Luxembourg releases draft law to implement global minimum tax

07/08/23

In brief

On 4 August 2023, the Luxembourg draft law to implement the global minimum tax was released (n°8292, hereafter “the draft law”). The draft law would transpose the EU Council Directive 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, known as the EU Pillar Two Directive or the GloBE Directive (Global anti-Base Erosion Directive). The EU Pillar Two Directive aims to implement a jurisdictional minimum taxation of at least 15 % and is based on the OECD Model Rules on Pillar Two that were released on 20 December 2021, with some necessary adjustments to guarantee conformity with EU law.

The implementation of the EU Pillar Two Directive would be through a separate law, composed of 58 articles divided over 12 chapters. The draft law foresees the implementation of 3 new taxes in Luxembourg, an Income Inclusion Rule tax (hereafter IIR, or in French impôt relatif à la règle d’inclusion du revenue, RIR), an Undertaxed Profits Rule tax (hereafter UTPR, or in French impôt relatif à la règle des bénéfices insuffisamment imposés, RBII) and a Qualified Domestic Minimum Top-up Tax (hereafter QDMTT, or in French impôt national complémentaire). 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.

The draft law closely follows the EU Pillar Two Directive and the Transitional Safe Harbour Rules issued by the OECD in December 2022. However, only some of the Administrative Guidance which was released by the OECD in February 2023 is reflected in the draft law, whereas the Administrative Guidance which was released by the OECD in July 2023 has so far not been covered in the draft law. This leaves uncertainty whether in-scope groups with a presence in Luxembourg could rely on such Administrative Guidance and future guidance, specifically on points where the guidance may deviate from the EU Pillar Two Directive, or whether this would first require the EU Pillar Two Directive to be amended.

The draft law confirms that the topic is relevant for all players, from multinational groups to funds but also for banks and insurances and all businesses need therefore to give it a careful reading and analysis.

In detail

Chapter 1 – Scope of application

The scope of application is aligned with the EU Pillar Two Directive, the rules would apply to multinational groups (“MNE groups”) or large-scale domestic groups with a presence in Luxembourg through a “constituent entity” provided that the group has an annual revenue of EUR 750,000,000 or more 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.

Observation: The draft law does not define the term “revenue” for testing the EUR 750,000,000 threshold and only refers to the consolidated financial statements of the group parent entity. The commentary to the draft law mentions that the revenue concept is expected to be aligned with country-by-country reporting rules (noting that Luxembourg country-by-country reporting rules only look at the year preceding the tested year). Therefore, the revenue threshold would be an accounting test based on the revenue in the consolidated financial statements (or deemed consolidated financial statements) of the group parent entity and subject to certain accounting standards that need to be complied with (including that the accounting standards need to be an acceptable or authorized accounting standard).

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). 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. In line with the EU Pillar Two Directive, the rules further extend the application to Joint Ventures and their subsidiaries, i.e., entities whose financial results are reported under the equity method in the consolidated financial statements (no line-by-line consolidation) of the ultimate parent entity and provided that the ultimate parent entity holds directly or indirectly at least 50% of its ownership interest.

Certain entities would be excluded from the rules, such as governmental entities, non-profit organizations, a pension fund, an investment fund that is an ultimate parent entity or a real estate investment vehicle that is an ultimate parent entity. Further, with the exception of pension services entities, entities which are set up by one of the aforementioned excluded entities could also qualify as excluded entities provided that they meet an ownership threshold (i.e., the value of the entity should be at least at 95% or 85% by one of the aforementioned entities) and an activity test (i.e., entities held at 95% would need to have the same or an ancillary activity to the one of the excluded entity, whereas the income of entities held at 85% would need to be substantially dividend income or capital gains or losses from equity investments which could be excluded from the GloBE income).

Observation: 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. With respect to Joint Ventures, groups may need to review the potential financial impact of potential top-up taxes applying and how those would be settled between joint venture partners.

Observation: With respect to investments funds, Luxembourg and foreign investment funds and their related entities are often exempt from preparing consolidated financial statements with their investments based on different accounting standards and local rules (e.g, IFRS 10 investment entities, the Luxembourg investment fund laws on Reserved Alternative Investment Funds, SICARs, Specialized Investment Funds and SICAVs subject to UCI Law - Part II, as well as consolidation exemptions foreseen by the Luxembourg company law and related guidance issued by the Luxembourg Commission on Accounting Standards (CNC)). 

