Luxembourg Tax Alert 2023-11

On 4 August 2023, the draft law (Bill of Law 8292, hereinafter “Bill” or “draft law”) implementing the OECD’s Pillar Two Model Rules as set out under the EU Minimum Tax Directive (Council Directive (EU) 2022/2523 of 15 December 2022) was filed with the Luxembourg Parliament.

The Bill aims to introduce into Luxembourg law new rules to ensure that large multinational groups (“MNE Groups”) and large-scale domestic groups with consolidated revenues of EUR 750m or more (for at least 2 of the past 4 years) are taxed at a minimum rate of 15%. Three new taxes are being introduced as part of this Bill:

• A tax levied based on the Income Inclusion Rule (“IIR”), which is applied at the level of the ultimate parent entity (“UPE”), or an intermediate parent entity (“IPE”) as the case may be, and imposes a top-up tax on constituent entities in jurisdictions that have an effective tax rate (“ETR”) below 15%;
• A tax levied based on the Undertaxed Profits Rule (“UTPR”), which acts as a backstop rule in case top-up taxes have not been collected under the IIR. It allocates the remaining top-up tax to be collected amongst the jurisdictions having a UTPR in force based on a specific formula; and
• A qualified domestic minimum top-up tax (“QDMTT”) to collect the top-up tax on Luxembourg constituent entities (if the ETR in Luxembourg falls below 15%).  Such QDMTT will apply before the IIR and UTPR. 

The draft law closely follows the text of the EU Minimum Tax Directive. The main highlights of the Bill are summarized below.

Incorporation of OECD guidance

In line with the EU Minimum Tax Directive, Luxembourg has incorporated several aspects of the OECD guidance into the draft law. This includes both guidance from the OECD Commentary (dated 14 March 2022) and the OECD administrative guidance (dated 2 February 2023).

The elements included in the Bill are, however, limited and some important aspects clarified by the OECD are not yet reflected. Amongst others, the Bill does not include guidance on the transitional rules with respect to transfer of assets, on the deemed consolidation or the optional equity gain or loss inclusion election. The Bill also does not seem to take into consideration the administrative guidance issued by the OECD in July 2023. It remains to be seen whether any further points will be added during the legislative process to provide more legal certainty to taxpayers.

GloBE Income and Covered Taxes

For the groups in scope, the Global Anti-Base Erosion Rules (“GloBE”) rules introduce a new requirement to compute the ETR for each jurisdiction they operate in. The ETR for a jurisdiction is calculated by dividing the Covered Taxes of all the constituent entities within that jurisdiction by the GloBE income of the same entities.

The Luxembourg draft law closely follows the EU Minimum Tax Directive with respect to the calculation of the GloBE Income, with no significant deviations.

For Covered Taxes, the commentary to the Bill provides that, in a non-exhaustive manner, corporate income tax, municipal business tax and net wealth should qualify as covered taxes.

Safe harbours

As anticipated, Luxembourg's draft law closely mirrors the OECD's Transitional Safe Harbour Rules issued in December 2022.

By way of background, to address various concerns about the complexity of the Pillar Two rules, the OECD was tasked to design a set of safe harbours which would relieve MNEs from performing full GloBE calculations during a transitional period (i.e., all of the fiscal years beginning on or before 31 December 2026, but not including fiscal years ending after 30 June 2028).

In more details, the draft law encompasses the Transitional Safe Harbour Rules released by the OECD in December 2022, which are primarily based on the information included within an MNE’s country-by-country report (“CbCR”). As explained by the OECD, the safe harbour would allow an MNE to avoid undertaking detailed GloBE calculations in respect of a jurisdiction if it can demonstrate, based on its qualifying CbCR and financial accounting data, that it has revenue and profit below the de minimis threshold (“the de minimis test”), or an ETR that equals or exceeds an agreed rate (“the ETR test”), or no excess profits after excluding routine profits (“the routine profits test”) in that jurisdiction. The Transitional CbCR Safe Harbour uses Revenue and Profit (Loss) before Income Tax from an MNE’s CbCR and income tax expense from an MNE’s financial accounts to determine whether the MNE’s operations in a jurisdiction meet these tests. The draft law elaborates on what constitutes a qualified CbCR for the purpose of Luxembourg's Pillar Two rules.

QDMTT

Luxembourg has taken the option to introduce a domestic top-up tax, considered to be a qualified domestic top-up tax as per the EU Minimum Tax Directive. The QDMTT would apply in priority to the IIR and UTPR and would collect any top-up tax due by Luxembourg low taxed constituent entities.

