New Luxembourg Circular clarifies the definition of a “Collective Investment Vehicle” for the purposes of its’ carve-out from the Reverse Hybrid Rules

Background

The reverse hybrid rules, which were implemented in Luxembourg as part of the Anti-Tax Avoidance Directive II (ATAD 2), which took effect in 2022, can subject Luxembourg tax-transparent entities, partnerships such as SCS and SCSp, to Luxembourg corporate income tax if certain conditions are met. This occurs when associated non-resident investors - who view a Luxembourg partnership as an opaque taxpayer – hold, alone or by acting jointly with others, a 50% or greater interest in the Luxembourg entity’s voting rights, capital interests or profit entitlements, and are not taxed in their countries of residence on the income attributed to them due to a qualification mismatch.

A key exception to these rules applies to CIVs. Article 168quater, paragraph 2, of the LITL defines a CIV as an investment fund or undertaking that meets the following conditions:

1. it is widely held,
2. holds a diversified portfolio of securities, and
3. it is subject to investor-protection regulation in its jurisdiction.

 What qualifies as a CIV?

Until now, the practical application of these three criteria was unclear.

The Circular confirms that the following Luxembourg undertakings and investment funds qualify as CIVs within the meaning of Article 168quater, paragraph2, of the LITL, provided that they are not considered to pursue a commercial activity:

• Undertakings for Collective Investment (UCIs) within the meaning of the amended Law of 17 December 2010,
• Specialized Investment Funds (SIFs) within the meaning of the amended Law of 13 February 2007, and
• Reserved Alternative Investment Funds (RAIFs) within the meaning of the amended Law of 23 July 2016.

Three Key Conditions for Other Fund Structures

For other Luxembourg investment undertakings and vehicles to qualify, they must meet all three of the following conditions:

1. Wide Investor Participation

The Circular clarifies that the “widely held” requirement is met if the fund is marketed for distribution to multiple unrelated investors. It is worth noting that there is flexibility in applying this criterion during the launch phase (up to 36 months from authorization to adequately extend the investor base) and during the liquidation phase, when a limited circle of investors is permitted.

Investors are considered “related” if:

• one holds, directly or indirectly, 50% or more of the capital or voting rights of the other;
• an individual or entity holds, directly or indirectly, more than 50% of the capital or voting rights of both investors;
• they are members of the same family; or
• one controls the other or both are controlled by the same individuals or entities.

A presumption applies if no single individual investor ultimately holds or controls, directly or indirectly, more than 25% of the capital or voting rights of the Luxembourg entity. For verification purposes the ACD may use information from the Luxembourg Register of Beneficial Owners.

In master-feeder structures, this condition must be assessed at the level of the feeder funds.

2. Diversified Securities Portfolio

In this context, the term “securities” is broadly defined to include:

• shares, partnership interests, and similar equity instruments;
• beneficiary shares and profit-sharing interests;
• bonds and other debt securities;
• fund units;
• deposits with credit institutions; and
• Financial derivatives (where the underlying assets consist of securities).

Risk diversification is assessed based on:

• the fund’s investment policy; and
• its exposure to market risk, including counterparty risk.

The Circular refers to the risk-spreading requirements set out in the SIF Law of 2007 to assess whether a portfolio is not considered appropriately diversified, stating that improper diversification is established if a fund:

• uses more than 30% of its assets or commitments to subscribe to securities issued by the same issuer, unless this approach can be adequately justified, or
• the use of derivatives does not achieve appropriate risk diversification.

3. Investor Protection Rules

The fund must be subject to investor protection rules in its home jurisdiction. This condition is presumed to be met for:

• CSSF-supervised funds (i.e., funds supervised by the Luxembourg regulator, the Commission de Surveillance du Secteur Financier, g. SIFs and Investment Companies in Risk Capital (SICARs)); or
• EU AIFMD-compliant Alternative Investment Funds (AIFs) managed by an AIF-Manager duly authorized under Directive 2011/61/EU (AIFMD), for example under the form of RAIF or RAIF-SICAR.

Lastly, the ACD emphasizes that the Circular’s guidance only concerns the concept and interpretation of CIVs from a tax perspective, as laid out in Article 168quater, paragraph 2, of the LITL and is not relevant or applicable in the context of other regulatory and legal applications, such as those governed by the CSSF.

Practical Implications and Conclusion

The Circular L.I.R. n° 168quater/2 provides legal clarity and facilitates the consistent application of the reverse hybrid rules. While many funds were already structured to avoid falling within the scope of these rules, the new guidance enables a broader range of investment vehicles - particularly those that do not automatically qualify based on their nature - to confidently assess their eligibility for the CIV carve-out.

If you would like additional guidance or wish to discuss your specific circumstances, please contact your trusted advisor at Tiberghien or any of the authors of this publication, who are ready to help you navigate these new requirements and optimize your fund structures.