Luxembourg Publishes Draft Law For ATAD 2 Expanding Anti-Hybrid Rules

On 8 August 2019, Luxembourg published its draft law for the transposition of the Anti-Tax Avoidance Directive 2017/952 focusing on hybrid mismatches with third countries ("ATAD 2").1

ATAD 2 follows ATAD 1 in extending the anti- hybrid mismatch provisions on hybrid instruments to countries outside the European Union, as well as extending the anti-hybrid rules to apply to certain hybrid entities.

The draft Luxembourg tax law mirrors the wording of ATAD 2 to expand hybrid mismatches to include:

a 'structured arrangement'; a hybrid payment or hybrid instrument between 'associated enterprises'; the relationship between a head office and a permanent establishment of the same entity (or between two or more permanent establishments of the same entity); and a situation of dual residency (i.e. being subject to tax in two or more jurisdictions). ATAD 2 can cause transactions or arrangements with hybrid mismatches falling in the above categories to either deny an otherwise taxable deduction or tax income that otherwise would be exempt or outside the taxable basis.

A hybrid instrument is an instrument that is treated as equity in one jurisdiction and debt in another, and a hybrid entity is an entity that is tax transparent in one jurisdiction and tax opaque in another.

One of the primary aims of ATAD 2 is to deny the tax deductibility of payments made under a hybrid instrument.

The ATAD 2 rules may have a particular impact on hybrid instruments such as PECs or CPECs used by Luxembourg companies with US tax resident shareholders or US tax resident investors. Any structure which includes a Luxembourg company that has issued any PECs or CPECS (or any derivative thereof such as 'tracking PECs' or 'IP-PECs') should be reviewed as soon as possible in light of the impact of ATAD 2.

'Associated enterprises' are broadly defined and can apply to two or more entities (or an individual and an entity) with direct or indirect links of 50% or more of the right to vote, capital ownership or right to profits. The threshold is reduced to only 25% for payments under a hybrid financial instrument.

Associated enterprises can also include otherwise non-related parties that act together resulting in exceeding the 50% threshold mentioned above when combining their respective interests. However, for investment funds, the 'acting together' concept will generally not apply to investors owning less than 10% of interest (directly or indirectly) in an investment fund.

The draft law...