June 21, 2024 Luxembourg proposes changes to Pillar Two Law
Executive summary On 12 June 2024, the Luxembourg government transmitted to Parliament a Draft Law that amends the Pillar Two Law. The Draft Law aims to incorporate the clarifications and additional provisions of the OECD Guidance without going beyond the guidance. Among other things, the Draft Law, in line with the OECD Guidance, extends the scope of Excluded Entities, adapts certain provisions relating to the Qualified Domestic Top-up Tax (QDMTT) and clarifies the application of the Transitional Country-by-Country Reporting (CbCR) safe harbor. The Draft Law will enter into effect for financial years starting from 31 December 2023. Detailed discussion Extended scope for Excluded Entities In line with the GloBE Model Rules, the Pillar Two Law excludes certain entities (Excluded Entities), which include investment funds and real estate investment vehicles that are the Ultimate Parent Entity (UPE) of a multinational enterprise (MNE) group as well as certain entities held by Excluded Entities (subject to an ownership and an activity test). In line with the OECD Commentary to the GloBE Rules,5 the Draft Law proposes to assimilate to an Excluded Entity, for purposes of determining whether an entity it holds meets the ownership and activity test to itself qualify as an Excluded Entity, an investment fund or a real estate investment vehicle that is not a UPE solely because it is not required under acceptable financial accounting standards or authorized financial accounting standards, as applicable, to prepare consolidated accounts. As a result, a holding company that is held by an investment fund or a real estate investment vehicle would, going forward, still be able to meet the requirements for the exclusion even though the investment fund or the real estate investment vehicle is not required to consolidate and is, therefore, not the UPE of that group. The entity would, however, still need to be considered for purposes of determining whether a MNE group's annual revenues exceed the €750m threshold. The Draft Law also clarifies, in line with the OECD Guidance, that a sovereign wealth fund that meets the definition of a Governmental Entity, and consequently is an Excluded Entity, is not considered a UPE or a member of an MNE group. The sovereign wealth fund is therefore disregarded for purposes of determining whether entities held by such a fund constitute an in-scope group. QDMTT Currency for QDMTT computations In line with the July Guidance, the Draft Law introduces rules that specify the functional currency to be used for computing the QDMTT, as follows:
Constituent Entities that prepare their financial statements on the basis of a functional currency that differs from the functional currency to be used for computing the QDMTT, must apply the conversion rules provided under the relevant financial accounting standard used for the QDMTT computation. Excluding MNE Groups from QDMTT in initial phase of international activity The Pillar Two Law provides for an exclusion from the Undertaxed Payment Rule (UTPR) and domestic Income Inclusion Rule (IIR) for up to five years for MNE groups during their initial phase of international activity. According to this provision, MNE groups will be exempt from UTPR and/or domestic IIR during this period, if (i) they have Constituent Entities in no more than six jurisdictions and (ii) the net book value of the tangible assets of all the MNE group's Constituent Entities located in all jurisdictions, other than the reference jurisdiction, does not exceed €50m. The Draft Law takes the option given by the July Guidance to reduce the QDMTT of a Luxembourg Constituent Entity to zero during the first five years of the international activity of the MNE group of which the Constituent Entity is a member. The reduction may also apply to large-scale domestic groups during the first five years beginning with the first day of the fiscal year in which a domestic group of which the Constituent Entity is a member becomes a large-scale domestic group covered by the Pillar Two Law. The five-year period begins on 31 December 2023 for MNE groups that were already in-scope on that date or from the beginning of the fiscal year during which the Pillar Two Law applies for the first time to the MNE group. Treatment of foreign taxes for the QDMTT The text of the Draft Law aligns the QDMTT rules to the July Guidance by specifying which foreign taxes (that would be allocated to a Luxembourg Constituent Entity under the IIR or the UTPR) should not be allocated for purposes of the QDMTT, with the effect that taxes incurred by foreign tax transparent entities are no longer excluded from the QDMTT computations. QDMTT safe harbor The Draft Law clarifies that the QDMTT safe harbor is based exclusively on the provisions of the July Guidance and aligns the wording of the Pillar Two Law with the said Guidance. Transitional CbCR safe harbor The Pillar Two Law provides for a transitional CbCR safe harbor that relies on CbCR data as the basis for calculating an MNE's revenue and income on a jurisdictional basis. The safe harbor rules apply for fiscal years beginning on or before 31 December 2026 and ending before 1 July 2028 (i.e., the years 2024 to 2026 if the fiscal year corresponds to the calendar year). The Draft Law aligns the existing provision with the December Guidance to clarify the conditions for the safe harbor to apply. These alignments include:
Groups that are in scope of the Pillar Two Law but are not required to file CbC Reports are still eligible for the transitional CbCR safe harbor if they use the data from Qualified Financial Statements that would have been reported if the Group were required to file a CbC Report. Finally, the Draft Law incorporates the provisions of the December Guidance on the treatment of hybrid arbitrage arrangements under the transitional CbCR safe harbor rules. The provisions shall apply to hybrid arbitrage arrangements entered into or modified after 18 December 2023. Moreover, in view of the transitional CbCR Safe harbor, the Draft Law incorporates OECD Guidance on: purchase price accounting adjustments in Qualified Financial Statements; the procedure in absence of separate financial statements for permanent establishments; the computation of the Simplified Effective Tax Rate (ETR) in cases where the Transitional CbCR safe harbor does not apply in a jurisdiction in which a permanent establishment, Controlled Foreign Entity (CFC) or Hybrid Entity is located, as well as the location of Joint Ventures (JVs) or members of a JV Group if the MNE Group has both Constituent Entities and a JV or members of a JV Group in the same jurisdiction. Utilization of transition year tax attributes In line with the Model Rules, the Pillar Two Law provides for a transition rule that is designed to allow preexisting deferred tax accounting attributes to be used in calculating the ETR to prevent distortions upon entry into the GloBE regime. It allows the MNE Group to take into account the deferred tax attributes of the MNE Group existing at the beginning of the Transition Year, at the lower of the minimum tax rate or the applicable domestic tax rate. If a deferred tax asset (DTA) has been recorded at a rate lower than the minimum tax rate, that DTA may be taken into account at the minimum tax rate if the taxpayer can demonstrate the DTA is attributable to a GloBE Loss. The Draft Law clarifies a number of items in relation to the use of historic tax attributes, in line with the February Guidance. This includes clarification that DTAs resulting from tax credit carryforwards are available for the determination of the ETR, regardless of the type of tax credit as well as the simplified approach suggested by the OECD for recasting DTAs in relation to credits, particularly foreign tax credits. Clarification on filing deadline The Draft Law also clarifies that none of the Pillar Two-related deadlines (filing of the GloBE information return, top-up tax return and the registration or notification) can occur before 30 June 2026. Other clarifications and adaptations to OECD Guidance The Draft Law further aligns the Pillar Two Law wording to the OECD Guidance in respect of:
Next steps and implications The Draft Law will now go through the legislative process, which involves the analysis of the text by a dedicated parliamentary commission, the collection of opinions from different advisory bodies (most importantly, the Council of State), discussion of and vote on the text in a parliamentary session and finally its publication in the Official Gazette (Memorial). The entire process may take a couple of months. Taxpayers potentially affected by the Draft Law should remain aware of its progress through Parliament and consult with their tax advisors to fully understand how it could affect them.
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