The reverse hybrid mismatch rule: considerations regarding alternative investment funds in Luxembourg

A reverse hybrid is an entity that is viewed as transparent under the laws of the jurisdiction in which it is established but treated as a separate entity (i.e. opaque) under the laws of the jurisdiction(s) of the investor(s).

Therefore, the income of a reverse hybrid may neither be taxable in its establishment jurisdiction (as the income is attributed to the investor) nor in the residence state of the investor(s) (where the income of the opaque entity is not included in the taxable income of the investor(s)). In many cases, the income realised by a reverse hybrid entity will only be taxable at the level of the investor when the income is distributed, resulting potentially in a (long-term) tax deferral.

Article 168quater of the Luxembourg income tax law (“LITL”), the Luxembourg reverse hybrid mismatch rule, may apply as from tax year 2022 to all entities within the meaning of Article 175 of the LITL that are established in Luxembourg (in particular, partnerships). Given that these entities are treated as fiscally transparent, their income is for Luxembourg (corporate) income tax purposes allocated to the owners. The reverse hybrid mismatch rule aims at eliminating double non-taxation outcomes through the
treatment of reverse hybrids as resident taxpayers.

The reverse hybrid mismatch rule must also be considered in the context of Alternative Investment Funds that are established in the legal form of a partnership or in contractual form (fonds commun de placement, “FCP”); both are viewed as transparent from a Luxembourg tax perspective.