10 Jul 2019
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Intra-EU anti-hybrid provisions – a possible source of double taxation ?

By Vincent Remy

EY Luxembourg Partner, Private Debt Leader

Dynamic. Team player. Problem solver. Fan of many things in life. Proud husband and father.

10 Jul 2019
Related topics Tax

With the Base Erosion and Profit Shifting (BEPS) project, the Organisation for Economic Co-operation and Development (OECD) has designed rules to neutralise the effects of hybrid instruments and entities (Action 2 of the BEPS Action Plan).

W
ith the Base Erosion and Profit Shifting (BEPS) project, the Organisation for Economic Co-operation and Development (OECD) has designed rules to neutralise the effects of hybrid instruments and entities (Action 2 of the BEPS Action Plan).

 

The EU Council welcomed these rules and stressed the need to apply an effective and coordinated implementation thereof at EU level. This led to the adoption of the Anti-Tax Avoidance Directive (ATAD)[1] which foresees binding rules to counteract mismatch situations within the EU, while ATAD II[2] will expand the territorial scope to third countries and to further types of hybrid mismatches.

From day one, Luxembourg has been fully supportive of the OECD's BEPS project and actively contributed to the adoption of ATAD, in the spirit of achieving a level playing field in the EU. Luxembourg has, in particular, been one of the early adopters within the EU of the anti-hybrid measures. Unlike other EU Member States such as the Netherlands or Ireland, Luxembourg incorporated the anti-hybrid measures applying to intra-EU situations already as from 1 January 2019, although the deadline for the implementation was only set at 31 December 2019.

Under the intra-EU anti-hybrid provisions, hybrid mismatch arrangements originate as a result of a difference in the legal characterization of an entity or instrument under the laws of Luxembourg and those of the other Member State which result in either a double deduction (a deduction of the same expense or loss occurs both in Luxembourg and in the other Member State) or a deduction without inclusion (a payment is deducted in Luxembourg without a taxable inclusion of the corresponding income in the other Member State). Such situation would lead to the denial of the deduction of the expense or the payment in Luxembourg.

While the policy objective of these rules is avoiding double non-taxation or double deductions, care should be taken that the new rules will not have the exact opposite result, i.e., a situation of double taxation. This would certainly go against the spirit of ATAD. In fact, the ATAD’s preamble states that “the rules should not only aim to counter tax avoidance practices but also avoid creating other obstacles to the market, such as double taxation.”  

From a practical perspective, the risk of double taxation may particularly arise in the private credit sphere where investors would typically rely on the flexibility and tax-neutrality of the limited partnership (in Luxembourg or elsewhere) as the vehicle of choice for pooling their debt investments. These partnerships typically hold their assets through Luxembourg corporate entities (Lux CEs). Although a limited partnership is generally considered as tax transparent from a Luxembourg perspective, it may be treated as a corporation by certain EU investor countries. Under a strict reading of the current anti-hybrid provisions, the resulting qualification of the partnership as a hybrid entity may lead to a so-called hybrid entity mismatch. This mismatch would entail the non-deductibility of expenses paid by the Lux CEs to the partnership leading to a significant increase of their Luxembourg taxable base. This outcome is surprising and counter-intuitive, particularly if the partnership were to on-pay or distribute all its proceeds to its EU investors where the proceeds would be fully taxable. In such a case there would be, economically, double taxation of the same payment. These investors would be well-served by a clarification by the authorities to the effect that, for example, no hybrid mismatch will arise if a distribution by the partnership of its proceeds to its investors within a certain limited period (e.g. 12 months) will result in taxation of these proceeds at the level of these investors. Such a clarification would be well within the stated spirit of the anti-hybrid measures.

The overall aim of the anti-hybrid rules is clear and laudable. However, their practical applications may, in certain cases, result in unintended consequences. To this day, in the absence of a clarification by the authorities, stakeholders are thus well advised to carefully analyse and potentially address these types of investment structure.

Vincent Rémy, Tax Partner, EY Luxembourg

 

[1] Council Directive (EU) 2016/1164 of 12 July laying down rules against tax avoidance practices that directly affect the functioning of the internal market

[2] Council Directive (EU) 2017/952 of 29 May amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries

 

This article was originally published on Luxembourg Times under the headline "Intra-EU anti-hybrid provisions – a possible source of double taxation?"

Summary

With the Base Erosion and Profit Shifting (BEPS) project, the Organisation for Economic Co-operation and Development (OECD) has designed rules to neutralise the effects of hybrid instruments and entities (Action 2 of the BEPS Action Plan).

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By Vincent Remy

EY Luxembourg Partner, Private Debt Leader

Dynamic. Team player. Problem solver. Fan of many things in life. Proud husband and father.

Related topics Tax