To the extent that there is a valid exemption from consolidation under an authorized accounting standard, such as the ones mentioned, those entities should not form part of a group for Pillar Two purposes and should hence in most cases be excluded from the Pillar Two rules. We would expect that consolidations which are prepared solely for management or investor purposes should not lead to constitute a group for Pillar 2 purposes, although the draft law and commentary do not provide further guidance on this point and only mention that “if an ultimate parent entity is not required to prepare consolidated financial statements in accordance with the qualifying accounting standard applicable to it, the ultimate parent entity does not form part of a group”.

Investment funds which are part of a financial consolidation, such as large real estate or infrastructure funds or investment entities consolidated with insurance groups should assess whether they could qualify as an excluded entity under the Pillar Two rules or whether one of the specific tax neutrality regimes foreseen for investment entities could apply. Asset managers and portfolio companies which meet the revenue threshold would generally not be excluded from applying the Pillar Two rules, subject to case-by-case review. For further details on funds and Pillar Two, please refer to https://www.pwc.lu/en/alternative-investments/atad-beps.html.

Chapter 2 – Income Inclusion Rule and Undertaxed Profits Rule

The draft law foresees the implementation of an IIR and a UTPR which are aligned with the EU Pillar Two Directive. The IIR would operate as a mechanism for a Luxembourg ultimate parent entity (UPE), an intermediate parent entity (IPE) or a partially-owned parent entity (POPE) to collect any top-up taxes under a top-down approach for any low-taxed constituent entities located in Luxembourg or abroad and which are directly or indirectly held by the Luxembourg parent entity. The UTPR would operate as a backstop rule in cases where top-up taxes are not fully collected in full through the IIR or a local QDMTT. UTPR top-up taxes would be split between jurisdictions having implemented a qualified UTPR based on an allocation ratio looking at the number of employees and tangible assets present in those jurisdictions.

Investment entities would not qualify as IPEs or POPEs, whereas investment entities which would be UPEs would generally be treated as excluded entities for the rules (unless an election is made not to treat those entities as excluded entities). Investment entities would further be excluded to collect top-up tax under the UTPR. Hence, investment entities would not be expected to collect top-up taxes under the IIR or the UTPR. However, the draft law currently does not foresee a similar exclusion for investment entities to be excluded from collecting top-up taxes under the Luxembourg QDMTT. It remains to be seen whether this treatment for the QDMTT is a deliberate choice or whether this would be amended in the final rules.

Observation: for the purpose of simplicity, the UTPR would be collected in Luxembourg as a direct tax charge (not as a non-deductible charge or other mechanism), hence the Luxembourg corporate tax base of Luxembourg entities would not be impacted. IIR would be collected by the relevant parent entity, whereas UTPR could either be collected by a designated Luxembourg paying entity or, in absence of a designated paying entity, by the relevant Luxembourg constituent entities which would be attributed UTPR top-up tax.

The Luxembourg QDMTT is provided under a separate Chapter 8 of the draft law. Chapter 2 recognises that other countries could implement equivalent QDMTT regimes. The draft law refers to such foreign QDMTTs being calculated based on the accounting standard of the group parent entity or IFRS (IFRS as adopted by the EU for EU groups). Provided that such domestic top-up tax regimes qualify as a QDMTT, no top-up tax should be calculated in Luxembourg for the constituent entities located in those jurisdictions. Hence, through this provision, the Luxembourg draft law could be considered as recognizing the QDMTT Safe Harbour, which would require only top-up tax calculation for the relevant jurisdiction. In case the foreign domestic top-up tax regime does not qualify as a QDMTT, the draft law mentions that a top-up tax calculation shall still be made for that jurisdiction under the Luxembourg Pillar Two rules.

Observation: The draft law does not seem to consider the Administrative Guidance which was released by the OECD in July 2023 with respect to the QDMTT Safe Harbour, which specifically foresees that jurisdictions could allow QDMTT calculations to be performed by applying a local accounting standard (under the conditions of the Local Financial Accounting Standard Rule or in case it would not be reasonable to apply the consolidated accounting standard). Further, the draft law does not yet distinguish between a foreign QDMTT (which could be credited against Luxembourg IIR and UTPR top-up tax, but which still requires two top-up tax calculations) and a foreign QDMTT which qualifies as a QDMTT Safe Harbour as per the July Administrative Guidance (which would turn off the Luxembourg IIR and UTPR, requiring only one top-up tax calculation for such jurisdiction). We expect that this will be updated in the final Luxembourg law.

Chapter 3 – Computation of the qualifying income or loss

The calculation of the GloBE income or loss, the denominator of the GloBE-effective tax rate computation, is generally aligned with the EU Pillar Two Directive. The starting point follows the financial accounting net income or loss as per the accounting standard used for group consolidation purposes, before any consolidation adjustments for eliminating intra-group transactions. Under certain conditions, another acceptable or authorised accounting standard may be used to determine the GloBE income or loss. The Pillar Two calculations follow the fiscal year, which is the accounting period with respect to which the ultimate parent entity of the group prepares the consolidated financial statements (or if no consolidated financial statements are prepared, the calendar year).

