Luxembourg Tax Alert 2024-05

On June 12, a new bill (Bill 8396) (PDF, 5.9MB) amending the Law of 22 December 2023 on Minimum Taxation (“Pillar Two Law”) was filed with the Luxembourg Parliament.

The bill introduces a significant number of changes to the Pillar Two Law, consisting of (1) the incorporation of technical aspects from the OECD Commentary, the OECD administrative guidance issued in February 2023 (“February guidance”), the OECD administrative guidance issued in July 2023 (“July guidance”), and the OECD administrative guidance issued in December 2023 (“December guidance” and together referred to as “OECD guidances”), (2) some amendments to existing provisions of the Pillar Two Law, and (3) the clarification on certain technical aspects.

This newsletter provides an overview of the key highlights of the bill. For an overview of the current provisions of the Pillar Two Law, please refer to our previous newsletters covering the initial bill issued in August 2023 (Tax Alert 2023-11) and the amended bill issued in November 2023 (Tax Alert 2023-18)

Transitional Country-by-Country Reporting (“CbCR”) Safe Harbour

The bill would introduce the provisions of the December guidance into the Transitional CbCR safe harbour (Article 59), which on the one hand includes some clarifications on how various aspects of the transitional CbCR safe harbour should apply, and on the other hand provides the new anti-avoidance provisions:

• Clarifications: the bill would introduce, amongst other items, (i) additional information on qualified financial statements (including for example in which cases the financial statements of a constituent entity may not be considered as “qualified” for the purpose of the CbCR safe harbour), (ii) a reference to the fact that no adjustments are permitted unless explicitly required by the Pillar Two Law, and (iii) the requirements for MNE groups and large-scale domestic groups (referred together as “Groups” or individually as a “Group””) that are not subject to CbCR filing. In addition, the bill also clarifies that for the Routine Profits test, the transitional rates may be used when calculating the substance-based income exclusion.
• Anti-avoidance provisions: there would be a new paragraph to require certain adjustments to the “Profit/loss before income tax” or to the income tax expense in case the Group has entered into a hybrid arbitrage arrangement as per the December guidance. A hybrid arbitrage arrangement may take the form of a deduction/non-inclusion arrangement, a duplicate loss arrangement, or a duplicate tax recognition arrangement. This new provision would only be applicable for transactions entered into after 18 December 2023 (as opposed to 15 December 2022, the alternative date proposed by the OECD).

Qualified domestic minimum top up tax (“QDMTT”) and QDMTT safe harbour

The bill introduces several amendments to the QDMTT and QDMTT safe harbour:

• A new paragraph (9) is added in Article 44 to provide that the QDMTT would be deemed to be zero in the following situations:
  • In the first five years of the initial phase of the international activity of the MNE group, starting 31 December 2023 or once the MNE group enters in scope for the first time, and
  • In the first five years starting from the first day of the fiscal year a large-scale domestic group falls within the scope of the Pillar Two Law.

This new provision is an extension of the general exclusion from IIR and UTPR for MNE groups that are in their initial phase of international activity and for large-scale domestic groups as provided under Article 55 of the Pillar Two Law.

• Another new paragraph (8) in Article 44 includes some guidance on the currency to be used as per the July guidance.
• An amendment to paragraph (5) in Article 44 is proposed with respect to the foreign taxes that are generally allocated to a Luxembourg constituent entity, but excluded for QDMTT purposes. The amendment aligns the exclusion to those foreign taxes that are listed by the OECD in the July guidance. Currently the relevant provision in the Pillar Two Law is stricter than the July guidance.
• The current text of the Pillar Two Law provides for two QDMTT safe harbours under Article 14, the QDMTT safe harbour as provided by the EU Directive (Article 11(2) of the EU Directive) and the QDMTT safe harbour as proposed by the OECD in the July guidance. The bill proposes to remove the QDMTT safe harbour as per the EU Directive, so that Luxembourg would only apply the QDMTT safe harbour as provided by the OECD in the July guidance.

Entities owned by an Excluded Entity

Under the current Pillar Two Law, an entity may be considered as an Excluded Entity (meaning that the Pillar Two rules would not be applicable to the entity) if (i) it meets a certain activity test and (ii) it is owned by another Excluded Entity (such as an investment fund that is the Ultimate Parent Entity (“UPE”) or a Real Estate Investment Vehicle (“REIV”) that is the UPE). It should be noted that such an exclusion was extended in the OECD Commentary (section 1.5.2. paragraph 45) to an entity that is a member of a Group but that is held by an investment fund or a REIV that is not the UPE.

As for other topics, the bill proposes to implement such an extension into Article 2 of the Pillar Two Law. This amendment would be especially welcome for Luxembourg investment funds, which typically benefit from a consolidation exemption (such that they are not the UPE of a Group).

