Luxembourg Pillar Two Law | Proposed amendments

Update to Pillar Two legislation

On 12 June 2024, draft law No. 8396 has been submitted to the Luxembourg Parliament (Chambre des Députés) (the “Draft Law”) proposing amendments to the Luxembourg law on Pillar Two (see our previous newsflash on the Pillar Two law).

Council Directive (EU) 2022/2523 of 15 December 2022 (the “Pillar Two Directive”) has been transposed through the Luxembourg law of 22 December 2023 (“Pillar Two Law”) meeting the transposition deadline of 31 December 2023.

The work of the OECD/G20 Inclusive Framework (“IF”) has been ongoing since the issuance of the Pillar Two Directive notably with the issuance of several sets of Agreed Administrative Guidance (“AAG”), which either provided clarifications or introduced additional technical rules; the Pillar Two Law already took into consideration certain aspects of these AAG.

The Draft Law aims to incorporate several items from the February, July and December 2023 AAG as well as clarifications from the OECD 2022 Commentary.

Transposition approach

The Draft Law provides that the amendments should have the same application date as for the Pillar Two Law (fiscal years starting as from 31 December 2023). 

Comments to the Draft Law give further insight on the transposition approach:

• OECD/IF deliverables form a global and coherent system, 
• taxpayers must be provided with legal certainty, 
• these updates are possible as potential tax liabilities arising from the Pillar Two Law are not yet definitive, and 
• Luxembourg rules must reach the qualified status under the forthcoming peer review in order to avoid double taxation.

In this context, the June 2024 AAG might lead to further updates to the Luxembourg Pillar Two legislation.

Comments to the Draft Law recall that these additions should also be interpreted in light of the OECD/IF work as permitted by Recital 24 of the Pillar Two Directive.

Key updates

The Draft Law intends to introduce the following key updates:

Filing obligations

• Pillar Two returns content, format and first filing deadline
  • a single return should be filed for the Top-Up Tax, Under Taxed Profit Rule and Domestic Top-Up Tax 
  • the Pillar Two returns must follow the format of the latest Globe Information Return approved by the IF 
  • the first filing obligations should not arise before 30 June 2026.

Scope clarifications

• Investment funds/real estate funds and excluded entities

Based on the OECD 2022 Commentary (Chapter 1-§45), entities held by an investment fund/real estate fund that does not qualify as an ultimate parent entity (“UPE”) solely on the basis that it is not required to prepare consolidated financial statements can still be considered as Excluded Entities where the relevant conditions are met.

• Deemed consolidation test (including details for investment funds)

Comments to the Draft Law, in line with the OECD 2022 Commentary, clarify that the deemed consolidation test does not change the outcome of the application of the Acceptable Financial Accounting Standard when testing for the line-by-line consolidation. Where such norm does not result in a line-by-line consolidation, the deemed consolidation test does not change this outcome and where a special law applicable to investment funds grants an exemption from consolidating line by line entities held for investment, the entity cannot be considered as meeting the test. Comments to the Draft Law also add that the same approach applies for the deemed consolidation test when assessing the presence of a Controlling Interest and where line-by-line consolidation only takes place because of a contractual obligation or on a voluntary basis, the test is not met.

• Sovereign wealth funds as Governmental Entities

The Draft Law intends to introduce the exclusions of Sovereign Funds qualifying as a Governmental Entity whose principal purpose is managing or investing the government’s or jurisdiction’s assets through the making and holding of investments, asset management, and related investment activities for the government’s or jurisdiction’s assets. In line with the February 2023 AAG - section 1.4., such entities will not be considered to be an UPE and will not be considered part of a Multi-National Enterprise Group (“MNE Group”) to achieve the neutrality initially planned by the OECD/IF for Governmental Entities.

• Meaning of “ancillary” activity for Non-Profit Organisations

Certain Constituent Entities can be considered as Excluded Entities where they are held 95% by an Excluded Entity and are engaged in activities accessory to the activities of their controlling entity. In line with the February 2023 AAG - section 1.6., the Draft Law introduces a definition of an accessory activity where the main Excluded Entity is a Non-Profit Organisation (so-called “bright-line test”).

Definitions

• EUR 750 million revenue threshold

  Given the potential variations between accounting standards and MNEs practices, the amendments clarify which items are to be considered for the purpose of the EUR 750 million revenue threshold: (i) economic benefits arising from delivering or producing goods, rendering services, or other activities that constitute the MNE Group’s ordinary activities, (ii) net gains (realised or unrealised) from investments and (iii) income or gains separately presented as extraordinary or non-recurring items (based on the December 2023 AAG.).

