Luxembourg sharpens its private capital edge: permanent carried interest regime and clarified reverse hybrid carve-out.
In context
As 2025 reached its midway point, Luxembourg has advanced a series of tax measures designed both to ensure compliance with international standards and to reinforce the Grand Duchy’s position as a leading hub for cross-border investment funds. Two recent developments illustrate this approach.
First, the proposed reform of the carried interest regime through bill No.8590, submitted on
24 July 2025 (the “Bill”). This initiative aims to modernise the tax treatment of carried interest, broaden the category of eligible beneficiaries, and align more closely with international best practices, thereby supporting its long-term attractiveness for fund managers and sponsors.
Second, the publication on 22 August 2025 by the Luxembourg tax authorities of the Circular L.I.R. n°168quater/2 (dated 12 August 2025) (the “Circular”), which provides for long-awaited guidance on the scope and application of the reverse hybrid rule, clarifying the collective investment vehicles (“CIVs”) carve-out from the reverse hybrid rule under Article 168quater, paragraph 2 of the Luxembourg Income Tax Law (“LITL”).
In short
Carried interest reform
The Bill introduces key clarifications and improvements to Luxembourg’s carried interest regime:
- Broader eligibility: access now extends beyond fund manager employees to include directors, partners, shareholders of management companies, and employees of investment advisers.
- Clearer tax treatment: it differentiates between:
- Contractual carry: qualifies as extraordinary miscellaneous income, taxed at one-quarter of the individual’s global rate (approximately 13% including dependency contribution); and
- Equity-linked carry: treated as speculative income, taxable at personal income tax rates (up to 45.78%) if disposed of within six months but exempt if held for longer than six months - except where the participation exceeds 10% of the fund’s capital, in which case the gain is taxed at half rates.
- Greater flexibility: deal-by-deal carry structures are now eligible, removing the previous whole-of-fund recovery requirement.
This reform positions Luxembourg as a leading jurisdiction for carried interest, offering fund managers one of the most attractive and competitive regimes in Europe and worldwide.
Reverse hybrid rule – A welcome clarification for funds
The Circular provides long-awaited guidance on the scope of the collective investment vehicle (“CIV”) carve-out under Luxembourg’s reverse hybrid rule.
Automatic CIV carve-out: UCITS and Part II UCIs (undertakings for collective investment governed by the amended law of 17 December 2010), Specialised Investment Funds (“SIFs”) and Reserved Alternative Investment Funds (“RAIFs”) are automatically recognised as CIVs and excluded from the reverse hybrid rule, without having to demonstrate further conditions.
Other vehicles: investment funds outside these categories may also qualify for the carve-out, provided they meet all three conditions:
- Widely held: marketed to multiple unrelated investors, with no single individual investor (direct or indirect) holding or controlling more than 25%; transitional tolerance applies during the 36-month ramp-up phase and in liquidation, and a look-through is applied in master-feeder structures;
- Diversified portfolio: a fund must include a broad range of securities, with no more than 30% investment in a single issuer’s securities; and
- Investor protection: subject to prudential supervision by the Financial Sector Supervisory Commission (“Commission de Surveillance du Secteur Financier - CSSF”) or managed by an authorised Alternative Investment Fund Manager (“AIFM”) under AIFM Directive1 (“AIFMD”).
The Circular significantly reduces market uncertainty by confirming the automatic carve-out for mainstream Luxembourg fund vehicles and clarifying the conditions for others, thereby limiting reverse hybrid exposure and reinforcing Luxembourg’s appeal as a secure and predictable fund jurisdiction.
Luxembourg turns clarity into competitiveness, reinforcing its role as Europe’s trusted home for private capital.
With a modernised carried interest regime and clear guidance on fund taxation, the Grand Duchy sends a strong signal: it remains a jurisdiction that listens, adapts and innovates to meet the needs of both institutional investors and entrepreneurial talent.
Fund managers, sponsors and the wider investment funds industry can therefore look ahead with renewed confidence, as Luxembourg continues to strengthen its position as a trusted and attractive home for private capital.
The White & Case Luxembourg tax team remains at your disposal to discuss these reforms in more detail and assess their potential impact on your fund structures and investment strategies.
In detail
Luxembourg advances on private capital attractiveness, including a new carried interest regime
International context
In today’s rapidly evolving tax environment, marked by both global alignment initiatives and national competitiveness strategies, Luxembourg continues to pursue a pragmatic path. While the OECD’s BEPS project and the EU tax agenda emphasise harmonisation and fairness, Luxembourg positions itself simultaneously as a leading hub for cross-border investments. This dual approach remains at the core of its fiscal strategy.
