While most of the European Anti-Hybrid Rules took effect on 1 January 2020, the last anti-hybrid provision – targeting the reverse hybrid mismatch – will enter into force in relevant EU jurisdictions (such as Luxembourg and Ireland) on 1 January 2022. The new anti-reverse hybrid rule could give rise to an unexpected tax liability for tax-transparent EU funds, so a review of any such funds is recommended before year end. This may affect funds set up as partnerships, unit trusts or other contractual/tax transparent entities.
The European Anti-Hybrid Rules derive from the Council Directive (EU) 2016/1164 of 12 July 2016 (known as “ATAD 1”), as amended by Council Directive (EU) 2017/952 of 29 May 2017 amending Directive (EU) 2016/1164 (known as “ATAD 2”). A reverse hybrid mismatch would occur if one or more of the investors/partners in a partnership fund are treated as associated entities of the fund by virtue of holding in aggregate a direct or indirect interest of 50% or more of the (i) voting rights, (ii) capital interests or (iii) rights to a share of profit in a transparent entity, established in a EU Member State, and are located in a jurisdiction or jurisdictions that regard the fund as an opaque entity. In that case, the entity shall be regarded as a tax resident of the EU Member State where it is established and taxed on its income to corporate income tax to the extent that that income is not otherwise taxed under the laws of the relevant Member State or any other jurisdiction.An exemption for the charge to tax can apply to a fund regarded as a collective investment vehicle (the “CIV Exemption”). The CIV Exemption is available to an investment fund or vehicle that:
a) is 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.
Application in Luxembourg
In Luxembourg, the anti-reverse hybrid rule may impact all funds set up as partnerships such as the société en commandite simple (SCS or ordinary limited partnerships) or the société en commandite spéciale (SCSp or special limited partnership), the fonds commun de placement or the fonds de titrisation.
Under the current legislation, if the anti-reverse hybrid rule applies, the partnership would be subject to Luxembourg corporate income tax at the maximum rate of 18.19%.
Concerning the CIV Exemption, it is generally considered it should apply to all Luxembourg specialized investment funds (“SIF”), UCITS, Part II Funds and Reserved Alternative Investment Funds. In addition, it should also apply to an alternative investment fund meeting the above-mentioned conditions.
Finally, it shall be noted that since the anti-hybrid rules apply only among associated enterprises, investors holding less than 10% in an investment fund are presumed not to be acting together (the Luxembourg tax authorities retain the ability to establish the opposite). Therefore, this de minimis rule may avoid the tax charge arising with respect to a widely held fund.
Application in Ireland
In Ireland, the anti-reverse hybrid rule may impact tax transparent funds such as those established as a Common Contractual Fund (CCF), an Investment Limited Partnership (ILP) or an unregulated partnership (including a limited partnership under the 1907 Limited Partnership Act).
If the anti-reverse hybrid rule applies, the partnership or CCF in question would be subject to Irish corporation tax at rates up to 25%.
The Irish implementation of the CIV Exemption, may apply to a CCF, an ILP or an unregulated partnership that is managed by an AIFM. In order for this exemption to apply, the fund must also (i) be widely held (which under the Irish rules looks to whether there are any individuals holding more than 25% under the tests applied under the Anti-Money Laundering Directive) and (ii) hold a diversified portfolio of securities (which under the Irish rules looks to a range of factors, including the nature of the assets, number of investments and whether derivatives are used, in addition to a safe harbour if no more than 10% of the securities are derived from a single issuer). The Irish rules allow a level of flexibility in meeting these conditions during ramp up and wind down periods.
The anti-hybrid rules apply only among associated enterprises and where there is a reverse hybrid mismatch outcome. A mismatch outcome does not arise where the investor, for example, is a tax-exempt entity or established in a territory that does not impose tax.
In the light of the above, we recommend that EU transparent fund structures (whether such fund is the main fund or parallel, feeder or subsidiary fund of the main fund) are reviewed before year end to establish whether such funds could be impacted by the implementation of the new anti-reverse hybrid rule. In addition, fund subscription documentation should ensure that relevant tax related information is obtained from investors to police compliance of the anti-reverse hybrid rule.