Luxembourg releases draft law to amend the Pillar 2 Law

The draft law proposes the following main amendments:

• Excluded entities

It clarifies that an Investment Fund or a Real Estate Investment Vehicle (“REIV”), which is not an Ultimate Parent Entity for the sole reason that the applicable financial accounting standard does not require it to prepare consolidated financial statements, would be assimilated with an Ultimate Parent Entity, for the purposes of applying the Excluded Entity test for holding entities or special purpose vehicles. This is a welcome clarification specifically for the private equity industry, e.g., entities which have been set up to acquire a target group could be qualified as Excluded Entities, allowing to push down the Pillar 2 compliance obligations to the operational entities. 

• Luxembourg exemption from consolidation

The commentary to the law further clarifies that the specific laws exempting Luxembourg investment funds to prepare consolidated financial statements (e.g., RAIF, SICAR, SIF), should be considered as valid exemptions from consolidation under an acceptable GAAP. Hence, it would not be required to perform a deemed consolidation test for those entities that rely on those exemptions to prepare consolidated financial statements. Further, the commentary mentions that consolidated financial statements that are prepared on a voluntary basis (e.g., for internal reporting purposes or consolidation performed under a legal contract), should not be treated as constituting a Pillar 2 group.

• Definition of revenue

The revenue concept as included in the administrative guidance of December 2023 would be included in Pillar 2 law. Hence, groups which have a revenue below or slightly above EUR 750 million are recommended to test  revenue as per the consolidated financial statements against the specific definition of revenue that would be included in the Pillar 2 law. This could be specifically relevant for groups that have unrealised gains or losses on investments (which are expected to be netted for Pillar 2 purposes), or groups which have certain operational expenses recorded in the revenue line of the consolidated financial statements (expected to be added back to the revenue for the purpose of determining the Pillar 2 threshold).

• QDMTT Safe harbour

Clarifications are included to follow the latest guidance on the QDMTT Safe harbour, which would allow switching off the Luxembourg IIR and UTPR for jurisdictions that follow the QDMTT rules as outlined by the EU and the OECD and that would benefit from QDMTT Safe harbour. For those rules to be switched off it is however required that the QDMTT is effectively payable in the foreign jurisdiction, and is not contested on treaty grounds, constitutional rules, rules of superior hierarchy or specific agreements concluded with tax authorities that would prevent the foreign jurisdiction effectively collecting the QDMTT.

• Reinsurance reserves/technical provisions

A clarification is included in the commentary to the law that the recapture exception accrual for insurance reserves shall equally apply for reinsurance reserves. This is a welcome clarification for Luxembourg reinsurance businesses, including captive reinsurance companies, which record deferred tax liabilities connected with reinsurance reserves. The draft law further includes the non-deductibility for Pillar 2 purposes of technical provisions which relate to excluded dividends or capital gains in connection with investments held on behalf of policyholders.

• Operational leasing

In case of operational leasing, it is recognised that under certain conditions both the lessee and the lessor could recognise a certain substance-based income exclusion amount for assets that are subject of an operational lease (without there being double counting and subject to assets being located in the same jurisdiction).

• Functional currency under Lux QDMTT

A clarification is included to determine the functional currency which is expected to be used for Luxembourg QDMTT purposes. The determination of the functional currency is connected to whether Luxembourg entities would work out the QDMTT based on the local accounting standard (i.e., Lux GAAP or IFRS), or based on the accounting standard used for the Income Inclusion Rule (e.g., the latter would be the case if there are Luxembourg entities that have a financial year that deviates from the group accounting year). In case Luxembourg entities follow the local accounting standard for QDMTT and all entities file statutory accounts based on EUR, then EUR should be used for QDMTT purposes. If one of the Luxembourg entities does not file statutory accounts based on EUR, a 5-years election could be made (which would be automatically renewed in absence of revocation) for the Luxembourg entities to choose either EUR or the currency  used for group accounting purposes. The law currently does not provide the option to choose a different currency, e.g., for Luxembourg entities that do not follow EUR nor the group accounting currency. In case Luxembourg entities follow for the QDMTT purposes the same accounting standard as is used for the Income Inclusion Rule, then the currency to be used for QDMTT purposes should be aligned with the currency used for group consolidation purposes.

• Allocation of cross border taxes

The allocation of cross-border taxes is slightly amended for the purpose of the QDMTT rules, notably to allow for taxes paid by transparent entities held by Luxembourg owners to be allocated to the Luxembourg owners.

• QDMTT exclusion for MNE groups in initial phase of expansion

Luxembourg entities which form part of MNE groups in their initial phase of expansion would be excluded from the application of the QDMTT for a period of 5 years. Such exclusion seems aligned with the EU Directive to temporarily switch off domestic IIR and UTPR (Art. 49 EU Directive), whereas OECD rules limit the exclusion to UTPR. Switching off the QDMTT for Luxembourg constituent entities seems interesting if other jurisdictions have a similar exclusion for MNE groups in their initial phase of expansion. In such case, we could expect that foreign entities could still be subject to IIR as the EU Directive only allows switching off the domestic IIR and UTPR.

• Equity Investment Inclusion Election and transitional period

With respect to the transitional rules, an important clarification is included in the commentary with respect to carried forward tax losses (and related deferred tax assets) that have been generated in relation to non-portfolio shareholdings during the transition period. The transition period started on 1 December 2021 and ends when a jurisdiction falls within the full Pillar 2 rules (the transitional year). If a jurisdiction applies one of the transitional country-by-country safe harbours, the transition period would be extended. Deferred tax assets due to losses on shareholdings (impairments or capital losses) which originated during the transition period would be grandfathered providing Luxembourg entities apply for the jurisdictional Equity Investment Inclusion Election in the transitional year. Hence, groups which have Luxembourg entities that generated such tax losses during the transition period would need to make the election to prevent that the future utilisation of those tax losses would have a dilutive effect on the jurisdictional effective tax rate.

• Carried forward tax credits

Important changes are included to ensure that carried forward tax credits generated before a group is subject to the Pillar 2 rules can be recognized as a deferred tax asset for Pillar 2 purposes (as an exception to the general treatment of tax credits under Pillar 2). Hence, groups with Luxembourg investment tax credits could benefit from such grandfathering even though the current investment tax credits are not qualified refundable tax credits under the Pillar 2 rules. The draft law also includes the OECD Administrative Guidance on intra-group transfers during the transition period and which have been subject to taxation (allowing for the recognition of a Pillar 2 DTA or the recognition of the asset at FMV).

• Transitional CbCR safe harbour and Hybrid Arbitrage Arrangement Rule

With respect to the transitional country-by-country safe harbours, the administrative guidance of the OECD until the end of 2023 was included in the draft law. Specifically relevant is the inclusion of the Hybrid Arbitrage Arrangement Rule, where Luxembourg has chosen to implement the rule with retroactive effect for arrangements implemented or amended after 18 December 2023. Under such a rule, certain expenses, income taxes or losses could be disregarded when testing the transitional country-by-country safe harbours. The Luxembourg Government included several arguments to defend the retroactivity of the rule in the commentary to the draft law. It remains to be seen whether the retroactive date would be upheld in the final law.

• IIR, UTPR and QDMTT filings

The draft law clarifies that Luxembourg IIR, UTPR and QDMTT returns are expected to be filed in Luxembourg based on the form being developed at OECD level, i.e. the GloBE Information Return. First filings in Luxembourg will be due by 30 June 2026 for groups with a calendar year-end, or for groups that have a shorter accounting year for their first Pillar 2 year (the rules would apply for group accounting years starting on or after 31 December 2023).