The financial accounting net income or loss is then adjusted with certain additions and reductions. In line with the EU rules, there is an exclusion for dividend income in case an ownership interest of at least 10% is held in an entity, or in case an ownership interest (irrespective of the ownership stake) has been held for at least 12 months at the time when the dividend is received.  Gains from shareholdings (including fair value adjustments or equity method gains) are excluded provided that an ownership interest of at least 10% is held in an entity (irrespective of the holding period, if the ownership interest is less than 10%).

The draft law further provides that income recorded in the financial statements from loan waivers could, under certain conditions, be excluded from the GloBE income. Such provision was not foreseen by the EU Pillar Two Directive, and it is based on the OECD Administrative Guidance issued in February 2023.

Income derived from international transportation of cargo or passengers and certain ancillary income would, subject to specific conditions, be excluded for the top-up tax calculations.

Observation: The determination of the GloBE income is broadly aligned with the determination of the Luxembourg corporate tax base. However, differences exist with the Luxembourg participation exemption which foresees an exemption from Luxembourg corporate income tax and municipal business tax for dividend income provided that a participation of at least 10% in the share capital or shares with an acquisition cost of at least EUR 1,200,000 in a qualifying entity has been held or commit to be held for an uninterrupted period of at least 12 months. Under the Luxembourg participation exemption, capital gains are exempt from Luxembourg corporate income tax and municipal business tax provided that a participation of at least 10% in the share capital or shares with an acquisition cost of at least EUR 6,000,000 in a qualifying entity has been held or commit to be held for an uninterrupted period of at least 12 months. Therefore, companies which rely on the acquisition cost threshold (which do not meet the 10% shareholding threshold) to exempt dividend income or capital gains could potentially have GloBE income but no Luxembourg tax payable. Similarly, companies that rely on meeting the 12 months holding period under the Luxembourg participation exemption on a commitment basis could potentially face a discrepancy between the Pillar Two rules and the Luxembourg participation exemption for dividends if the participation does not meet the 10% ownership condition (and in any case for capital gains).

The Pillar Two rules do not foresee a recapture mechanism such as the one foreseen by the Luxembourg corporate tax rules in case of excluded dividend income (which under the Luxembourg corporate tax rules could disallow the deductibility of charges that are in economic connection with an equity participation, up to the amount of exempt dividend income derived from such participation during a fiscal year) or excluded capital gains derived from an equity participation (which under Luxembourg corporate tax rules could render a gain to be partially or fully taxable up to the amount of previously deducted charges in relation to such participation). This means that charges that are in economic connection with such income (e.g., financing charges) should generally not be added back to the financial accounting net income or loss for the purpose of the effective tax rate computation. However, impairment charges or losses on shareholdings would need to be added back to the financial accounting net income or loss, unless those are incurred in relation to a portfolio shareholding (see below).

Observation: Impairments and losses on shareholdings are generally deductible for Luxembourg corporate income tax and municipal business tax purposes, though the Pillar Two rules only allow deductions in case of portfolio shareholdings (i.e., an ownership interest which carries rights to less than 10% of profits, capital, reserves or voting rights). This could have a dilutive effect on the Pillar 2 effective tax rate for Luxembourg constituent entities as the potential covered taxes (numerator of the effective tax rate computation) may not arise due to the deduction of an impairment or a loss on a shareholding, whereas the GloBE income (denominator) would potentially not allow for such a charge to be taken into consideration. The draft law currently does not foresee an Equity Gain or Loss inclusion election as provided by the February 2023 Administrative Guidance issued by the OECD which, based on the interpretation of such guidance, would allow to take into consideration losses on shareholdings in the GloBE income (i.e., ensuring the symmetry between the domestic tax consequences of the loss in the numerator and the associated consequences in the denominator of the computation). As the election is not foreseen in the draft law, it leaves uncertainty whether in-scope groups with a presence in Luxembourg could rely on such Administrative Guidance and future guidance, or whether this would first require the EU Pillar Two Directive to be amended.

