Luxembourg Government Submits Bill To Parliament Implementing The EU Anti-Tax Avoidance Directive 2 Into Domestic Law

On 8 August 2019, the Luxembourg Government submitted a draft law to the Parliament (the Draft Law) to implement the Council Directive (EU) 2017/952 of 29 May 2017 (ATAD 2 or the Directive) into Luxembourg domestic law.

As a reminder, ATAD 2 constitutes an update of the Council Directive (EU) 2016/1164 of 12 July 2016 (commonly referred to as ATAD 1) which aims to target tax avoidance practices in the context of intra-EU transactions. The purpose of ATAD 2 is to neutralise a wider range of tax advantages obtained by taxpayers resident in EU Member States due to the hybridity of an instrument or an entity within the context of transactions both within the EU but also with third countries.

Subject to an exception regarding provisions targeting reverse hybrids, EU Member States have until 1 January 2020 to implement ATAD 2 into their domestic law. In order to do so, Luxembourg's government has chosen to use a wording close to the text of the Directive and to apply the exceptions granted by ATAD 2.

The Draft Law provides clarification on some crucial questions, in particular regarding the application to the new rules to investment funds. However, at this stage, the Draft Law still needs to go through the Luxembourg legislative process and we expect that some amendments will be made, in particular further to the input of the Luxembourg Council of State.

Scope

Luxembourg corporate income taxpayers, including Luxembourg permanent establishments of foreign entities, will be subject to the Draft Law as from 1 January 2020. In addition, provisions targeting reverse hybrid mismatches will be applicable to Luxembourg transparent partnerships that would be treated as opaque by their nonresident owners as from 1 January 2022.

General

Conditions for the recognition of a hybrid mismatch

Test 1: Existence of a Mismatch Effect

The first criteria to consider when assessing the application of the Draft Law is the existence of a Mismatch Effect.

Hybrid mismatches targeted by the Draft Law are defined as arising when a payment leads to the realisation of a Mismatch Effect which is defined as:

a double deduction: when the same payment is deducted for tax purposes in the jurisdiction where the payment has its source (payer jurisdiction) and in another jurisdiction (investor jurisdiction); or a deduction without inclusion: when a payment is tax deductible at the level of the payer but not included in the taxable income of the recipient. To the extent that a hybrid mismatch gives rise to a double deduction, the deduction should be denied at the level of the investor. When the deduction has been made in the jurisdiction of the investor, the deduction should be denied at the level of the payer. However, any deduction should remain deductible to the extent that there is dual inclusion income during the same fiscal year. Payments, expenses or losses which were not deductible in a given tax year remain deductible from a dual inclusion income in a future tax year.

To the extent that a hybrid mismatch gives rise...