Insights into Insurance and Asset Management: Exploring Pillar 2 Perspective

2. Pillar 2 and the Luxembourg funds: What are the challenges?

One of the main drivers for top-up tax would relate to funds (including UCITS) which are consolidated with insurance groups (e.g. UCITS investors are exclusively or mainly insurance companies of the same group, or single investor insurance investment entities). Similar situation is observed with UCITS funds being consolidated into one single investor or in a fund of fund consolidation situation. It is not widely impacting the UCITS industry but we noticed some Pillar 2 impacts with some German, French or UK asset managers.

If an entity is consolidated on a line-by-line basis, the entity would fall within the scope of the Pillar 2 minimum taxation rules. In this respect, it should be reviewed in detail which income the entity derives (dividends, equity capital gains, interest income, gains from bonds, etc.). This income would need to be divided into different tranches to apply the correct Pillar 2 treatment for such income (e.g. dividend income derived from shareholdings held for more/less 10%, dividend income from shareholdings held for more/less than 12 months, capital gains derived from shareholdings held for more/less 10%, etc.).  

As part of this analysis, an entity could elect to apply for the realisation principle under Pillar 2 (Art. 3.2.5 OECD rules /Art 16 §6 of Pillar 2 Law). This election allows for assets which are recorded at fair value for accounting purposes to be recorded at historic cost for Pillar 2 purposes (until the date the asset is disposed - hence potentially mitigating top-up tax impact for fair value fluctuations).

With respect to investment entities (including insurance investment entities), contrary to countries like Ireland, the Law provides that those entities are excluded from the application of the Luxembourg QDMTT. A similar exclusion is foreseen for IIR and UTPR purposes. This ensures that those entities keep their tax neutral character and external investors are not (indirectly) impacted by top-up tax to be potentially paid by those entities. This however requires that the entities qualify either as an Investment Entity or an Insurance Investment Entity within the meaning of the definitions foreseen in the Pillar 2 rules. Furthermore, it does not prevent another jurisdiction applying the IIR or the UTPR with respect to the income of such entities if the entities form part of a Pillar 2 group.

In addition, the equity gain or loss inclusion election as foreseen by the Administrative Guidance of February 2023 (Art. 2.9 of the Administrative Guidance of February 2023/ Art 16 §15 of Pillar 2 Law) has been included in the Law. The election allows to a certain extent, to align Pillar 2 treatment of income/gains and charges/losses on equity participations with local tax treatment. The election is a jurisdictional election, applicable to all shareholdings held by constituent entities located in Luxembourg and applies for five years (with automatic renewal, unless revoked). 

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 also has an impact on the preparation of the annual accounts.

Finally, 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.