Observation: Specific rules apply for the allocation of income for flow-through entities, i.e., entities which are fiscally transparent in the jurisdiction where they are created, which could either qualify as a transparent entity (to the extent that it is fiscally transparent in the jurisdiction in which its owner is located) or as a reverse hybrid entity (to the extent that it is not fiscally transparent in the jurisdiction in which its owner is located). The test shall be made on an ownership-stake by ownership-stake basis, where the GloBE income of a transparent entity should generally be allocated to its owners (except if the transparent entity is the UPE of a group) and the GloBE income of a reverse hybrid entity should be allocated to the reverse hybrid. These concepts are different from the reverse hybrid concept under Luxembourg and EU ATAD 2 reverse hybrid rules and could lead to certain Luxembourg tax transparent entities (e.g., SCS, SCSp, SNC) or foreign transparent entities being treated as reverse hybrid entities for Pillar Two purposes, whereas they may not necessarily be qualified as a reverse hybrid for corporate income tax purposes. Therefore, the potential impact of those deviating concepts should be reviewed on an entity-by-entity and an ownership-by-ownership stake basis.

Chapter 4 – Computation of adjusted covered taxes

The computation of the adjusted covered taxes, the numerator of the GloBE-effective tax rate computation, is aligned with the EU Pillar Two Directive.

Covered taxes include

(i) taxes recorded in the financial accounts of a constituent entity with respect to its income or profits, or its share of the income or profits of a constituent entity in which it owns an ownership interest;

(ii) taxes on distributed profits, deemed profit distributions, and non-business expenses imposed under an eligible distribution tax system;

(iii) taxes imposed in lieu of a generally applicable corporate income tax; and

(iv) taxes levied by reference to retained earnings and corporate equity, including taxes on multiple components based on income and equity.

The draft law does not outline which Luxembourg taxes should be treated as covered taxes. The commentary to the draft law mentions that in “a non-exhaustive manner, the taxes concerned include notably corporate income tax, municipal business tax and net wealth tax”.

Observation: We would assume that the reference to Luxembourg corporate income tax should also include the 7% solidarity surtax to finance the employment fund which is applied on the corporate income tax rate. In addition to the above taxes, for the purpose of the computation of the effective tax rate for Luxembourg entities, Luxembourg withholding tax on distributions should be a covered tax. We would expect that subscription taxes applicable to certain investment funds could also be considered as a covered tax, although the draft law nor the commentary provide further guidance in this respect. The attribution of foreign taxes to Luxembourg constituent entities, such as foreign CFC taxes or net basis taxes on distributions is expected to be limited in practice given the limitations foreseen by the Luxembourg QDMTT rules to allocate any foreign taxes to the Luxembourg constituent entities.

The adjusted covered taxes would comprise of current taxes (subject to certain adjustments) and the total deferred tax adjustment amount as outlined in the rules. A complex rule is foreseen in case the adjusted covered taxes are negative and less than the expected adjusted covered taxes under the Pillar Two rules, which could lead to potential top-up tax to apply even in loss years (Art. 21, (5), which is the equivalent of Art. 4.1.5. under the OECD Model Rules).

Observation: The OECD had softened the application of Art. 4.1.5 through the February 2023 Administrative Guidance by foreseeing an Excess Negative Tax Carry-forward mechanism. However, such mechanism is currently not foreseen by the draft law. As the election is not foreseen in the draft law, it leaves uncertainty whether in-scope groups with a presence in Luxembourg could rely on such Administrative Guidance in the future, e.g., in cases where impairments or losses on shareholdings would create a deferred tax asset (i.e., negative adjusted covered taxes).

Tax credits could decrease the amount of covered taxes for the purpose the calculation of the effective tax rate, unless the credits qualify for a beneficial treatment under the Pillar Two rules such as Qualified Refundable Tax Credits (“QRTCs”). QRTCs require that the credits are refundable in cash or cash equivalents within 4 years as from the date the entitlement to the tax credit arises. In the latter case, such credits should be treated as income for the Pillar 2 calculations, in which case they should be less dilutive for the Pillar Two effective tax rate compared to recording the tax credit as decrease of covered taxes. The draft law currently adheres to the wording of the EU Pillar Two Directive and does not foresee the considerations outlined by the OECD Administrative Guidance of February 2023 (including the pre-GloBE deferred tax assets with respect to tax credits to be utilised in calculating the effective tax rate) and July 2023 (including notably the guidance on Marketable Transferable Tax Credits).

Observation: Luxembourg tax credits are currently not refundable, nor transferable as they are credited against Luxembourg corporate income tax. Therefore, a Luxembourg constituent entity using tax credits would decrease its covered taxes and the impact of using such credits on the Pillar Two effective tax rate should be reviewed in detail. We would expect that the final Luxembourg rules would be more explicit on the OECD Administrative Guidance issued in February and July 2023 with respect to tax credits, which would be specifically relevant for entities with pre-GloBE deferred tax assets due to tax credits and for Luxembourg entities that directly or indirectly hold other constituent entities that have Marketable Transferable Tax Credits.

