On 4 August 2023, draft law 8292 (the “draft law”) implementing the OECD’s Pillar Two model rules1 as set out under the EU’s Minimum Tax Directive2 was filed with the Luxembourg parliament.
Pillar Two model rules
The draft law aims to introduce new rules into Luxembourg law to ensure that large multinational groups (MNE groups) and large-scale domestic groups with consolidated revenues of EUR750 million or more (for at least two of the past four years) are taxed at a minimum rate of 15%. The draft law introduces three new taxes:
- A tax based on the income inclusion rule (IIR), applied at either the ultimate parent entity (UPE) level or the intermediate parent entity (IPE) level, imposing a top-up tax on constituent entities in jurisdictions with an effective tax rate (ETR) of below 15%.
- A tax based on the undertaxed profits rule (UTPR), which acts as a backstop if top-up taxes have not been collected under the IIR. Based on a specific formula, it allocates the remaining top-up tax to be collected amongst jurisdictions that have a UTPR in force.
- 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%). This QDMTT will apply before the IIR and UTPR.
Entry into force
The draft law must follow the usual legislative process to become final and may be subject to change. Although the timing is currently unclear at the time of the writing due to Luxembourg’s general election in October, this law is still expected to be voted on in 2023.
As foreseen by 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 apply one year later for fiscal years starting on or after 31 December 2024. An exception for the UTPR applies if an MNE group’s UPE is located in an EU Member State that has deferred the IIR and UTPR application, an option for States with fewer than 12 UPEs. Meaning that, for Luxembourg, the UTPR will apply for fiscal years starting on or after 31 December 2024.
The OECD’s July 2023 guidance4 includes a UTPR safe harbor, which applies to UPEs located in a jurisdiction with a nominal tax rate of at least 20%. This means that the UTPR would not apply for fiscal years beginning on or before 31 December 2025 and ending before 31 December 2026. At this stage, Luxembourg has not included the UTPR safe harbor in the draft law.
How are investment funds affected?
The Pillar Two model rules allow certain carveouts for investment fund structures that meet certain conditions regarding the fund vehicle itself and the underlying investment vehicles. The draft law’s provisions closely follow those of the EU Minimum Tax Directive.
When determining whether they could be affected by the Pillar Two model rules, investment entities should follow these steps:
1. Identify the entities within the consolidation perimeter and assess the minimum revenue threshold of EUR750 million
First, investment funds should identify the UPE. This is 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 participating in an entity whereby the parent entity is required (or would have been required under the so-called “deemed consolidation” rules) to consolidate the entity’s assets, liabilities, income, expenses and cash flows on a line-by-line basis following an acceptable financial accounting standard. Notably, the draft law does not clarify the deemed consolidation concept further.
Therefore, investment funds must first determine whether a Luxembourg fund and its underlying investment entities (i.e. the investment vehicles) could benefit from a consolidation exemption or exclusion under Luxembourg law. If a consolidation exemption or exclusion exists, these entities may not qualify as UPE and, therefore, should not be under Pillar Two’s scope. However, if they do not exist, the “excluded entities” carveout may still apply (further explained in step 2).
In practice, this could result in a Luxembourg fund structure not being in scope of Pillar Two while the underlying structure (i.e. the portfolio entities) is in scope. In this case, potential cashflows and investment returns could be impacted, although the fund itself would be carved out or exempt from Pillar Two.
If there’s a Luxembourg UPE, investment funds should check whether the EUR750 million revenue threshold is met.
2. If an investment fund is part of or is the UPE of a consolidated group, determine whether the excluded entities carveout could apply
According to the draft law, certain entities are excluded from the Pillar Two model rules, including:
- investment funds that are the UPE
- real estate investment vehicles that are the UPE and
- pension funds.
To benefit from this carveout, the vehicles must meet specific conditions. Intermediate entities or holding entities owned under certain conditions — notably via a participation of at least 95%, or 85% in some cases — by entities benefiting from the carveout are also excluded from Pillar Two model rules. Excluded entities are out of scope and have no formal obligations.
However, if a fund benefits from the excluded entities carveout, its revenue should be included in the EUR750 million revenue threshold assessment. In practice, this means the revenue of all portfolio entities held by a given AIF must be included in the MNE group revenue calculation.
The Pillar Two model rules are complex, and the Luxembourg tax authorities (LTA) have not yet provided a comprehensive guide to their application. Although investment fund structures may benefit from carveouts and exemptions, they must review these in detail and perform a risk assessment to ensure fund managers have no material impacts or reporting requirements.