On 20 December 2023, the law (the “Pillar Two Law”) transposing Council Directive (EU) 2022/2523 of 15 December 2022 (the “Pillar Two Directive”) has been adopted by the Luxembourg parliament, thus ensuring the Income Inclusion Rule (“IIR”) and the Qualified Domestic Minimum Top-up Tax (“QDMTT”) apply in fiscal years starting on or after 31 December 2023 and the Undertaxed Profits Rule (“UTPR”) applies in fiscal years starting on or after 31 December 2024.
Main additions to the initial draft law
The initial draft law (see our previous newsflash), which closely followed the Pillar Two Directive, was amended by the Government on 13 November 2023 to include certain elements from the February and July 2023 OECD administrative guidance. All proposed amendments have been adopted as part of the Pillar Two Law and include notably the following:
- QDMTT computation: The QDMTT computation for Luxembourg constituent entities should be based on the local accounting standard, which would be either Luxembourg GAAP or IFRS, where one of these standards is used by all Luxembourg constituent entities and they have the same fiscal year than the Group they belong to (otherwise the general rule, the application of the ultimate parent entity accounting standard, applies) (July 2023 OECD administrative guidance).
- QDMTT scope: investment entities and insurance investment entities are excluded from the QDMTT as per the July 2023 OECD administrative guidance.
- QDMTT Safe Harbour: The Pillar Two Law includes the QDMTT Safe Harbour rule and the requirements for a QDMTT rule to be considered eligible as provided for in the July 2023 OECD administrative guidance. This safe harbour intends to reduce compliance obligations by providing the option to not compute the IIR for constituent entities subject to an eligible QDMTT as described in the July 2023 OECD administrative guidance.
- UTPR Safe Harbour: The Pillar Two Law includes the optional UTPR Safe Harbour provided for under the July 2023 OECD administrative guidance. This safe harbour will be available during tax years starting prior to 1 January 2026 and ending prior to 31 December 2026 and would deem the UTPR in the jurisdiction of the ultimate parent entity to be zero if this jurisdiction has a nominal corporate tax rate of at least 20%. The parliamentary comments note that Luxembourg would be eligible to such safe harbour.
- Permanent Safe Harbour: The OECD work on the Permanent Safe Harbour is not yet finalized but the OECD report on Safe Harbours and Penalty Relief issued on 15 December 2022 already provided for the general framework that would apply. The Luxembourg Pillar Two Law provides for this general framework around the three alternative tests, the Routine Profits Test, the De Minimis Test and the ETR Test which should be applicable once further details are made available by the OECD.
- Transferable and Marketable Tax Credits: The Pillar Two Law includes the possibility to issue a Grand Ducal Decree to assimilate the Pillar Two treatment of such tax credit to the one of Qualified Refundable Tax Credits (i.e., treatment as income rather than reduction of the tax due) as developed in the July 2023 OECD administrative guidance. According to parliamentary discussions, the Luxembourg investment tax credit regime (i.e., a non-refundable tax credit granted for certain investments reducing the corporate income tax liability) might evolve in the future to remain efficient in the context of Pillar Two.
- Asymmetric treatment of dividends and distributions: The Pillar Two Law includes the provisions related to the asymmetric treatment of a financial instrument within a Multinational Group or Large Domestic Group as developed in the February 2023 OECD administrative guidance which aims at aligning the treatment of a financial instrument at the level of the subscriber with the treatment adopted by the issuer.
- Other notable additions to the rules governing the adjustments to determine the qualifying income or loss: The Pillar Two Law also includes (i) the Equity Gain or Loss inclusion election developed under section 2.9 of the February 2023 OECD administrative guidance creating an option to include certain capital gains or losses in the calculation of qualifying profit or loss, (ii) the Excluded Equity Gains or Loss and hedges of investments in foreign operations (February 2023 OECD administrative guidance - section 2.2) providing the option to treat certain foreign exchange gains or losses on hedging instruments as excluded capital gains or losses and (iii) the Simplification for Short-term Portfolio Shareholdings (February 2023 OECD administrative guidance - section 3.5) providing the option to include all dividends and distributions received or receivable in respect of portfolio shareholdings.
Interpretation and future amendments
Regarding the interpretation of the Pillar Two Law, the parliamentary work reiterated that Recital 24 of the Pillar Two Directive provides that Member States can use the OECD guidelines “as a source of illustration or interpretation in order to ensure consistency in application across Member States to the extent that those sources are consistent with this Directive and Union law.” On 9 November 2023, the European Commission stated that it is “of the view that the administrative guidance endorsed by the OECD/G20 Inclusive Framework on BEPS in December 2022, February 2023 and July 2023 is compatible” with the Pillar Two Directive.
The Pillar Two Law has been voted on time to meet the required transposition deadline although the legislative work will continue to ensure Luxembourg legislation stays up to date with ongoing OECD developments.
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