The Pillar Two rules require that covered taxes shall be reduced by any amount of current tax expense that is not expected to be paid within 3 years after the end of the fiscal year. As an additional rule, if a current tax expense is included in adjusted covered taxes for a fiscal year, but such tax is not paid within 3 years after the end of the fiscal year, the effective tax rate and top-up tax for the fiscal year in which the unpaid amount was claimed as a covered tax shall be recomputed if such unpaid current tax was more than EUR 1,000,000 (if the amount was less, the adjustment could be made for the ongoing fiscal year and no computation for past years shall be made).

Observation: The Luxembourg statutory period of limitation for corporate tax matters is generally 5 years (and could be prolonged to 10 years under certain circumstances). In practice, tax assessments and payments could occur after the 3 years period required under the Pillar Two rules. The commentary to the draft law mentions that from a Luxembourg perspective, the issuance of provisional tax assessments issued by the Luxembourg tax authorities (§100a Abgabenordnung) should not be considered to imply that the corresponding amount of tax would not be intended to be paid within the 3-years period. The commentary further mentions that the filing of the tax return by the taxpayer should be considered, except in specific circumstances, as triggering an expectation on the part of the taxpayer that the corresponding taxes are to be paid within three years. While this addresses the point with respect to the rule that taxes are expected to be paid within 3 years (assuming that tax filings are made timely), it still leaves uncertainty with respect to the rule which requires to recalculate the effective tax rate if current taxes are not effectively paid within 3 years (e.g., in case of tax audits that go beyond the 3 years period).

Chapter 5 – Computation of the effective tax rate and the top-up tax

The computation of the effective tax rate and top-up tax is aligned with the EU Pillar Two Directive. The GloBE income and adjusted covered taxes of the constituent entities are aggregated on a jurisdictional basis. If the adjusted covered taxes divided by the GloBE income leads to an effective tax rate of at least 15%, no top-up shall be due for that jurisdiction. If the rate is lower than 15%, the difference between 15% and the computed effective tax rate shall constitute the top-up tax percentage. To determine the top-up tax due for a jurisdiction, the top-up tax percentage shall be multiplied with the Excess Profit. The Excess Profit is determined by subtracting from the GloBE income a Substance-based Income Exclusion (SBIE) which is calculated on a jurisdictional basis (based on employee costs and net book value of tangible assets).

Observation: The draft law does not include a reference to the July 2023 Administrative Guidance issued by the OECD in relation to the SBIE such as for cross-border employees, assets used in a cross-border context or the different treatment between operational and financial leasing for the determination of the SBIE. As such guidance does not materially deviate from the EU Pillar Two Directive, which should be interpreted in line with the OECD Model Rules, we would expect that Luxembourg entities should be able to rely on the Administrative Guidance with respect for the determination of the SBIE.

Chapter 5 includes the de minimis rule which excludes jurisdictions from top-up tax in case the average qualifying revenue is less than EUR 10,000,000 and the average qualifying income or loss for the jurisdiction is less than EUR 1,000,000 (averages calculated over a 3 year period). It further includes the Transitional Safe Harbour rules that were released by the OECD in December 2022 and are mainly based on information included in a group’s country-by-country report (CbC-report), i.e., the transitional safe harbour de minimis test, the simplified effective tax rate test and the routine profits test (applicable for fiscal years starting before or on 31 December 2026 and excluding fiscal years ending after 30 June 2028). Certain adjustments to the data included in the CbC-report should be made.

The draft law does not yet include the UTPR Safe Harbour for UPE jurisdictions as provided by the July 2023 Administrative Guidance issued by the OECD. We expect that the UTPR Safe Harbour (and potential other safe harbours such as the permanent safe harbours under development by the OECD) will be included in the Luxembourg law in the future.

Observation: In order to rely on the Transitional Safe Harbour rules, the CBC-report should be a “qualified CbC-report”, with the OECD Guidance providing limited details on what constitutes a qualified CbC-report. The draft law defines a qualified CbC-report is a report which (i) corresponds for Luxembourg to the law of 23 December 2016 on CbC-reports or, for other jurisdictions, to rules according to an equivalent standard, and (ii) which has been prepared and filed on the basis of qualified financial statements (as further defined in the law). Groups should assess whether their current CbC-report meets those requirements to ensure that they can make use of the Transitional Safe Harbour rules. As there may a timing gap between calculating any Pillar 2 tax provisions (e.g., by the end of Q1-2024 or year-end 2024) and the finalization of the CbC-report (e.g., during 2025), tax provisions may need to be calculated based on prior year CbC figures, requiring for a certain prudency margin to be considered. 

