Luxembourg - Tax

On 29 August 2025, a draft law No. 8590 was tabled before the Luxembourg Parliament (the Draft Law) which proposes a significant reform of the tax regime applicable to carried interest1. This initiative seeks the modernisation of the current regime to enhance Luxembourg’s position as a preferred residence for fund professionals.

The Existing Temporary Regime

Since 2013, Luxembourg has applied a temporary preferential regime on carried interests paid to certain Luxembourg tax resident individuals2. These tax resident individuals, being foreign employees of an AIF or AIFM that became Luxembourg resident, may benefit from a tax rate of 25% of the normal tax rate on carried interest received without capital contribution. If the carried interest is linked to a participation held for more than six (6) months and below a 10% threshold, it may, under certain conditions, be fully tax-exempt3. However, only genuine performance-based carry qualifies, while structures resembling a fixed remuneration are excluded.

Key Features of the Draft Law

The Draft Law offers a permanent and more advantageous tax regime for carried interest. It distinguishes between two types of carried interest:

• Contractual carried interest: Carried interest which is not inseparably linked to a participation in an AIF or represented by a participation in an AIF. The regime will not be temporary anymore and the income will qualify as a speculative gain, taxable as extraordinary income at 25% of the taxpayer’s global tax rate.
• Participation-based carried interest: Carried interests which are inseparably linked to a direct or indirect participation in an AIF or when the carry is represented by such a participation. Participation-based carried interest may be fully exempt under the new rules providing the participation has been held for more than six (6) months and providing the individual does not hold a substantial shareholding in a corporate vehicle (i.e. not more than a 10% shareholding).

In addition, the Draft Law significantly enlarges the personal scope of the carried interest qualifying for the above tax treatment. In addition to employees of AIFs and AIFMs, the regime will now also apply to employees of management companies and related group entities and to certain non-employees, such as independent board members of AIFs or other individuals entitled to carried interest under contractual arrangements.

Once adopted, the Draft Law should be applicable as of 1 January 2026. The legislative proposal is a welcome development for the Luxembourg fund industry. By providing a clear, permanent and advantageous tax framework, it further highlights the appeal of Luxembourg as a major actor in the fund industry.

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[1] Draft Law modifying : 1° Luxembourg Income Tax Law from 4 December 1967 (LITL) ; 2° Alternative Investment Fund Manager Law from 12 July 2013 (AIFM Law) (Projet de loi portant modification : 1° de la loi modifiée du 4 décembre 1967 concernant l’impôt sur le revenu ; 2° de la loi modifiée du 12 juillet 2013 relative aux gestionnaires de fonds d’investissement alternatifs).

[2] Article 208 AIFM Law

[3] Article 99bis LITL

The Director of the Luxembourg Tax Administration issued Circular LIR n°168quater/2 on 12 August 2025 (the Circular). The Circular provides long-awaited guidance on the application of the reverse hybrid mismatch rules to collective investment vehicle (CIV).

Reverse hybrid Rule under Article 168quater LITL.

Article 168quarter of the Luxembourg Income Tax Law (LITL)1 implements the reverse hybrid rule of the EU Anti-Tax Avoidance Directive on hybrid mismatches with third countries (ATAD 2)2. Under this rule, a Partnership or transparent entity may become subject to corporate income tax if:

(i) one or more foreign (limited) partners individually or jointly hold more than 50% of the voting rights, capital ownership, and entitlement to profits of the relevant Partnership;

(ii) such partner does not (or such partners do not) consider the relevant Partnership as tax transparent from their own tax perspective, and

(iii) such partner does not (or such partners do not) include the partnership income in its taxable income as a result of the reverse hybrid qualification.

In such cases, the Luxembourg entity becomes liable to 16.75% corporate income tax (but not to municipal business tax) on the portion of income not otherwise taxed in the hands of the partners.

In line with the exclusion provided for in ATAD 2, CIVs are out of the scope of this provision. A CIV is defined in the LITL as an investment fund or vehicle that is (i) widely held, (ii) holds a diversified portfolio of securities and (iii) is subject to investor protection regulation in the country in which it is established.

Key provisions of the Circular

The Circular confirms that regulated Luxembourg investment vehicles such as Undertakings for Collective Investments3, Specialised Investment Funds4 and Reserved Alternative Investment Funds5 are deemed to be CIVs per default.

For other vehicles (including unregulated partnerships), the following three cumulative conditions must be met:

• A broad investor protection, deemed fulfilled if the vehicle is managed by an authorised Alternative Investment Fund Manager or is supervised by the CSSF; and
• A diversified portfolio of securities which must align with the specialised investment fund diversification rules, such as avoiding excessive concentration in a single issuer; and
• A broad participation, which is met when the fund is marketed to a sufficiently wide base of unrelated investors. There is a presumption that broad participation exists if no single investor holds more than 25% of the funds capital or voting rights, with exceptions applying during starting phase and liquidation.

The Circular provides more legal certainty for fund structuring and confirms that many Luxembourg investment vehicles can benefit from the CIV exemption. This is particularly relevant for unregulated partnerships, which are commonly used for alternative investment structures.

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[1] Luxembourg Income Tax Law from 4 December 1967 (Loi modifiée du 4 décembre 1967 concernant l’impôt sur le revenu)

[2] COUNCIL DIRECTIVE (EU) 2017/952 of 29 May 2017 amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries.

[3] UCI Law from 17 December 2010 (Loi 17 décembre 2010 concernant les organismes de placement collectif).

[4] SIF Law from 13 February 2007 (Loi du 13 février 2007 relative aux fonds d'investissement spécialisés).

[5] RAIF Law from 23 July, 2016 (Loi du 23 juillet 2016 relative aux fonds d’investissement alternatifs réservés).