Luxembourg was eventually able to implement Council Directive (EU) 2022/2523 of 15 December 2022 on ensuring a global minimum level of taxation for multinational enterprise groups and large-scale domestic groups in the European Union (EU) right on time.
These rules were initially derived from the OECD Global Anti-Base Erosion Model Rules Pillar 2 initiative for a 15% global minimum tax on certain large multinationals (the "Pillar 2 Rules"). Whilst the law voted on 20 December 2023 (gazetted on 22 December 2023) was able to include some welcome elements of the OECD administrative guidance, the most recent and third set of administrative guidance released by the OECD only on 18 December 2023 did not lead to further changes to the law. This is presumably due to the timing of their release and the desire of the government and parliament to move forward and have the Directive implemented on time. Nevertheless, we expect such guidance to remain an important source of interpretation for the Pillar 2 Rules as they are expected to be incorporated later this year into a revised version of the Commentary to the GloBE Model Rules originally issued in March 2022.
In the meantime, we thought it useful to summarise and discuss below the main drivers of the Pillar 2 Rules as adopted by Luxembourg.
In a nutshell
Where the effective tax rate paid by certain entities is lower than 15%, an additional amount of tax – referred to as "top-up tax" – will be added in compensation for the low-taxed entities, to reach the minimum tax rate of 15%.
Scope
The Pillar 2 Rules apply to certain entities or permanent establishment of such entities ("constituent entities" as they are termed) located in Luxembourg, which are part of a multinational enterprise group or of a large-scale domestic group, where consolidated annual revenues exceed EUR 750 million in at least two of the last four consecutive fiscal years (a "Group").
Considering the “look back” exercise when conducting an assessment on the aforementioned revenues threshold, the Pillar 2 Rules obviously have some retrospective implications insofar that fiscal years already closed on or prior to 31 December 2023 will need to be scrutinised by taxpayers belonging to a potential Group (i.e. the Pillar 2 Rules apply where the threshold is exceeded during two years
– consecutive or otherwise – in retrospect over a four-year period).
There are also a number of other practicalities to take into consideration when carrying out the threshold test, namely when a Group was subject to a corporate reorganisation (e.g. merger and division) for which certain specific rules apply when computing consolidated Group revenues. For instance, when several Groups are merging and if their aggregated revenues (derived from each of their consolidated financial statements) during the year preceding the merger exceed EUR 750 million, the consolidated annual revenues threshold is deemed to be met.
Three main interlocking taxing rules
To enable the application of the targeted minimum tax rate of 15%, the new legislation comprises the following main taxing rules:
- The first rule is a qualified domestic top-up tax that Luxembourg has opted to introduce: low-taxed Luxembourg tax resident constituent entities of a Group will first and foremost be subject to a domestic qualified top-up tax aimed at reducing to zero any top-up tax that could be due locally by a Luxembourg resident parent entity or in another EU Member State if the parent entity is not located in Luxembourg.
- The second rule – referred to as Income Inclusion Rule or IIR – imposes top-up tax on a parent entity in respect of low-taxed income of non-Luxembourg constituent entities (EU resident or not) within a Group; and
- The third rule – referred to as Undertaxed Payment Rule or UTPR – is a backstop to the IIR that allocates top-up tax amongst constituent entities, to the extent that the low-tax income of a constituent entity is not subject to an IIR. For instance, where the ultimate parent entity of a Group is an entity excluded from the scope of the Pillar 2 Rules or is located in a jurisdiction outside the EU that does not apply rules similar to the IIR, a Luxembourg constituent entity could potentially be subject the UTPR in compensation.
Impacts for investment funds
- Pillar 2 Rules exclude from their scope investment funds that are part of a Group if they can be considered as the parent entity of this group. EU Member States have agreed on a definition of "investment fund" that is specific to the Pillar 2 Rules and in our view rather restrictive. As a result, each investment fund should carefully assess the application of the exemption to its individual situation as the extensive conditionality of that term may not include all the practical diversity of funds that we experience on the market.