A clear expression of this balance is the tax reform adopted on 11 December 2024, contained in Bills no. 84142 and no. 83883. This reform introduces a wide-ranging package of measures that modernise the tax framework and enhance legal certainty - a critical foundation for the private capital market.
These reforms - from the corporate tax rate cut to enhancements of the inpatriate regime and updates in fund taxation - paved the way for the next strategic step: the modernisation of the carried interest regime.
Why this matters for fund managers and sponsors
Luxembourg is already a globally recognised hub for Alternative Investment Funds (“AIF”). Yet, its carried interest rules - a key incentive for fund managers - have long been criticised for their narrow scope and lack of clarity.
The Bill, submitted on 24 July 2025, directly addresses these concerns. It seeks to modernise and expand the regime, attract and retain front-office talent, provide tax certainty, and reinforce Luxembourg’s competitive position.
A broader push to enhance Luxembourg’s attractiveness
The Bill is part of a broader legislative agenda aimed at consolidating Luxembourg’s status as a premier hub for international investment platforms.
In his State of the Nation Address on 11 June 2024, Prime Minister Luc Frieden announced a comprehensive programme of fiscal and regulatory measures designed to enhance the Grand Duchy’s appeal to global businesses, institutional investors, and financial professionals (for further information, please refer to our earlier published newsletter4). Among the headline initiatives are:
- Corporate income tax reduction: from 17% to 16% as of 1 January 2025;
- R&D and innovation incentives: for sectors including digital assets and sustainable finance;
- Asset management modernisation: updates to the legal framework for alternative funds, actively managed ETFs and participative bonuses; and
- Single company group concept: introduced in December 2024, providing relief to structures impacted by interest limitation rules, especially securitisation vehicles (for further information, please refer to our earlier published newsletter5).
Taken together, these reforms underline Luxembourg’s commitment to remain a stable, innovation-oriented, and business-friendly environment. The carried interest reform is one of the most strategic elements of this agenda.
Former carried interest tax regime (2013–2018)
Luxembourg first introduced a favourable carried interest tax regime in 2013, alongside the implementation of the AIFMD through the amended Law of 12 July 2013 (the “AIFM Law”)6. While the regime is no longer open to new entrants, understanding its framework remains important for legacy arrangements and structuring still in effect today.
Luxembourg first introduced a favourable carried interest tax regime in 2013, alongside the implementation of the AIFMD through the amended Law of 12 July 2013 (the “AIFM Law”) . While the regime is no longer open to new entrants, understanding its framework remains important for legacy arrangements and structuring still in effect today.
Carried interest (“intéressement aux surperformances”) was defined, in accordance with Article 1, point 52 of the AIFM Law, as follows:
“a share of the profits of the AIF which is allocated to the manager as compensation for managing the AIF, excluding any share of the profits attributable to the manager by virtue of investments made by the manager in the AIF”.
In other words, it refers to the reward granted to the manager of an AIF for the strong performance of the portfolio of investments they have selected and managed. This remuneration was variable, paid only if the fund’s performance exceeded a predefined return threshold (the “hurdle rate”).
Importantly, capital gains arising from the disposal of an individual’s own units or shares in an AIF were excluded from the carried interest regime. Such gains were instead taxed under the general capital gains rules: in principle exempt if the units or shares were held for more than six months and did not represent a substantial participation (i.e. more than 10%, including holdings by household members).
The preferential regime was strictly limited in scope:
- It applied only to individuals becoming Luxembourg tax residents between 2013 and 2018, provided they had not been tax-resident during the preceding five years;
- The benefit was capped at ten tax years from the start of professional activity in Luxembourg;
- Eligible individuals had to be employees of the AIF’s manager or management company;
- Carried interest entitlement was conditional on investors having first recovered their contributed capital; and
- Advance payments were prohibited; amounts had to be withheld until conditions were met.
Carried interest that did not satisfy these requirements was taxed as ordinary income at full personal income tax rates.
Although the regime has been closed to new entrants since 2018, legacy beneficiaries who entered during the eligibility window may still rely on it, provided they continue to meet all applicable conditions and remain within the ten-year timeframe.
Current tax regime of capital gains on movable assets
The Luxembourg taxation of capital gains on movable assets is governed by rules that differentiate between short-term and long-term holdings, substantial participations and the residency status of the seller.
As a general principle, capital gains on movable assets are taxable in Luxembourg only if realised within six months of acquisition. Under Article 100 LITL, however, gains on shares may remain taxable even after the six-month period if the seller holds, or has held, within the preceding five years, a substantial participation in the relevant company. For this purpose, a substantial participation is generally defined as more than 10% of the share capital, considering holdings by household members.