Observation: The Transitional Safe Harbour rules are mentioned to apply to both MNE groups and large-scale domestic groups. The reference to large-scale domestic groups is not entirely clear as those groups could in any case benefit from a 5-years carve out under the transition rules included in Chapter 11 of the draft law.

Chapter 6 – Special rules for corporate restructuring and holding structures

The draft law includes special rules for group mergers, demergers, entities joining another group, transfers of assets and liabilities, Joint Ventures and multi-parented groups. Those rules are generally aligned with the EU Pillar Two Directive.

Chapter 7 – Tax neutrality and distribution regimes

The draft law includes special rules in case the UPE is a flow-through entity, the UPE is subject to a deductible dividend regime, treatment of constituent entities which are subject to eligible distribution tax systems, the determination of the effective tax rate and top-up tax of investment entities, election to treat an investment entity as a tax transparent entity and election to apply a taxable distribution method. Those rules are generally aligned with the EU Pillar Two Directive.

Chapter 8 – Qualified Domestic Minimum Top-up Tax

In addition to the IIR and the UTPR, Luxembourg would implement a domestic minimum top-up tax which would allow Luxembourg to collect any top-up tax for low-taxed Luxembourg entities in priority to any other jurisdiction applying an IIR or a UTPR for those entities. Joint Ventures and their subsidiaries would be subject to a separate QDMTT calculation as if they were a separate group. The commentary to the draft law makes it clear that the intention is to have the Luxembourg domestic top-up tax being treated as a QDMTT for Pillar 2 purposes (and likely also to qualify for the QDMTT Safe Harbour).

The computation of the QDMTT would broadly follow the similar computation as for the IIR and the UTPR, taking into consideration any mandatory adjustments as outlined by the OECD for a QDMTT. In this respect, the Luxembourg QDMTT calculation would exclude from covered taxes any foreign taxes which would otherwise be attributable to Luxembourg constituent entities under Art. 24. Given the general reference to any foreign taxes, this would include CFC taxes, taxes incurred by Main Entities and allocable to Luxembourg Permanent Establishments, taxes incurred by constituent entity-owners in relation to Luxembourg Hybrid entities, net basis taxes of foreign Constituent Entities on distributions from Luxembourg Constituent Entities, as well as taxes recorded in the accounts of a flow-through – transparent entity.

Observation: With respect to the exclusion for QDMTT computation purposes of taxes recorded in the accounts of a flow-through – transparent entity, this would appear to go further than the July Administrative Guidance issued by the OECD. While the OECD Administrative Guidance on a QDMTT does not prevent a stricter approach for a domestic tax to qualify as a QDMTT, it remains to be seen whether this would be updated in the final Luxembourg law.

Observation: As currently drafted, the QDMTT calculations would need to be calculated using the same accounting standard which is used for the IIR and UTPR purposes (i.e., in most cases using the accounting standard which is used for group consolidation purposes, unless specific cases where it would not be reasonable to follow that accounting standard). Hence, for non-Luxembourg MNE groups this would in most cases exclude a calculation based on Luxembourg GAAP. It remains to be seen whether this is a deliberate choice or whether this would potentially be updated based on the July Administrative Guidance which foresees that under certain conditions the local accounting standard could be followed (i.e., under the conditions of the Local Financial Accounting Standard Rule as per the QDMTT Safe Harbour guidance).

Observation: The draft law currently does not foresee that investment entities would be excluded from collecting top-up taxes under the Luxembourg QDMTT. It remains to be seen whether this omission is deliberate or whether this would be amended in the final rules.

Chapter 9 – Allocation and payment of IIR, UTPR and QDMTT top-up tax

The draft law foresees that top-up tax shall be allocated as follows:

  • IIR top-up taxes would be due by the Luxembourg parent entity (UPE, IPE or POPE) applying the IIR. Each Luxembourg constituent entity would be jointly and severally liable for the IIR top-up tax;
  • UTPR top-up tax would be allocated and be payable to a designated UTPR paying entity. In absence of a designated paying entity, the UTPR top-up tax shall be allocated based on a formula which relies on the number of employees and the net book value of tangible assets of the Luxembourg constituent entities. Each Luxembourg constituent entity would be jointly and severally liable for the UTPR top-up tax;
  • QDMTT top-up tax would be allocated and be payable to a designated QDMTT paying entity. In absence of a designated paying entity, the QDMTT top-up tax would be split pro rata between the Luxembourg constituent entities reporting positive GloBE income. Each Luxembourg constituent entity would be jointly and severally liable for the QDMTT top-up tax. For purpose of paying QDMTT top-up tax, Joint Venture entities and their subsidiaries would be treated as if they were part of a separate Pillar Two group.

