Hybrid mismatches typically result from a different tax treatment of an entity, a permanent establishment (“PE”) or a financial instrument under the laws of two or more jurisdictions and may give rise to deduction without inclusion or double deduction outcomes.
The new hybrid mismatch rules target a variety of different situations including direct hybrid mismatches between associated enterprises, structured arrangements between third parties, imported hybrid mismatches and tax residency mismatches. Most of the hybrid mismatch rules are included in a new version of Article 168ter of the Luxembourg Income Tax Law (“LITL”) which entered into force on 1 January 2020. In addition, Article 168quater of the LITL provides for a reverse hybrid mismatch rule that will apply as from tax year 2022.
While the primary objective of the hybrid mismatch rules is the elimination of double non-taxation, tax adjustments under the hybrid mismatch rules should likewise not result in economic double taxation. This is ensured through a number of carve-outs and limitations that discharge the application of the hybrid mismatch rules.
ATAD 2 follows the recommendations of the OECD in regard to Base Erosion and Profit Shifting (“BEPS”) Action 2 that aim at neutralising the effects of hybrid mismatch arrangements through the application of linking rules that align the tax treatment in two or more jurisdictions. ATAD 2 explicitly states that the explanations and examples in the Final Report on Action 2 may be a source of interpretation to the extent this guidance is consistent with the provisions of the Directive.