On 12 June 2024, the Luxembourg government presented a bill of law to incorporate clarifications and technical provisions resulting from the OECD's Pillar 2 Administrative Guidance issued in February, July and December 2023 into domestic law.
Bill of law 8396 (Bill) amends and complements the Luxembourg law of 22 December 2023 (Pillar 2 Law) implementing Council Directive (EU) 2022/2523 of 14 December 2022 on ensuring a global minimum level of taxation for multinational enterprise groups and large-scale domestic groups in the Union (Pillar 2 Directive).
The main amendments are detailed in 2. below.
1. Background: what is the Pillar 2 Law?
The Pillar 2 Law applies to constituent entities located in Luxembourg that are members of a multinational enterprise (MNE) group or a large-scale domestic group with annual revenue of at least EUR 750,000,000, including the revenue of excluded entities, in the ultimate parent entity's (UPE) consolidated financial statements for at least two of the four fiscal years immediately preceding the tested fiscal year.
In-scope MNE groups and large-scale domestic groups will pay a top-up tax whenever the effective tax rate (ETR) of constituent entities determined on a jurisdictional basis is below the minimum rate of 15%. The Pillar 2 Law does not apply to excluded entities, including inter alia governmental entities, pension funds, investment funds that are UPE or real estate investment vehicles that are UPE, as well as certain entities at least 95% or 85% owned by these excluded entities and meeting certain criteria.
The Pillar 2 Law is summarised here.
2. What are the main proposed amendments in the Bill?
Scope
One of the most significant amendments is the clarification of the scope of the Pillar 2 Law in the context of investment funds. An investment fund or real estate investment vehicle (located in Luxembourg or abroad), which is not a UPE solely because the relevant applicable financial accounting standard does not require it to prepare consolidated financial statements, is to be treated as an excluded entity. As a result, (Luxembourg) entities owned (at least 95% or 85%) by such an investment fund or vehicle and meeting certain criteria will be considered excluded entities for the purposes of the Pillar 2 Law.
In addition, the commentary to the Bill clarifies the "deemed consolidation" test. Rather, it checks whether a consolidated group would exist if the acceptable financial accounting standard (or a similar standard with adjustments to prevent competitive distortions) were mandatory. An investment entity will not be required to prepare consolidated financial statements on a line-by-line basis if the (deemed) applicable accounting standard does not require it to do so. The deemed consolidation test will also not apply to investment funds that are exempted from the requirement to consolidate by any of the investment fund laws. In the same vein, the deemed consolidation test does not treat a person as having a controlling interest in an entity if the applicable accounting standard does not require that person to consolidate the entity on a line-by-line basis. The same approach applies to an entity that performs line-by-line consolidation voluntarily or on a contractual basis.
The Bill also clarifies that a sovereign wealth fund that meets the definition of a governmental entity (broadly, an entity that manages or invests a government's assets but does not carry on a trade or business) will not be considered a UPE or a member of an MNE group.
Definitions
The Bill now defines revenue as that reflected in the profit and loss account of the MNE group's consolidated financial statements and including the aggregate amount of (i) revenues derived from the supply or production of goods, the provision of services or other activities that constitute the ordinary activities of the MNE group, before deduction of operating expenses, (ii) net realised or unrealised gains on investments, and (iii) income or gains presented separately as extraordinary or non-recurring income.
The Bill includes rules to be applied where the constituent entity and the UPE have different accounting periods. In particular, where the constituent entity is part of the line-by-line consolidation of the parent entity, Pillar 2 computations that relate to the fiscal year of the UPE are to be based on the method used in the consolidated financial statements of the UPE.
QDMTT
The Bill updates the rules on the qualified domestic minimum top-up tax (QDMTT). To compute a jurisdiction's top-up tax, any amount of QDMTT that the MNE group directly or indirectly challenges in judicial or administrative proceedings (on the basis of constitutional or other superior legal rules), or that the tax authority of the jurisdiction has determined is not assessable or collectable, is not included for the fiscal year in question. This QDMTT amount will be taken into account for the fiscal year to which it relates once it is paid and no longer contested. Similarly, the QDMTT safe harbour (i.e. the option not to compute a top-up tax for a jurisdiction which applies a QDMTT) will not operate where the QDMTT is contested under the above principles.