The QDMTT would be calculated in accordance with the GloBE rules in the same accounting standard that is used for the purpose of these calculations. In this respect, it remains to be seen whether the draft law would be changed during the legislative process to include the July 2023 OECD guidance on the QDMTT and the safe harbour that would allow (under certain circumstances) taxpayers to use local GAAP for purposes of the QDMTT safe harbour.

Allocation and payment of Top-Up Tax

Under the IIR, top-up tax would be allocated and payable by the relevant parent entities (UPE, IPE, or a partially-owned parent entity – “POPE” -).  Each constituent entity in Luxembourg would be jointly and severally liable to pay the top-up tax under the IIR, as well as any late interest and penalties.  

For the UTPR, Luxembourg has taken the option to levy this tax via an additional top-up tax. With respect to the allocation, the draft law provides that the UPE of the group, or the constituent entities in Luxembourg, may designate a local entity to pay the tax on behalf of the other entities (Luxembourg designated entity). In the absence of a Luxembourg designated entity, UTPR would be allocated among the constituent entities in Luxembourg according to a formula.

The draft law also provides that for the QDMTT a Luxembourg designated entity may be designated to pay the tax on behalf of the other entities.

Administration and Penalties

Registration Requirement

The draft law introduces a registration requirement for each constituent entity in Luxembourg in scope of the GloBE rules. For this registration, constituent entities must provide a list of information to the Luxembourg tax authorities at the latest 15 months after the end of the fiscal year (18 months for the transition year). The draft law also mentions that any updates to the information required should be filed within the same deadline.

Similarly, each constituent entity also needs to deregister with the Luxembourg tax authorities when the MNE group falls out of the scope. The deadline is the same as the one for registration.

A penalty of EUR 5,000 may apply if the registration, change of information, or deregistration is not done within the prescribed time limit.

GloBE Information Return

Each constituent entity has to file a GloBE information return (“GIR”) with the Luxembourg tax authorities at the latest 15 months after the end of the fiscal year (18 months for the transition year). An exemption from this filing obligation applies, if the GIR is filed by a local designated entity, who files on behalf of the Luxembourg entities.

An exemption from this filing obligation may also apply if the UPE or a designated filing entity of the group has filed such a GIR in another jurisdiction, and this jurisdiction has an exchange agreement with Luxembourg in place. In such a case, Luxembourg constituent entities should notify the Luxembourg tax authorities that the GIR will be filed by a designated filing entity.

Penalties of up to EUR 250,000 may apply in case of non-compliance. Moreover, a statute of limitation of 10-years would apply.

IIR, UTPR and QDMTT tax return

In addition to the GIR, the draft law also introduces an additional filing obligation taking the form of a tax return, which would include the amount of IIR, UTPR, and QDMTT. The same filing deadline applies and the filing should be done with the Luxembourg tax authorities office in Diekirch. The top-up tax is to be paid at the latest one month after the filing of this tax return. In case of non-compliance, penalties would apply.

The draft law also clarifies that a tax paid under IIR, UTPR or QDMTT cannot be credited or deducted against another Luxembourg tax.

Draft Grand-Ducal regulations

Grand-Ducal regulations will be issued to provide more information on the above compliance aspect.

Together with the Bill, the Luxembourg Government already issued two draft Grand-Ducal regulations in relation with the Pillar Two Bill. 

• The first draft Grand-Ducal regulation modifies the Grand-ducal regulation of 28 December 1968 on articles 155 and 178 of the Luxembourg Income Tax Law (“LITL”) by adding the IIR, UTPR and QDMTT to the list of taxes to which late interest will apply in case of late or non-payment.
• The second draft Grand-Ducal regulation clarifies that any registration, deregistration or notification made with respect to top-up tax, as well as the submission of the top-up tax return for the QDMTT, should be done electronically according to the administrative procedures in place.

Entry into force

As foreseen in the EU Minimum Tax Directive, the IIR and the QDMTT would apply for fiscal years starting on or after 31 December 2023. The UTPR would be applicable one year later, for fiscal years starting on or after 31 December 2024. For the UTPR, an exception would apply if the UPE of the MNE group is located in an EU Member State that has opted to defer the application of IIR and UTPR, which is an option for those EU Member States that have less than 12 UPEs. In that case, the UTPR in Luxembourg would already apply for fiscal years starting on or after 31 December 2023.

