Following the EU Anti Tax Avoidance Directive II (“ATAD II“) coming into force, since 2020 EU Member States have been required to implement into their domestic law a package of “anti-hybrid” laws.

The aim of these laws is to counteract tax advantages arising from certain “hybrid” features that may exist in any given structure, such as a hybrid instrument (treated as debt in one jurisdiction but equity in another jurisdiction) or a hybrid entity (treated as tax transparent in one jurisdiction and tax opaque in another jurisdiction).

The “reverse hybrid” rule forms part of this package of “anti-hybrid” laws and has been introduced in Luxembourg, among other countries. The purpose of the “reverse hybrid” rule is to counteract “double non-taxation outcomes” arising as a result of an entity, for example a Luxembourg fund partnership, being treated as tax transparent in its home jurisdiction, in this example Luxembourg, but tax opaque in the jurisdiction of one or more of its investors.

A double non-taxation outcome would arise in this example because income arising to the Luxembourg fund partnership is not taxed in Luxembourg as a result of Luxembourg treating it as tax transparent and the same income is also not taxed in that investor’s jurisdiction as a result of the investor jurisdiction treating it as tax opaque.

The Luxembourg “reverse hybrid” rule is potentially triggered if investors who treat the Luxembourg fund partnership as tax opaque in their home jurisdictions hold 50% or more of the voting rights, capital interests or rights to a share of profit in that fund partnership. This is subject to certain aggregation or “acting together” rules.

If the “reverse hybrid” rule applies, the Luxembourg fund partnership is instead treated as a corporate for Luxembourg tax purposes and becomes subject to Luxembourg corporate income tax (but not Luxembourg net wealth tax or, provided the partnership qualifies as an alternative investment fund (“AIF“) for the purposes of the AIFM EU Directive of 2013, municipal business tax), although there is an exemption from the Luxembourg “reverse hybrid” rule for collective investment vehicles that meet certain conditions.

Recent Development in Luxembourg

On December 23, 2022, Luxembourg amended its “reverse hybrid” rule to clarify certain of the conditions that must be satisfied in order for this rule to apply. The conditions can now be summarised as follows:

  1. there is an entity (the “Entity”) established in Luxembourg that is treated as tax transparent under Luxembourg domestic law (e.g. a société en commandite simple or “SCS” or a société en commandite spéciale or “SCSp”);
  2. one or more investors in the Entity are located in a jurisdiction that treats the Entity as opaque for tax purposes (i.e. the Entity is a “Reverse Hybrid Entity”);
  3. income allocable to such investor or investors is not subject to tax as a result of the Entity being a Reverse Hybrid Entity (such persons being “Hybrid Investors”);
  4. such Hybrid Investors hold at least 50% of the Entity’s voting rights, capital, or profits (taking into account certain complex “acting together” aggregation rules); and
  5. the Entity’s income is not otherwise taxed under the laws of Luxembourg or any other jurisdiction.

It is condition (3) above that has been introduced as a result of the December 23, 2022 amendment. This is an important amendment as it makes clear that, for an investor to be treated as a “Hybrid Investor”, any double non-taxation outcome must arise as a result of the Entity being a Reverse Hybrid Entity, and not for some other reason e.g. because an investor is tax exempt (e.g. certain pension funds or sovereign wealth funds).

Prior to this amendment, the rules were considered to go beyond their intended aim as they counteracted certain mismatches that were not caused by a hybridity but rather an investor’s tax exempt status. If a tax exempt investor located in a jurisdiction that treats a fund vehicle as a Reverse Hybrid Entity invested in the underlying assets directly rather than through the fund vehicle, the tax result would be the same (i.e. no tax in the jurisdiction of the investor given its tax exempt status). In other words, in such a scenario there is no tax advantage arising from the hybridity of the fund vehicle.

The amendment has retrospective effect from 1 January 2022.


The effect of this change is that certain tax exempt investors, and potentially certain other investors, should no longer be considered “Hybrid Investors” notwithstanding that they are in a jurisdiction that treats the Luxembourg fund partnership as opaque for tax purposes. Such investors should instead count towards the percentage interests or rights held by “Non-Hybrid Investors” when applying the 50% threshold mentioned above.

This could prove significant for Luxembourg funds with a significant number of tax exempt investors in jurisdictions such as Netherlands, France, Italy, South Korea, Japan, Australia and/or the US, who typically view, or could view, a Luxembourg partnership as tax opaque. This is because such funds are now more likely to fall outside of the “reverse hybrid” rule altogether by virtue of being less likely to breach the 50% “Hybrid Investor” threshold.

Fund managers that use Luxembourg fund partnerships will still need to collect and assess information regarding the hybrid status of investors when considering the application of the Luxembourg “reverse hybrid” rule. Where a fund’s investor base would cause the Luxembourg reverse hybrid rule to be implicated, there may be ways to structure around this or the fund may seek to rely on available exemptions. However, the recent amendment described above is a welcome development that will hopefully mean that in many cases such additional structuring and/or reliance on an exemption is unnecessary.

This note does not constitute legal advice of any kind and in all cases local tax advice should be sought.