The Bill includes provisions on which functional currency to use for QDMTT computations in Luxembourg. The objective is that all constituent entities of an MNE group apply the same functional currency in Luxembourg. For instance, QDMTT computations will be made in euros where all the Luxembourg constituent entities apply the same acceptable financial accounting standard and use the euro as their functional currency. If the functional accounting currency of one or more of the Luxembourg constituent entities is not the euro, all Luxembourg constituent entities must carry out their QDMTT calculations either (i) in euros or (ii) in the functional currency used to prepare the consolidated financial statements of the UPE. Where the functional currencies used in the constituent entities' financial statements and for QDMTT computation differ, the conversion rules set out in the financial accounting standard used to calculate the QDMTT will apply. A Grand Ducal regulation with more detailed rules may be issued.
There will be no QDMTT in the initial phase of the international activity of an MNE group, i.e. where the group has constituent entities in no more than six jurisdictions, and the sum of the net book values of tangible assets of all constituent entities located in all jurisdictions other than the reference jurisdiction does not exceed EUR 50,000,000. The commentary to the Bill clarifies that application of this provision is not conditional on calculation of the QDMTT in the first instance.
Qualifying income or loss
The Bill clarifies the rules on the computation of the qualifying income or loss of insurance companies. Technical provisions that economically match an excluded dividend or capital gain (net of the investment management fee) from a security held on behalf of a policyholder are not allowed as an expense in the computation of the qualifying income or loss.
The Bill also clarifies the rules on the determination of the substance-based income exclusion amount in the context of an operational leasing contract (i.e. a leasing contract for which the leasing period is significantly shorter than the useful life of the tangible asset and for which the investment risk is borne by the lessor). The proposed provision and related commentary detail the conditions under which the lessor and the lessee may take into consideration the tangible assets subject to an operational lease.
Election to treat an investment entity as a tax transparent entity
The Bill clarifies that this election will be possible where a constituent entity owner of an (insurance) investment entity is a regulated mutual insurance company, as it will be treated as being subject to tax under a mark-to-market or similar regime based on the annual changes in the fair value of its ownership interest in the (insurance) investment entity.
Transition year – deferred tax expenses
In a transition year (where an MNE group falls within the scope of the Pillar 2 rules for the first time), the MNE group can take into account deferred tax expenses reflected or disclosed in the financial statements of constituent entities in order to compute the ETR in a jurisdiction at the lower of the minimum rate or the applicable domestic tax rate (NB: the Luxembourg tax authorities have recently clarified the terms "reflected or disclosed" in an FAQ). The proposed rules clarify the amount of deferred tax expenses that may be taken into account when computing the ETR in a fiscal year. For instance, a new formula helps to determine the amount of deferred tax assets related to tax credits (whether qualifying as refundable or non-refundable) that can be taken into consideration where the domestic tax rate is equal to or higher than 15%.
The Bill further clarifies the rules applying to transfers of assets between constituent entities of an MNE group that occurred after 30 November 2021 and before the transition year. It details the rules on the asset carrying value, the conditions for the acquiring entity to recognise a deferred tax asset resulting from the asset transfer and the definition of asset transfer.
Country-by-Country Reporting (CbCR) safe harbour
These proposed amendments are based on the OECD's Administrative Guidance of December 2023. They clarify the conditions for application of the transitional CbCR safe harbour regime (e.g. to ensure consistency of data used by each constituent entity of an MNE group) and the treatment of hybrid arbitrage arrangements within this framework. A hybrid arbitrage arrangement is an arrangement resulting in a deduction without inclusion, a duplicate loss or a duplicate tax recognition. Under the new rule, an expense, loss or amount of tax which results from a hybrid arbitrage arrangement entered into or modified after 18 December 2023 with the aim of obtaining the benefit of the safe harbour regime, will not be taken into account in determining the pre-tax income or the amount of the income tax charge for that jurisdiction.
Other clarifications
The Bill amends the transitional rules on controlled foreign companies to take account of the December 2023 OECD Administrative Guidance (detailing in particular how to compute a jurisdiction's ETR where a QDMTT or a CbCR safe harbour applies).
Timing
The new provisions will apply to tax years starting on or after 31 December 2023.
Conclusion
The proposed amendments are clearly welcome in so far as they provide legal certainty and confirm market practice, particularly with respect to the scope of the Pillar 2 Law. Once again, they confirm Luxembourg's determination to apply OECD guidance on Pillar 2 in compliance with EU law.
The Bill will now follow the usual legislative process through Parliament.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.