The OECD July 2023 guidance includes a UTPR safe harbour that would apply in case the UPE is located in a jurisdiction that has a nominal tax rate of at least 20%. The safe harbour provides that in these cases, no UTPR would apply for fiscal years beginning on or before 31 December 2025, and ending before 31 December 2026. At this stage, Luxembourg has not included a UTPR safe harbour in the draft law.  

The Bill now has to follow the usual legislative process to become law. It may still be subject to changes during this legislative process. Although the timing is unclear at this stage due to the upcoming Parliamentary elections in October, it is expected that this law will still be voted this year.

What should MNE groups in scope keep in mind?

It is important to understand that although Luxembourg has a corporate tax rate which is higher than 15%, companies may, in certain instances, still have an ETR below 15% when calculated under GloBE rules. The calculation of the tax base under GloBE is in many aspects aligned with the calculation of the Luxembourg tax base. In certain instances, however, there may be differences which could have a negative effect on the ETR. Examples include permanent differences, such as tax incentives that are available under Luxembourg domestic tax rules but not under GloBE (e.g., the current IP regime or investment tax credit), or just timing differences.

Furthermore, while tax losses may also be used under the GloBE rules, bear in mind that the method for using them (i.e. deferred tax accounting) may differ from the standard Luxembourg taxation rules.

KPMG Tax Professionals, together with our large network, can assist you by performing an impact assessment of your structure.

What is the impact for Investment Funds?

The GloBE rules provide for certain carve-outs for investment fund structures (roughly speaking for the fund vehicle itself and the underlying SPVs, to the extent certain conditions are met) which will depend on consolidation requirements and other conditions.

The provisions of the draft law follow very closely those of the EU Minimum Tax Directive.

Investment entities should notably consider the following when determining whether they could be impacted by the GloBE rules:

• Identify the entities that are part of the consolidation perimeter and assess the minimum revenue threshold of EUR 750m.
  • The starting point is the determination of the UPE which is defined as an entity that owns, directly or indirectly, a controlling interest in any other entity and that is not owned, directly or indirectly, by another entity with a controlling interest in it. A controlling interest could be defined as a participation in an entity whereby the parent entity is required, or would have been required (so-called deemed consolidation rules), to consolidate the assets, liabilities, income, expenses and cash flows of the entity on a line-by-line basis, in accordance with an acceptable financial accounting standard. We note that there is no additional clarification provided in the draft law to the concept of deemed consolidation.
  • For this purpose, it will be necessary to first determine whether a Luxembourg fund and the underlying investment entities (i.e., the SPVs) could benefit from an exemption from consolidation requirements as per the Luxembourg law. If a consolidation exemption or exclusion under Luxembourg law and the relevant financial accounting standard does not exist, the Excluded Entities carve-out may nevertheless apply (see more details in the paragraph below). However, if a consolidation exemption or exclusion under Luxembourg law and the relevant financial accounting standard exists, such entities should generally not qualify as UPE and hence should not be covered by Pillar Two. In practice, it would potentially mean that the Luxembourg fund structure would not be within the scope of Pillar Two but the underlying structure (i.e., portfolio entities) could be.
  • If there is a Luxembourg UPE, it must then be checked whether the EUR 750m revenue threshold is met.
• If an investment fund is part of or is the UPE of a consolidated group, determine whether the Excluded Entities carve-out could apply.
  • According to the draft law, certain entities should be excluded from the application of the GloBE rules, including (i) investment funds that are the UPE, (ii) real estate investment vehicles that are the UPE, and (iii) pension funds. To benefit from the carve-out, specific conditions should be met depending on the vehicles. Intermediate entities or holding entities owned under certain conditions (notably via a participation of at least 95% or 85% depending on the cases) by entities benefiting from the carve-out are also excluded from the scope of GloBE rules. Excluded Entities are out of scope of the GLoBE rules and do not have any formal obligations, such as filing a GIR return.
  •  If a fund benefits from the Excluded Entities carve-out, the revenue of such fund would, however, need to be taken into account for the purpose of the EUR 750m revenue threshold assessment. In practice, it would mean that the revenue of all portfolio entities held by a given alternative investment fund would need to be included in the computation of the MNE group revenue.  

KPMG Luxembourg has developed a high-level assessment tool to help you navigate through these rules and assess the likelihood that Pillar Two may apply to your group.

For a state of play of the implementation of Pillar Two around the world, please refer to KPMG’s implementation tracker.