Pillar Two Implementation in Luxembourg

Background

On 4 August 2023, Luxembourg published a bill of law (the “Bill”) to transpose the EU directive no. 2022/2523 largely known as the “EU Minimum Tax Directive” or “Pillar Two Directive”, ensuring a minimum global Effective Tax Rate (“ETR”) of 15% for the global activities of large multinational groups (“MNE”) and large-scale domestic groups in the Union, to be effective on 23 December 2023. The Pillar Two Directive is directly coming from the OECD’s Pillar Two model rules of the OECD/G20 Inclusive Framework on BEPS.

New Rules in Luxembourg

The Bill introduces a minimum level of taxation through a top-up tax. This top-up tax applies to MNE and large-scale domestic groups with a combined annual turnover equal to or above EUR 750 million in at least two of the four fiscal years preceding the tested fiscal year, as per the consolidated financial statements of the group parent entity. A group is defined by the Bill as a group of entities linked by virtue of their ownership or control structure and included in the consolidated financial statements of the ultimate parent entity.

For this purpose, the Bill establishes three new taxes:

• the Income Inclusion Rule (“IIR”) which applies to a Luxembourg parent entity to collect a top-up tax, being the IIR tax, for any low-taxed constituent entity held directly or indirectly by this Luxembourg parent entity; 
• the Undertaxed Profit Rule (“UTPR”) which acts as a back-up rule where the top-up tax is not fully collected through IIR or a QDMTT;
• the Qualified Domestic Minimum top-up tax (“QDMTT”) which is a domestic top-up tax that allows Luxembourg to collect a top-up tax for low-taxed Luxembourg entities in priority to any other jurisdiction applying an IIR or a UTPR for those entities.

Are Investment Funds Excluded From Pillar Two Rules?

The view taken during the OECD’s consultation, as well as the commentary to the Bill, was that the principle of the tax neutrality of collective investment vehicles should be protected and that investment funds should be carved out from the scope of the Pillar Two rules.

In this sense, the Bill provides that investment funds that are ultimate parent entities of a MNE group are, in principle, excluded entities for the application of Pillar Two rules. However, a number of Luxembourg investment funds will not be able to benefit from this carve-out as some funds may not meet the criteria set out by the draft law.

The holding companies that are exclusively, or almost exclusively, owned by an excluded investment fund seem to be also excluded under certain conditions.

However, the management and portfolio companies, even though they generally do not consolidate with investment funds, might still be subject to Pillar Two rules if they meet the revenue threshold and earn income that has a low effective tax rate. These rules should be carefully considered by asset managers.

What’s Next?

The legislative process will continue in Luxembourg and, per the Pillar Two Directive, the transposition should take place by 31 December 2023. The IRR and the QDMTT will apply in respect of financial years beginning on or after 31 December 2023. The UTPR will generally apply a year later, for financial years beginning on or after 31 December 2024.

It is important for taxpayers to start evaluating the potential impact of these new rules on their business structures. Asset managers should examine how their structures, investments, and returns could be impacted by Pillar Two.