Chapter 10 – Administrative provisions

Registration obligations

The draft law mentions that all Luxembourg constituent entities shall register with the Luxembourg direct tax authorities (Administration des Contribution Directes) at the latest within 15 months after the end of a Pillar Two fiscal year (which would generally follow the group consolidated financial year) or within 18 months after the end of the transition year (first year of application of the rules). This registration is separate from the existing corporate tax registrations and would be only for Pillar Two purposes.

The draft law sets out a broad list of information to be provided, including the name of the entity, the name of the group to which it belongs, the name of the ultimate parent entity, the name of the local entity filing the GloBE information return (if applicable), the name of the local entity which is the UTPR designated paying entity (if applicable), the name of the local entity which is the QDMTT designated paying entity (if applicable), and other information. Updates for groups that would end their Pillar Two obligations would equally need to be notified within 15 months after the end of the relevant fiscal year. Non-compliance with those filing obligations could be fined up to EUR 5,000 per constituent entity (with the requirement to make or correct the notification).

Tax filing and payment obligations

With respect to the filing obligations, the draft law sets out separate procedures for the filing of information on the IIR and UTPR computations and the QDMTT information. It is not clear yet whether potentially the information could be combined under the form of a single return (the modalities of the filings would be detailed in a grand-ducal regulation).

In line with the EU Pillar Two Directive, a GloBE return (“GIR”) would in principle be due by each Luxembourg constituent entity, unless a designated Luxembourg filing entity is appointed. As a second exception, the group ultimate parent entity or a designated group entity could be appointed to file the GIR for the Luxembourg entities, provided that such foreign entity is located in a jurisdiction with which Luxembourg has an eligible agreement between competent authorities for the automatic exchange of the GIR information. In such case, the Luxembourg constituent entities would need to notify the Luxembourg tax authorities of the identity and country of the filing constituent entities (the modalities of the filings would be detailed in a grand-ducal regulation).  Non-compliance with the notification obligation could be fined up to EUR 5,000 per constituent entity (with the requirement to make or correct the appropriate filing). Non-compliance with the GIR filing obligation could be fined up to EUR 250,000 per constituent entity (with the requirement to make or correct the appropriate filing). GIR filings in Luxembourg would be automatically exchanged with jurisdictions with which Luxembourg has an eligible agreement between competent authorities for the automatic exchange of the GIR information.

A filing in Luxembourg would need to be made at the latest 15 months after the end of the relevant fiscal year, whereas the deadline would be 18 months for the first filings (transitional year filings). The statutory period of limitation is set at 10 years starting after the end of the relevant fiscal year.

Observation: The Luxembourg draft law sets out certain information which would need to be included in the GIR. We understand that the OECD Guidance on the GIR which was issued in July 2023 has so far not been reflected in the draft law. We expect that the Luxembourg Pillar Two rules (including the grand-ducal regulation setting out the information to be included in the GIR) would take into consideration the Transitional simplified jurisdictional reporting framework, which would allow for a simplified jurisdictional reporting framework for fiscal years beginning on or before 31 December 2028 if no top-up tax is due or needs to be split between constituent entities. Further, we would expect that the Luxembourg rules would follow the dissemination of GloBE information as outlined in the OECD Guidance on the GIR in July 2023 (i.e., not necessarily requiring a full GIR to be filed or exchanged if Luxembourg is not the jurisdiction of the ultimate parent entity).

The draft law further provides that Luxembourg parent entities which have an IIR tax liability in Luxembourg, or Luxembourg constituent entities which have a UTPR liability or a QDMTT liability, would be obliged to make a filing in Luxembourg. Hence, despite the possibility to have foreign constituent entities filing the GIR, the takeaway seems that at least a Luxembourg local filing would be due in case there is any top-up tax to be paid in Luxembourg (i.e., the automatic exchange of GIR information by other jurisdiction may not undo any filing obligations if top-up tax would be due in Luxembourg). This would need to be further detailed through the grand-ducal regulation.

Filings would need to be made with a specific tax office (Tax Office Sociétés Diekirch of the direct tax administration). Top-up tax due would need to be paid at the latest one month after the filing of the relevant return. The Luxembourg draft law does not establish quarterly or annual prepayments for any top-up tax amounts. In case of an overpayment of top-up tax, the draft law foresees that a claim for reimbursement could be made until the end of the calendar following the year of the overpayment.

The draft law does not provide further information in relation to cross-border dispute resolution, which is still under development at OECD level.

