Luxembourg enacted the law to implement global minimum tax

In detail

The Pillar 2 Law is a separate law from the Luxembourg Income Tax Law, it is composed of 61 articles divided over 12 chapters. The Law foresees the implementation of three new taxes in Luxembourg:

• Income Inclusion Rule tax (hereafter IIR, or in French impôt relatif à la règle d’inclusion du revenue, RIR), 

• Undertaxed Profits Rule tax (hereafter UTPR, or in French impôt relatif à la règle des bénéfices insuffisamment imposés, RBII) and 

• Qualified Domestic Minimum Top-up Tax (hereafter QDMTT, or in French impôt national complémentaire, INC). 

The Law closely follows the EU Pillar Two Directive and the Transitional Safe Harbour Rules issued by the OECD in December 2022 but has only selectively included OECD Administrative Guidance from February and July 2023.  The Administrative Guidance issued by the OECD in December 2023 has so far not yet been included, we may expect that there could be further clarifications to the Pillar Two law in 2024, notably to include further Administrative Guidance of the OECD. 

The IIR and the QDMTT are set to become effective for fiscal years starting on or after 31 December 2023, whereas the UTPR would become effective for fiscal years starting on or after 31 December 2024.

For the purpose of QDMTT calculation, the Luxembourg Pillar 2 Law provides that the Local Accounting Standard Rule should be used. This means that the QDMTT for Luxembourg entities should be calculated either under Luxembourg Generally Accepted Accounting Principles (Lux GAAP) or under IFRS. Whether Lux GAAP or IFRS should be followed depends on the accounting standard  used for statutory filing purposes in Luxembourg. If there are entities using different accounting standards for statutory filings in Luxembourg (e.g. one using Lux GAAP and another IFRS), there is a tie breaker rule foreseeing that calculations shall be made under IFRS, irrespective of the number of entities preparing statutory accounts under Lux GAAP or IFRS. Furthermore, if there is a Luxembourg entity with a fiscal year which deviates from the group financial year, the QDMTT calculation shall generally be based on the accounting standard used for consolidation purposes (with some exceptions in case it would not be reasonable to follow such accounting standard and subject to conditions). 

The IIR and the UTPR would continue to be calculated based on the accounting standard used for consolidation purposes (with some exceptions).

For Pillar Two purposes, a group and its constituent entities are defined as entities which are related through ownership or control and included in the consolidated financial statements (or deemed group financial statements in absence of an actual consolidation) of the Ultimate Parent Entity, i.e. following a line-by-line consolidation in which assets, liabilities, income, charges and cash flows are presented as a single economic unit (extending also to entities that are excluded from consolidation based on size, materiality or on the grounds that the entity is held for sale). 

Therefore, banking groups should assess which entities could fall within the scope of the rules, including entities which may currently not be part of the financial consolidation, or which may require a specific treatment under the Pillar Two rules, such as flow-through entities, investment entities, minority-owned constituent entities (entities which are consolidated line-by-line in which the groups hold a direct or indirect ownership of less than 30%), Joint Ventures and others. Banking groups need to pay attention to permanent establishments all of which are considered as separate entities for Pillar Two purposes meaning that the ETR calculation would need to be done based on the permanent establishment’s results. 

The Law clarifies that Tier 1 capital that banks must maintain is to be treated as an expense for the purposes of calculating the qualifying profit or loss of the Constituent Entity, which has a positive effect on the ETR calculation. Tier 1 capital is defined in the Law as any amount recognised as a deduction from the capital of a Constituent Entity and attributable to distributions paid or payable under an instrument issued by that Constituent Entity in application of prudential regulatory requirements.

Luxembourg tax credits are currently not refundable, nor transferable as they are credited against Luxembourg corporate income tax, thus not qualifying as Qualified Refundable Tax Credits (QRTCs) or Qualified Flow through Tax Benefits for tax equity structures (QFTBS), that have beneficial treatment under the Pillar Two rules. QRTCs require that the credits are refundable in cash or cash equivalents within four years as from the date the entitlement to the tax credit arises. This includes also the new investment tax credits (bill n°8276 – new article 152bis LITL) relating to digital and ecological transformation. Therefore, covered taxes of Luxembourg companies – amongst others, banks – using tax credits will be decreased (leading to a decrease of the ETR) and the impact of using such credits on the Pillar Two ETR should be reviewed in detail. To note however that the 2023 February OECD guidance foresees that the investment tax credit generated before the end of 2023 are likely to be considered as good tax credits for the purposes of the ETR calculation. Further clarifications are expected from the legislator in 2024 on that specific point.

From a compliance perspective, this new Law comes not only with the requirement to be registered for Pillar 2 purposes with a dedicated tax office (separate from the corporate tax registration) but has also an impact on the preparation of the annual accounts.

In this respect, the Luxembourg Accounting Standard Board (Commission des Normes Comptables) issued two recommendations, the Q&A 24/31 on the impact of the Pillar 2 Law on the notes to the annual and consolidated accounts under LuxGAAP or LuxGAAP-FV and the Q&A 24/32 on the Pillar 2 Law and the option to disclose deferred tax assets and liabilities in the notes to the 2023 annual accounts.

The first recommendation foresees adding a Pillar 2 disclosure to the notes to the annual accounts for Luxembourg companies and groups affected by the Pillar 2 Law who establish and publish their annual accounts and/or their consolidated accounts under Lux GAAP regimes. More specifically, the Pillar 2 disclosure should include qualitative information, in particular on how the Luxembourg company and/or group would be affected by the Pillar 2 Law and the main countries where the Luxembourg company and/or group could be exposed to income tax arising from the Pillar 2 Law; and quantitative information such as an indication of the fraction of their profits that might be subject to income taxes arising from the Pillar 2 Law and the average effective tax rate applicable to these profits or an indication of how the Pillar 2 Law, if it had been in force in 2023, would have changed their overall effective tax rate.

The second recommendation foresees adding a disclosure on tax attributes and temporary differences in the Lux GAAP accounts. These recommendations are critical to minimise the risk for companies to be challenged on the future use of tax attributes / deductible temporary differences for Pillar 2 purposes. We highly recommend banks ensuring that appropriate wording has been including to the notes to the annual accounts on the existence of the tax attributes (i.e. tax losses carried forward, tax credit losses carried forward etc).

In light of the above, now is the time for banking groups within scope to evaluate and model the impacts of Pillar Two across the organisation. This includes, but is not limited to, assessing the additional data and reporting/compliance requirements, evaluating the existing technological ecosystem and capabilities, establishing processes and controls, preparing and training resources, and managing stakeholder expectations.

PwC Luxembourg and the PwC network firms provide tailor-made solutions to prepare groups for their Pillar Two obligations, including estimating potential top-up tax impact, reviewing disclosures in annual and consolidated accounts, preparing systems for data gathering and automation, upskilling teams and assisting groups with the Pillar Two compliance process.