg funds.
The law provides that, with retroactive effect to January 1, 2022 (which is the date on which the Luxembourg reverse hybrid rules entered into effect), the reverse hybrid rules will be amended to the effect that investors benefitting from a tax exemption do not trigger the rules.
A Luxembourg SCS(p), which is the default Luxembourg fund vehicle, can become subject to Luxembourg tax (18.19%) on part of its income if it has ‘associated investors’ that are located in a jurisdiction that treats the fund as opaque from a tax perspective (herein referred to as ‘Bad Investors’) and the Bad Investors control at least 50% of the fund. Pursuant to the revision of the reverse hybrid rules contained in the budget law, tax exempt investors do not qualify as Bad Investors for purposes of this 50% threshold even if they are located in a jurisdiction that treats the SCS(p) as opaque. Luxembourg funds can now welcome commitments from sovereign wealth funds, endowments pensions funds and investors located in zero tax jurisdictions without any concerns that those investors trigger the application of the reverse hybrid rules.
If the reverse hybrid rules are triggered, Luxembourg tax is due on the portion of the Luxembourg SCSp’s income ‘that is not taxed elsewhere’. There are uncertainties regarding the interpretation of the latter concept. Despite the above-discussed amendment of the reverse hybrid rules, it remains unclear whether the portion of the SCSp’s income that is allocable to tax exempt investors is treated as ‘not being taxed’. On the basis of a literal reading of the law, it cannot be excluded that such income is taxable in the hands of the SCSp (if the reverse hybrid rules are triggered), even though the commentaries of the law try to suggest differently.
Want to know more about the reverse hybrid or other Luxembourg tax rules? Reach out to our experts from our NYC team.