Chapter 11 – Transition rules

The draft law includes special rules for the treatment of deferred tax assets and liabilities and transferred assets for groups entering into the scope of Pillar Two rules. Further, there are rules foreseeing:

  • transitional relief for the substance-based income exclusion;
  • rules that foresee an exemption to apply the IIR to local entities and the UTPR for expanding MNE groups and large-scale domestic groups for a 5-year period as from when a group starts to apply the Pillar Two rules;
  • the recognition that some EU member states could elect to delay the application of the IIR and UTPR for 6 years if they have no more than 12 UPEs of in-scope groups; and
  • rules regarding transitional relief for filing obligations, with the first GloBE information returns and QDMTT returns being due 18 months after the last day of the reporting fiscal year, i.e., by 30 June 2026 for calendar-year groups.

Large-scale domestic groups which only have operations in Luxembourg would benefit from a 5-year exemption to apply the rules starting from the day when such groups fall within the scope of the rules for the first time. Such groups would still need to inform the Luxembourg tax authorities that they benefit from such exemption through the filing of a GIR.

Observation: With respect to the treatment of deferred tax assets and liabilities and intra-group transfers during the transition period (as from 1 December 2021 until a constituent entity becomes subject to the transitional rules), the draft law currently does not reflect the February nor the July 2023 Administrative Guidance issued by the OECD. This leaves uncertainty whether in-scope groups with a presence in Luxembourg could rely on such Administrative Guidance and future guidance, or whether this would first require the EU Pillar Two Directive to be amended.

Observation: With respect to the Substance-based Income Exclusion, similar to the EU Pillar Two Directive, the draft law foresees a 10% rate for payroll carve-out and 8% rate for tangible asset carve-out for 2023 (with rates gradually declining to 5% over a 10-years period). The draft law includes a confusing statement mentioning that the rate tables shall apply for fiscal years starting during one of the calendar years mentioned in the table, i.e. suggesting that the 10% and the 8% rate should only be available for groups starting their fiscal year on 31 December 2023. We would expect that this should be updated as the spirit of the rules should be for those higher rates to be available for groups that would have their first Pillar 2 year starting on 31 December 2023 or during 2024.

Chapter 12 – Final provisions

The final chapter includes the entry into force of the Pillar Two provisions. 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.

The draft law further recognizes that some EU member states may apply for 6 years delayed application with respect to the IIR and the UTPR (if there is not more than 12 UPEs in-scope groups located in those member states), which would potentially lead Luxembourg to apply the IIR or UTPR for entities controlled by those UPEs.

Conclusion

The draft law to implement the global minimum tax in Luxembourg follows the complex rules set out by the EU Pillar Two Directive. The draft law is complemented with a high-level budget assessment, though without providing an indication on the expected additional revenue to be collected by Luxembourg through the Pillar Two rules and only recognizing that additional resources would be required for the Luxembourg direct tax administration.

The text of the draft law strictly adheres to the text of the EU Pillar Two Directive, with some additions such as for the Transitional Safe Harbour Rules and the QDMTT. Certain aspects remain unresolved, such as the possibility to rely on the elections foreseen in the OECD Administrative Guidance issued in February and July 2023, and potential future guidance. The draft law will be reviewed by the Luxembourg Council of State and relevant industry organizations may share comments on the content of the draft law.  While the draft law may still be subject to certain changes and clarifications, we would generally expect that the text of the law would remain close to the EU Pillar Two Directive.

As the EU and other countries move toward enacting the Pillar Two, businesses will need to navigate intensive data collection, analysis and compliance. 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, preparing systems for data gathering and automation, upskilling teams and assisting groups with the Pillar Two compliance process. Have a look at PwC's Pillar 2 Training Program, a customized training course to upskill your teams, adapted to the needs of your organization and business industry: https://www.pwc.lu/en/tax/docs/pwc-pillar-2.pdf

Contact us

Philippe Ghekiere

Tax Director, Pillar 2 Specialist, PwC Luxembourg

Tel: +352 621 333 228

Vincent Lebrun

Tax Leader, PwC Luxembourg

Tel: +352 49 48 48 3193

Murielle Filipucci

Tax Partner, Global Banking & Capital Markets Tax Leader, PwC Luxembourg

Tel: +352 49 48 48 3118

Anthony Husianycia

Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 3239

Géraud de Borman

Tax Partner, Insurance, PwC Luxembourg

Tel: +352 49 48 48 3161

Lilia Samai

Tax Partner, PwC Luxembourg

Tel: +352 621 333 408

Thierry Braem

Tax Partner, Alternative Investments, PwC Luxembourg

Tel: +352 49 48 48 5106

Nenad Ilic

Tax Partner, Banking & Capital Markets Tax Leader, PwC Luxembourg

Tel: +352 49 48 48 2470

Wim Piot

Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 2568

Sidonie Braud

Tax Partner, AWM Tax Leader, PwC Luxembourg

Tel: +352 49 48 48 5469