Where shares are disposed of within six months of acquisition, the gain is classified as speculative income and taxed at the individual’s standard personal income tax rates, currently up to 45.78% (including a 9% solidarity surcharge and a 1.4% dependency contribution). No withholding tax applies, and an annual exemption of EUR 250 is available. Conversely, gains on shares disposed of after six months are exempt, provided that the seller (together with their household) has not held more than 10% of the company’s share capital at any point in the previous five years. If such substantial participation has been held during that period, the gain remains taxable but at half the ordinary personal income tax rates.
The Luxembourg tax authorities have clarified in Circular 100/1 of 13 July 2007 that a switch from one compartment to another within an undertaking for collective investment or a securitisation company is treated as a disposal followed by a re-acquisition and therefore constitutes a taxable event.
Special step-up rules apply for non-resident individuals transferring their tax residence to Luxembourg. In such cases, the value of their substantial participations is stepped up to fair market value on arrival, which then serves as the acquisition price for future disposals. This measure prevents double taxation, particularly where the country of origin imposed an exit tax. The step-up also extends to convertible debt held in companies where the individual has a substantial participation. However, it is not available where an individual has been Luxembourg resident for more than 15 years and becomes non-resident less than five years before relocating back, a restriction intended to discourage purely tax-driven relocations.
Finally, under domestic law, and subject to treaty provisions, capital gains realised by non-residents on shares in a Luxembourg company (not attributable to a Luxembourg permanent establishment or fixed place of business) are in principle exempt. Taxation may nevertheless arise where the non-resident disposes of a substantial participation exceeding 10% and either was a Luxembourg tax resident for more than 15 years and became non-resident less than five years before the sale or sells the shares within six months of acquisition.
Key aspects of Bill No.8590
The Bill introduces important clarifications and improvements to the personal income tax treatment of carried interest, as governed by Article 99bis LITL. While the core definition of carried interest under the AIFM Law remains unchanged, the Bill significantly reshapes how the regime applies in practice.
1. Broader eligibility - Opening the door to more professionals
The scope of beneficiaries is expanded well beyond employees of alternative investment fund managers or their management companies. It now includes independent directors, partners, shareholders of management companies and employees of investment advisers. This modernisation reflects how today’s fund structures operate in practice and gives managers greater flexibility to allocate carried interest to the professionals directly driving value creation.
This significantly widens the pool of talent that can benefit from Luxembourg’s preferential regime.
2. Clearer tax treatment - Contractual vs equity-linked carry
The Bill draws a clear line between two categories of carried interest:
- Contractual carry (not linked to a fund participation) qualifies as extraordinary miscellaneous income and is taxed at one-quarter of the individual’s global rate (approximately 13%, including dependency contribution). This typically applies to carry granted free of charge and triggered purely by fund performance, often above an 8% hurdle rate.
- Equity-linked carry is aligned with the general capital gains regime. Gains are taxed as speculative income if realised within six months of acquisition but are exempt if the participation is held for more than six months, provided that it does not exceed 10% of the AIF’s capital. Where the carried interest represents a substantial participation (i.e. more than 10%), the gain remains taxable even after six months, but only at half the ordinary personal income tax rates.
The tax transparency of an AIF structured as a special limited partnership (société en commandite par actions), a limited partnership (société en commandite simple) or a contractual investment fund (fonds commun de placement) is disregarded solely for the application of the carried interest regime.
This removes a source of longstanding uncertainty under the current law, ensuring that carry received via transparent entities is taxed as if received directly from the AIF, without requiring a look-through into the AIF’s own transparency status, preventing mismatches leading to dry taxation.
3. Greater flexibility - Deal-by-deal structures recognised
Previously, preferential tax treatment was contingent on investors first recovering their entire contributed capital - a condition that worked for traditional “whole-of-fund” models but effectively excluded deal-by-deal arrangements. While that rule suited funds distributing profits only after assessing the overall performance of the vehicle, it failed to reflect the increasing prevalence of structures rewarding performance on an investment-by-investment basis. The reform remedies this by extending the favourable regime to deal-by-deal carry structures, allowing carried interest to be paid to managers and other eligible participants based on the success of individual deals, without requiring that all investors first recover their capital at the level of the fund as a whole.
This ensures Luxembourg’s regime is aligned with the growing use of deal-by-deal waterfalls in international fund practice.
4. Permanency - From transitional to stable regime
Finally, the Bill makes the quarter-rate taxation for contractual carry permanent. This replaces the transitional regime under Article 213 of the AIFM Law, which remains in force until 2028 for existing beneficiaries but has been closed to new entrants since 2018. Under the new rules, individuals relocating to Luxembourg with pre-existing carry entitlements may also benefit, subject to their residence status and applicable treaty provisions.
