Hybrid mismatches are the consequence of differences in the tax treatment of an entity, a financial instrument or a permanent establishment under the laws of two or more jurisdictions and those differences may give rise to deduction without inclusion or double deduction outcomes.
The hybrid mismatch rules provided under Article 168ter of the Luxembourg Income Tax Law (LITL) apply as from 1 January 2020 and 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. In addition, Article 168quater of the LITL provides for a reverse hybrid mismatch rule that applies 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 Organisation for Economic Co-operation and Development in regard to Action 2 of the Base Erosion and Profit Shifting (BEPS) Project 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.