- For instance, one of the criteria to qualify as an investment fund is to have some of the investors being considered as "non-connected". The commentaries raised during the legislative process have brought a welcome clarification that a 50% participation threshold (inferred from the OECD model convention) should be applied to determine whether investors should be considered as "connected". It is also possible for an investment fund to still qualify for an exclusion from the Pillar 2 Rules even if there is only a single investor for a short period of time, which is also useful.
- Direct and indirect subsidiaries of exempted investments funds can also under certain circumstances be excluded from the scope of the Pillar 2 Rules, but it should be noted that this exclusion is subject to additional and more restrictive conditions, notably regarding the subsidiaries' activities. Special attention is therefore to be paid to sizeable subsidiaries of investments funds that might still be covered by the Pillar 2 Rules, although the controlling investment fund would benefit from an exemption.
- Finally, although excluded, (qualifying) investments funds are nonetheless subject to compliance requirements and, as a parent entity of constituent entities, could be responsible for the payment of the IIR and potentially the UTPR in respect of non-exempt subsidiaries.
Other key considerations
- Although still subject to some compliance requirements, real estate investment vehicles (alongside investment vehicles discussed above) being the parent entity of the Group and their (direct and indirect) subsidiaries should – under certain conditions – be excluded from the Pillar 2 Rules. An important clarification has also been made for real estate investment vehicles for which one of the criteria is to be "widely held": according to the aforementioned commentaries, this condition can also be appreciated at the level of indirect entities investing in such a real estate vehicle.
- To ensure a fair comparability between the tax computation of the different jurisdictions involved, specific rules related to eligible profits and losses are provided for the computation of the effective tax and these may substantially differ from the Luxembourg tax laws (as these rules are essentially IFRS based, which is generally not the case for the Luxembourg tax laws principles). Along the same line of comparability, there are specific rules foreseen for the eligible taxes and as a result certain taxes paid in other countries may be disregarded for the Pillar 2 Rules. In practice, this means that incurring a tax liability of at least 15% in a given jurisdiction does not automatically mean that the Group is compliant under the Pillar 2 Rules. A specific Pillar 2 assessment of the tax base and taxes paid must be carried out to determine whether or not additional taxes are due by a Group.
- Other sets of specific rules apply under certain circumstances. These include the determination of eligible assets, liabilities and taxes in the case of an entry into and exit from a Group, the determination of eligible capital gains or losses in the case of transfer of assets and liabilities, as well as rules for Groups with multiple parent entities. For instance, an entity that would exit a Group and enter into another one would be considered as a constituent entity of both groups if part of its financial items are consolidated on a line-by-line basis in the consolidated financial statements of the parent entities. This is because – as outlined by the commentaries to the law – a consolidation on a line-by-line basis is indicative of the existence of a control over an entity.
Compliance requirements
- Luxembourg tax resident constituent entities must register their status with the Luxembourg tax authorities within 15 months of the end of the relevant fiscal year or 18 months of the end of the year of transition (i.e. the first year during which the group is subject to the Pillar 2 Rules).
- Unless an exception applies, Luxembourg tax resident constituent entities must file an informative top-up tax declaration within 15 months of the end of the relevant fiscal year.
- Luxembourg tax resident parent entities subject to the IRR and/or the UTPR must file a top-up tax return for each civil year within 15 months of the end of the relevant fiscal year and pay the relevant taxes at the latest one month after the filing of the top-up tax return.
- Fines of up to EUR 250,000 are applicable in the case of non-respect of compliance requirements.
Timing
The Pillar 2 Rules are applicable to tax years starting as from 31 December 2023, with a look back exercise and various transitory rules applicable to the UTPR, which should apply as from 31 December 2024 to the extent the parent entity is not located in an EU Member State having introduced the optional qualified domestic top-up tax.
If you need assistance in assessing your status and position with respect to the Pillar 2 Rules and determining your compliance requirements, our team will be pleased to help you navigate through these new rules and to understand your tax obligations and – if needed – comply with your tax filing obligations.