How does this impact fund structuring?
The reform is expected to bring greater certainty and flexibility to Luxembourg fund structures. It enhances legal certainty around the classification and taxation of carried interest, encourages the local presence of sponsors - particularly front-office functions - and ensures Luxembourg keeps pace with evolving international standards. By making the preferential regime permanent, Luxembourg also strengthens its ability to attract and retain top talent, offering one of the most competitive carried interest regimes globally.
This long-term certainty consolidates Luxembourg’s position as a jurisdiction of choice for fund managers and positions the Grand Duchy alongside - and in some respects ahead of - competing European fund domiciles by combining clarity, flexibility and permanence.
When will this apply?
The Bill has been submitted and is scheduled for parliamentary debate in the last quarter of 2025. If adopted, the new regime will apply as from tax year 2026.
What should you do now?
Fund managers and sponsors should begin preparing now to ensure they are ready to take advantage of the new regime once it enters into force. This includes assessing the impact on existing carried interest arrangements, reviewing fund documentation - such as LPAs and waterfall provisions - to ensure alignment with the forthcoming rules, and planning for timely implementation and compliance ahead of the 2026 tax year.
Together, these reforms send a strong signal: Luxembourg is not only modernising its carried interest rules but also clarifying fund taxation in key areas. The next milestone is the long-awaited guidance on the reverse hybrid rule - a development of equal importance for the funds industry, which we turn to below.
Luxembourg tax authorities clarify the reverse hybrid rule through new circular
As part of Luxembourg’s continued alignment with international tax standards - while safeguarding its position as a leading fund hub - the tax authorities issued on 22 August 2025 the Circular L.I.R. n°168quater/2 (dated 12 August 2025). This much-needed guidance addresses the reverse hybrid rule introduced by the second EU Anti-Tax Avoidance Directive (“ATAD 2”) and implemented into Article 168quater LITL.
Applicable since 1 January 2022, these rules aim to counter situations where tax transparent entities are treated as opaque by foreign investors, creating risks of double non-taxation.
Market uncertainty before the circular
A reverse hybrid arises where a Luxembourg entity is treated as transparent domestically but as opaque (i.e. taxable) in the jurisdiction of its associated non-resident investors. In such cases, the entity’s net income not otherwise taxed in Luxembourg or abroad becomes subject to Luxembourg corporate income tax at 17.12% (including the 7% employment fund surcharge on corporate income tax) in 2025.
The rules apply where “associated enterprises” or “persons acting together” hold at least 50% of the voting rights, capital, or profit entitlement of the Luxembourg entity. Uncertainty also surrounded the scope of “associated enterprises”, in particular the undefined concept of “significant influence”.
Article 168quater, paragraph 2 LITL provides that CIVs are excluded from the reverse hybrid rule if they are (i) widely held, (ii) hold a diversified portfolio of securities, and (iii) are subject to investor-protection regulation. Before the Circular, it was unclear whether the carve-out extended beyond UCITS and Part II UCIs to SIFs and RAIFs, and how the CIV conditions should be applied in practice. This lack of clarity led to hesitation and higher compliance costs across the market.
Clarifications brought by the circular
UCITS and Part II UCIs, SIFs and RAIFs Automatically Recognised as CIVs
The Circular expressly confirms that the following Luxembourg investment funds qualify as CIVs for the purposes of the carve-out:
• UCITS and Part II UCIs governed by the amended law of 17 December 2010;
• SIFs governed by the amended law of 13 February 2007; and
• RAIFs governed by the amended law of 23 July 2016.
These vehicles are therefore automatically excluded from the scope of the reverse hybrid rule and need not demonstrate compliance with the general CIV conditions.
Guidance for Other Investment Vehicles
For funds outside these categories, the Circular sets out how the three CIV conditions should be assessed:
1. Insights into the “Widely Held” requirement
A fund will generally be regarded as widely held where its units or shares are marketed to several unrelated investors. The condition is presumed satisfied if no individual, directly or indirectly, holds or controls more than 25% of the voting rights or capital of the fund, or otherwise exercises control.
To verify compliance, the Luxembourg tax authorities may rely on the Register of Beneficial Owners, where applicable. This mirrors the AML beneficial-owner threshold and gives a rebuttable presumption of compliance.