   

• Fiscal year mismatch between UPE and Constituent Entity

Guidance from the December 2023 AAG - sections 3.2.3. and 3.2.6. - has been included to resolve situations where the financial year of a Constituent Entity (or a Joint Venture or a JV Group of the MNE Group) diverges from the UPE’s financial year whether the entity is included in the Consolidated Financial Statements of the UPE or not. 

• Mismatch between fiscal year and tax year of Constituent Entity

Guidance from section 3.3.3. of the December 2023 AAG has been included to clarify the computation of the Adjusted Covered Taxes where a Constituent Entity (or a Joint Venture or a JV Group of the MNE Group) is required under domestic legislation to apply a diverging taxable period.

Transitional CbCR Safe Harbour

• The transitional CbCR safe harbour provides for three simplified tests based on data from the group’s country-by-country report and is applicable until the financial year ending on 30 June 2028. For groups meeting one of the three tests, the Top-Up Tax shall be deemed zero.
• The Draft Law intends to introduce the guidance from the December 2023 AAG - section 2 and notably rules pertaining to hybrid arbitrage arrangements applicable to arrangements entered into or amended after 18 December 2023 to benefit from this safe harbour.

Qualified Domestic Minimum Top-up Tax (“QDMTT”) 

• QDMTT considered as payable in a jurisdiction does not include the amounts challenged by the MNE Group (under certain conditions) or considered as not assessable/collectible by local tax authorities. Such amount being included for the fiscal year during which it is no longer challenged and has been paid (based on July 2023 AAG - section 4). 
• Where the QDMTT is not considered as payable under the above conditions, the QDMTT Safe Harbour (i.e., option not to compute the Top-up Tax for a jurisdiction where a QDMTT applies) cannot apply (based on July 2023 AAG - section 5.1.).

Luxembourg QDMTT updates

• Rules governing allocation of Covered Taxes between Constituent Entities: Currently these rules are disregarded for the computation of the QDMTT. Under the proposed amendments they would notably remain applicable for tax transparent entities (based on the July 2023 AAG).
• Use of different accounting standards by Luxembourg Constituent Entities: In case Luxembourg Constituent Entities prepare their local financial statements based on different accounting standards, relevant computations must be based on IFRS. The Draft Law specifies that in such case the IFRS refers to the IFRS as adopted by the UE.
• Functional currency: clarifications based on the July 2023 AAG - section 4, § “Currency for QDMTT computations”, to resolve situations where Luxembourg Constituent Entities use different currencies. The rule notably clarifies that EUR applies where all Luxembourg Constituent Entities prepare EUR denominated financial statements based on an acceptable financial accounting standard. Where at least one Luxembourg entity does not apply EUR, the Luxembourg entities must opt for a five-year period either for EUR or the currency used for the UPE’s consolidated financial statements.
• Exclusion of groups in the initial phase of their international activity from the QDMTT: The Draft Law intends to make use of the option provided by the July 2023 AAG and extend the 5 years exclusion already applicable for the Top-up Tax and Under Taxed Profit Rule to the QDMTT.

Determination of the qualifying income or loss / Determination of the GloBE Income or Loss

• Treatment of Restricted Tier One Capital relevant for insurance companies is aligned to the treatment of Additional Tier One Capital (based on the February 2023 AAG - section 3.3).
• Technical provisions of insurance companies are not deductible when they economically relate to Excluded Dividends or Excluded Equity Gain or Loss resulting from investments on behalf of policy holders (based on the February AAG - section 3.4).
• The Equity Investment Inclusion Election is adjusted to reflect the February 2023 AAG - section 2.9 adding § 57.2 to the OECD 2022 Commentary on Article 3.2.1(c) of the Model Rules notably to include impairments. Such option notably allows for an exception to the general exclusion of certain Equity Gains or Losses from the GloBE Income or Loss (with adjustments to the treatment of related Covered Taxes).

Other updates

• Substance-based income exclusion and tangible leased assets: clarification of the treatment of tangible assets under an operational leasing agreement (based on the OECD July 2023 AAG - section 3).
• Special rules for corporate restructuring and holding structures - Transfer of assets and liabilities: introduction of the precisions from the July 2023 AAG - section 2.1. under which the result from an intra-group disposal of asset shall be determined under the arm’s length principle.
• Investment Entity Tax Transparency Election: addition of the specific rules introduced by the July 2023 AAG – section 3.4., taking into account the specifics of mutual insurance companies in the context of this election.
• Transition rules: clarifications essentially in relation with the treatment of deferred tax in the context of the transition year and intra-group asset transfers before applicability of the Pillar 2 rules (based on the additions of the February 2023 AAG - section 4).
• Allocation of taxes arising under a Blended CFC Tax Regime: update of these rules to consider the precisions added by the February 2023 AAG - section 4.