Introduction
On 4 August 2023, the text of the draft law (the "Draft Law") transposing the Council Directive (EU) 2022/2523 of 14 December 2022 on ensuring a global minimum level of taxation for multinational enterprise ("MNE") groups and large-scale domestic groups in the Union (the "Directive") was presented to Parliament. This Directive implements the Global Anti-Base Erosion ("GloBE") rules, also called "Pillar Two", agreed upon by the OECD/G20 Inclusive Framework on BEPS in the Statement to Address the Tax Challenges Arising from the Digitalisation of the Economy and the Detailed Implementation Plan, on 8 October 2021.
To ensure that large internationally operating businesses pay a minimum level of tax regardless of where they are headquartered or the jurisdictions they operate in, Pillar Two introduces a global minimum corporate tax rate set at 15% through a top-up tax using an effective tax rate test calculated on a jurisdictional basis and using a common definition of covered taxes and a tax base determined by reference to financial accounting income (with agreed adjustments consistent with the tax policy objectives of Pillar Two and mechanisms to address timing differences). The minimum tax would apply to MNE or large-scale domestic groups with a combined annual turnover above EUR 750 million. For more details about the GloBE Rules at OECD and European Union levels, read one of our previous articles.
In order to implement this minimum effective taxation in Luxembourg, the Draft Law provides for the introduction of three new taxes in Luxembourg law.
The first two are based on the application of two interdependent rules, namely the income inclusion rule ("IIR1 ") and the undertaxed payments rule ("UTPR2 "). Under the IIR, the minimum tax is paid at the level of the parent entity in proportion to its ownership interests in entities that have low-taxed income. The UTPR is designed to operate as a backstop to the IIR.
A qualified domestic top-up tax ("QDMTT3 ") will also be implemented, allowing Luxembourg to tax Luxembourgish low-taxed entities and prevent the application of the IIR and UTPR rules by other jurisdictions with respect to these entities.
In principle, the IIR and QDMTT are intended to come into effect for tax years beginning on or after 31 December 2023, while the UTPR will come into effect for tax years beginning on or after 31 December 2024.
These complex measures about to be implemented in Luxembourg are largely in line with the Directive. However, additional guidance and clarification, as well as additional complementary rules (in line with OECD guidance), are still required to address important Luxembourg-specific points.
Please see below a few selected issues.
Relevance of OECD Guidance
In line with Recital 24 of the Directive, the Draft Law acknowledges the GloBE rules published by the OECD on 20 December 2021 (the "OECD Model Rules") and related administrative guidance as sources of illustration and interpretation, even where such guidance was issued after the Directive. However, the Draft Law only considers "a number of guidelines and solutions identified at OECD level after the date of adoption of Directive". In this respect, explicit reference is, for example, made to OECD guidance published on 14 March 2022, 15 December 2022 and 2 February 2023.
An important point to note at this stage is that the 13 July 2023 OECD guidance is not explicitly mentioned in the Draft Law and part of the 2 February 2023 OECD guidance seems to not have been taken into consideration either. The OECD guidance notably included important safe harbour rules on QDMTT (including the possibility to perform the computations under local GAAP different from those of the ultimate parent entity ("UPE")) and on UTPR. At this stage it is thus unclear whether this possibility will be granted.
We expect the Draft Law to be amended so as to reflect the additional OECD guidance and to equip the Luxembourg Pillar Two rules with more flexibility, safe harbours and transitional rules to mitigate unnecessary adverse consequences for Luxembourg taxpayers.
Scope and carve-outs of the Draft Law
Annual group turnover of at least EUR 750 million
The new rules will apply to "constituent entities4 " located in Luxembourg belonging to MNEs or large-scale domestic groups with a combined annual turnover equal to or above EUR 750 million in at least two of the four fiscal years preceding the tested fiscal year, as per the consolidated financial statements of the group parent entity. A "group" is defined by the Draft Law as a group of entities linked by virtue of their ownership or control structure and included in the consolidated financial statements of the ultimate parent entity (extending also to entities that are excluded from consolidation based on size, materiality or on the grounds that the entity is held for sale). A group could also be a main entity and one or more permanent establishments, provided that such group is not part of another group based on the above consolidation threshold.
- Deemed consolidation – legal uncertainty remains
Entities that do not prepare consolidated accounts on a line-by-line basis may nevertheless be considered to form a group with their subsidiaries and therefore be in the scope of Pillar Two (e.g. if they are not required to prepare accounts at all or they do not prepare accounts under an acceptable accounting standard).
Previous OECD guidance already clarified that certain investment entities (e.g. under IFRS 10) that are exempt from line-by-line consolidation and that are merely required to fair value their investments (including where majority stakes are held in subsidiary companies) do not fall within the deemed consolidation rule, i.e. such entities do not qualify as parent entities of a group.
The Draft Law unfortunately remains silent on this point. In order to have legal certainty and in light of the large number of Luxembourg investment fund vehicles concerned, it is particularly important to clarify whether Luxembourg-specific exemptions from consolidation vehicles companies or for most investment funds based on the respective special laws such as for reserved alternative investment funds, specialised investment funds or companies in risk capital ("SICAR") are consolidation exemptions comparable to the IFRS 10 investment entity exception.
Investment fund definition – positive clarification for seed investors
Government entities, international organisations, non-profit organisations, pension funds and investment funds that are ultimate parent entities of an MNE group are so-called excluded entities which are not subject to the GloBE rules. However, a number of Luxembourg investment funds will not be able to benefit from the carve-out rule as they will fail to meet all criteria.
While there are certain exemptions available for investment funds that carve them out entirely from the GloBE rules, this exemption will by no means automatically apply to all investment funds since a specific set of criteria needs to be fulfilled in order to be considered as an excluded entity. Typical cases where no carve-outs are available are single investor funds and other managed accounts (absent a number of investors at least some of which are unrelated parties).
The commentary to the Draft Law clarifies that a fund failing to meet the above diversified investor requirement merely for a short time (e.g. since the fund is still in the fundraising period) may still meet this criterion provided that the fund has been set up to pool the assets of a number of investors, at least some of which are unrelated.
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Footnotes
1. Règle d'inclusion du revenu ("RIR") as per the wording used in the Draft Law drafted in French.
2. Règles des bénéfices insuffisament imposés ("RBII") as per the wording used in the Draft Law drafted in French.
3. Impot national complémentaire qualifié as per the wording used in the Draft Law drafted in French.
4. A "constituent entity" as defined by the Draft Law means an entity or permanent establishment that is part of an MNE group or a largescale domestic group.
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.