EUR 750m revenue threshold

There would be a new paragraph (6) in Article 2 aiming at providing additional clarifications on the types of revenue considered for the EUR 750m revenue threshold, which is in line with the December guidance.

The definition of “Revenue” shall include the inflow of economic benefits arising from delivering or producing goods, rendering services, or other activities that constitute the Group’s ordinary activities, net gains from investments (whether realized or unrealized), and income or gains separately presented as extraordinary or non-recurring items.

Mismatches in fiscal year-ends

Another new clarification would be included in Article 3 for constituent entities that have a fiscal year-end not matching with the fiscal year-end of the consolidated accounts.

The clarification incorporates the December guidance and provides that the fiscal year for Pillar Two purposes is generally the accounting period used in the consolidated accounts of the UPE.

In the case that some constituent entities maintain their financial accounts with a year-end diverging from the Group consolidated financial statements, the Pillar Two computations should be based on the same method to address the discrepancy in the fiscal years that is used by the Group in the consolidated financial statements. 

In addition to the above, one should carefully consider the additional background brought by the commentary to the bill. This would come in handy when interpreting the Pillar 2 Law.

Deemed consolidation and voluntary consolidation

The newly proposed commentary to Article 2 on the scope of the Pillar Two Law includes helpful clarifications on the concept of deemed consolidation and voluntary consolidation that are specifically relevant for the investment fund industry.

• Deemed consolidation test: the commentary to the bill provides that the deemed consolidation test does not change the outcome of the consolidation rules of the applicable financial accounting standard. The objective of this test is to determine whether a consolidated group would have existed if the application of the acceptable financial accounting standard had been mandatory. Accordingly, as per the commentary to the bill, an Investment Entity that is benefitting from a consolidation exemption under a specific fund law may not be considered as fulfilling the deemed consolidation test.
• Voluntary consolidation: it also clarifies that entities preparing line-by-line consolidated accounts on a purely voluntary basis, or under a contractual basis, would not be considered  as having a so-called “controlling interest” in the  entities that are part of this voluntary consolidation. This is due to the fact that the definition of “controlling interest” refers to a “requirement” to prepare consolidated accounts under an acceptable financial accounting standard.

Interaction of the Equity Investment Inclusion Election (“EIIE”) with Article 53(3) related to the transition rules

Under Article 53(2) constituent entities are generally allowed to take into account all deferred tax assets and liabilities reflected or disclosed in the financial statements.

A limitation to this rule is provided by Article 53(3), which excludes all deferred tax assets related to items that are excluded from the GloBE basis under Chapter 3 of the Pillar Two Law if those deferred tax assets were generated in a transaction that took place in the transition period after 30 November 2021.

The commentary to the bill clarifies that Article 53(3) would not apply to any deferred tax assets generated in the transition period if they relate to items that would be included in the GloBE Income or Loss as a result of the EIIE (Article 16(15) of the Pillar Two Law). An example would be a deferred tax asset arising from a sale of a shareholding at a loss during the transition period, which may now be available for GloBE purposes if the EIIE is taken when the Pillar Two rules are first applicable for the Group.

As a reminder, the EIIE is a five-year election that a Group may take on a jurisdictional basis.

Equalization Provision for Reinsurance companies

The Pillar Two Law includes under Article 22 a recapture mechanism for deferred tax liabilities that are not reversed within a period of five years.

The same article also includes certain exceptions to this recapture mechanism.

In the reinsurance sector, equalization provisions that are recognized as such under Luxembourg GAAP are often not respected in the consolidated accounts of the Group typically prepared under IFRS or US GAAP giving rise to a deferred tax liability which then reverses with the release of the equalization provision potentially several years later. The commentary to Article 22 in the bill clarifies that the exception to the 5-year recapture mechanism for deferred tax liabilities is also applicable to equalization provisions for captive reinsurance entities.

The bill now needs to follow the usual legislative process such that changes may still occur during this process.

Once voted into law, the provisions in the bill would apply for fiscal years starting on or after 31 December 2023, which corresponds to the date of entry into effect of the Pillar Two Law. As a result of the retroactive effect, we highly recommend that all taxpayers impacted by these rules are already considering the above amendments to the Pillar 2 rules.

As a general conclusive note, we would like to highlight that we expect regular subsequent upgrades of the Pillar 2 rules and Groups should be prepared to monitor these changes from time to time. As an example, on Monday, 17 June, the OECD issued its additional (fourth) set of administrative guidance (PDF, 9.5MB) providing several additional technical clarifications. This might soon result in an additional amendment of the Luxembourg Pillar Two law.

Please do not hesitate to contact your KPMG tax professional to discuss any questions you may have.

KPMG also offers a full technology solution that can help you evaluate, monitor, compile, analyze, report and comply with Pillar Two obligations. You can visit this website and contact us if you would like to get a demo of the technology.

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