The Circular further clarifies that:
- A fund may still qualify as widely held despite a limited number of investors, depending on its circumstances and objectives. This applies in particular during the ramp-up period (up to 36 months) or in the liquidation phase, where a temporary concentration of investors - linked to the winding-up process - does not prevent the condition from being met;
- In master-feeder structures, the widely held test is assessed at the master fund, applying a look-through to the feeder’s investors; where the feeder is the tested vehicle, a look-through approach also applies; and
- Investors are considered related when (i) one directly or indirectly holds 50% or more of another’s capital or voting rights, (ii) both are under common control, (iii) they belong to the same family group (including spouses, civil partners, relatives or adopted persons), or (iv) one exercises effective control over the other based on all relevant facts and circumstances.
Although the Circular does not expressly define “significant influence,” its approach - particularly the 25% threshold for the widely held test - suggests that investors above this level may be regarded as exercising such influence.
2. Assessment of the “Diversified Securities Portfolio” condition
For the purposes of Article 168quater, paragraph 2 LITL, the Circular adopts a broad interpretation of the term “securities”. This includes shares and similar equity instruments, beneficiary shares, bonds and other debt instruments, fund units, deposits with credit institutions, and financial derivatives where the underlying consists of securities.
Whether a portfolio is diversified must be assessed both in light of the fund’s stated investment policy - as set out in its management regulations or constitutional documents - and its actual market risk exposure, including direct and indirect counterparty risk.
Consistent with standards applicable to SIFs, a fund will not be considered diversified if it invests more than 30% of its assets or commitments (directly or indirectly, applying a look-through where relevant, to reflect SIF risk-spreading standards) in securities of a single issuer without adequate justification, or if its use of derivatives does not achieve a comparable level of risk spreading.
3. Guidance on “Investor Protection” condition
The third condition requires that the fund be subject to appropriate investor-protection rules in its jurisdiction of establishment.
This requirement is presumed satisfied where the fund:
- is under the prudential supervision of the CSSF; or
- qualifies as an AIF managed by an authorised AIFM in accordance with the AIFMD (or subject to equivalent non-EU authorisation) - note: a registered but not authorised AIFM does not suffice.
By aligning the test with established regulatory standards, the Circular provides a clear and workable benchmark, reducing uncertainty for managers and investors while ensuring that only funds subject to robust safeguards benefit from the carve-out.
Why does this matter?
The Circular brings long-expected clarity for the investment funds industry. By confirming the scope of the CIV carve-out and providing practical guidance on its conditions, the Luxembourg tax authorities have significantly reduced the risk that mainstream Luxembourg fund structures could inadvertently fall within the scope of the reverse hybrid rule. At the same time, the Circular underscores the importance of ongoing monitoring and robust record-keeping, to ensure that the exemption conditions continue to be satisfied over time.
What should be done?
Fund managers and sponsors should view these measures as a welcome development. In practice, it is advisable to:
- Review existing structures to confirm that they clearly fall within the CIV carve-out as clarified by the Circular;
- Implement monitoring procedures to ensure continued compliance with the widely held, diversification, and investor protection conditions where relevant; and
- Assess new fund launches in light of the clarified guidance, to secure upfront comfort and minimise reverse hybrid risk.
For those not yet present in Luxembourg, the Circular reinforces the Grand Duchy’s status as a secure and predictable jurisdiction of choice for structuring future investment platforms.
The Circular provides long-awaited legal certainty, ensuring that mainstream Luxembourg funds can rely on the CIV carve-out with clear, workable conditions.
1 Directive 2011/61/EU
2 Projet de Loi no. 8414 du 17 juillet 2024 portant modification de la loi modifiée du 17 avril 1964 portant réorganisation de l’administration des contributions directes, de la loi modifiée du 4 décembre 1967 concernant l’impôt sur le revenu, de la loi modifiée du 11 mai 2007 relative à la création d’une société de gestion de patrimoine familial (« SPF ») et de la loi modifiée du 17 décembre 2010 concernant les organismes de placement collectif.
3 Projet de Loi no. 8388 du 23 mai 2024 portant modification de la loi générale des impôts modifiée du 22 mai 1931 (“Abgabenordnung”), de la loi modifiée du 16 octobre 1934 sur l’évaluation des biens et des valeurs (“Vermögensteuergesetz”), et de la loi modifiée du 4 décembre 1967 concernant l’impôt sur le revenu.
4 https://www.whitecase.com/insight-alert/luxembourg-tax-update-key-takeaways-prime-minister-luc-friedens-state-nation-address.
5 Capital Markets, Securitization and Debt Investment Fund Platforms: Important Luxembourg Tax Legislation Update | White & Case LLP
6 Law of 12 July 2013 on alternative investment fund managers, Mém. A 2013, No 119.
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