Luxembourg hybrids
1. General context
– Various structures involve hybrids, with debt (deduction, no WHT) or
equity treatment (exemption) application
– Revised Parent-Subsidiary Directive: no exemption if payment is
deductible
– OECD BEPS initiatives (on hybrids, but also on TP and
documentation, on substance, communication of rulings, etc.)
– Luxembourg’s efforts to become more transparent: banking secrecy,
bearer shares, base erosion, draft legislation on rulings and TP
documentation
© Allen & Overy 2014
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2. Hybrid financial instruments (D/NI): the PECs/CPECs example
PECs issued by Lux Co. are treated as debt in Luxembourg, giving rise to deductible interest payments.
The PECs are treated as equity in jurisdiction A and, therefore, the payments are exempt as dividends.
2. Defensive rule
•
Country
A must
include
payment as "ordinary income"
if Luxembourg does not apply
primary rule
•
No dividend exemption
Luxembourg
1. Primary rule
Luxembourg refuses deduction if
payment is not recognised as
"ordinary income" in jurisdiction A.
NI encompasses long-term tax deferral, but reasonable differences in timing of the recognition of payments
do not constitute a mismatch.
PECs are, from a Luxembourg perspective, comparable to a loan.
© Allen & Overy 2014
3. Hybrids: impact on US structures?
US LP
US LP
US LP
If US does not disregard Lux
HoldCo:
•
US tax benefit is just a deferral
of taxation until payments are
made under the PECs. To the
extent payments are made in a
"reasonable" time period, than
the PECS/CPECs should not be
considered as hybrid financial
instruments (i.e. interest should
remain deductible in
Luxembourg).
•
It is unlikely that the US will
change its international tax rules
in the short term.
US LLC
CPECs
PECs
Lux HoldCo
Loan
TargetCo
© Allen & Overy 2014
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4. Prevention of treaty benefit
– Obtaining treaty benefit was one of the main purposes of the structure
– Holding companies with adequate substance and diversified investments
– WTO and customs duties
– Legal unsafety, impact on funds and private equity
– Impact on freedom of establishment in the EU (only wholly artificial
arrangements may be challenged)
© Allen & Overy 2014