Luxembourg updates draft legislation on implementation of the EU Minimum Tax Directive

 

• The Luxembourg government tabled several amendments (Amendments) to the legislative proposal (Draft Law) for transposition into domestic law of Council Directive 2022/2523¹ of 14 December 2022 on minimum taxation (Minimum Tax Directive).
• The Amendments aim to include certain clarifications and additional provisions that were agreed at the level of the Organisation for Economic Co-operation and Development (OECD)/G20 Inclusive Framework through Agreed Administrative Guidance on the Global Anti-Base Erosion (GloBE) Model rules (Pillar Two) in February 2023 (February Guidance)² and July 2023 (July Guidance)³.
• The Amendments also introduce certain options and safe harbor regimes in line with such Guidance.

Executive summary

On 10 November 2023, the Luxembourg government transmitted to Parliament Amendments to the Draft Law⁴ that is currently running through the legislative process. 

The Draft Law aims at implementing the Pillar Two Global Minimum Tax rules as laid down in the Minimum Tax Directive. The Minimum Tax Directive introduces minimum effective taxation of 15% for large multinational enterprise (MNE) groups and large-scale domestic groups with annual revenues of at least €750m in at least two of the last four financial years. It sets forth a system consisting of two interlocked rules — the primary Income Inclusion Rule (IIR) and the secondary Undertaxed Payment Rule (UTPR), together referred to as the GloBE rules. In addition to introducing the IIR and the UTPR, the Draft Law makes use of the option provided in the Minimum Tax Directive to introduce a Qualified Domestic Minimum Top-up Tax (QDMTT), allowing Luxembourg to collect top-up tax on the excess profit of a low-taxed Luxembourg entity that is part of an in-scope group.

The Amendments aim to incorporate guidance and options of the February and July Guidance.

Detailed discussion

Luxembourg QDMTT 

Accounting reference framework for the QDMTT

In line with the July Guidance, the rules on the financial accounting standard to be used to determine the QDMTT are amended. 

Under the amended provision, GloBE income is to be computed using the financial accounting standard permissible in Luxembourg (i.e., Luxembourg generally accepted accounting principles (LUX GAAP) or International Financial Reporting Standard (IFRS)) that all the Luxembourg constituent entities of the MNE or large-scale domestic group or all the constituent entities of a joint venture (JV) group use to establish their financial statements. These financial statements must be based on the same financial year as the one covered by the consolidated financial statements of the MNE or large-scale domestic group. If some of the constituent entities use LUX GAAP while others use IFRS for their filed and published financial statements, the QDMTT must be computed using IFRS for all the Luxembourg constituent entities. If the financial year of one or more of the Luxembourg constituent entities of the group deviates from that covered by the consolidated financial statements, then the financial standard used for consolidation must be used.

Exclusion of investment entities and insurance investment entities from QDMTT

In line with the July Guidance, the Amendments exclude investment entities and insurance investment entities from the scope of the QDMTT. 

Deferred tax

The Amendments clarify that the deferred tax to be considered in computing Covered Taxes corresponds to the deferred tax recognized in the entity’s financial statements as well as the deferred tax recognized only in the consolidated financial statements of the Ultimate Parent Entity (UPE) in so far as the deferred tax is attributable to the entity concerned. 

Safe harbors

QDMTT safe harbor

The Amendments introduce the QDMTT safe harbor as foreseen by the July Guidance. To qualify for this safe harbor, the QDMTT of a jurisdiction must pass the peer review process that will be undertaken at the level of the Inclusive Framework. According to the July Guidance, the peer review process of the Inclusive Framework will determine whether a QDMTT meets a determined set of standards to qualify for the safe harbor, namely: 

• The Accounting Standard, which requires a QDMTT to be computed based on the UPE’s Financial Accounting Standard or a local Financial Accounting Standard subject to certain conditions
• The Consistency Standard, which requires the QDMTT computations to be the same as the computations required under GloBE Model Rules, except where the Commentary to the QDMTT definition explicitly requires the QDMTT to depart from the GloBE Rules or the Inclusive Framework decides that an optional variation still meets the standard
• The Administration Standard, which requires the QDMTT jurisdiction to meet the requirements of an ongoing monitoring process similar to the one applicable to the GloBE Rules; the ongoing monitoring process will include a review of the information collection and reporting requirements under the QDMTT to ensure that they are consistent with the equivalent requirements under the GloBE Rules and the approach set out in the GloBE Information Return

Where the QDMTT of a jurisdiction is considered to meet the conditions to qualify for the safe harbor as a result of the peer review process, the filing constituent entity may opt to exclude that jurisdiction from the computation of minimum taxes.  The election to apply the QDMTT safe harbor must be made annually and separately for each sub-group of constituent entities subject to a separate QDMTT calculation (e.g., separately for the members of a JV group). The QDMTT safe harbor does not extend to constituent entities that have their effective tax rate calculated separately and that are not subject to QDMTT in a given jurisdiction based on domestic rules (e.g., investment entities if they are not subject to a QDMTT in the jurisdiction where they are located). 

Transitional UTPR safe harbor

In line with the July Guidance, the Amendments provide for a transitional UTPR safe harbor. When the filing constituent entity makes an election for a given fiscal year, the UTPR top-up tax amounts determined for the low-taxed constituent entities located in the UPE jurisdiction are excluded from the total UTPR top-up tax amount for financial years beginning before 1 January 2026 and ending before 31 December 2026 if the UPE jurisdiction has a (nominal statutory) corporate income tax rate of at least 20%.

Permanent safe harbors

The Amendments introduce the framework for permanent safe harbors in line with the Simplified Calculations Safe Harbour Framework as per the OECD guidance on GloBE safe harbors⁵. Upon annual election of the filing constituent entity, the top-up tax in a jurisdiction for a determined fiscal year is zero if one of the following three tests is met on a jurisdictional basis:

1. Routine profits test, to verify that the GloBE income, as determined under a simplified calculation, is equal to or less than the amount that results from computing the Substance-Based Income Exclusion (SBIE) for that jurisdiction
2. De minimis test, to verify that the average GloBE revenue of all constituent entities in the jurisdiction, as determined under a simplified calculation, is less than €10m and the average GloBE income of such entities is less than €1m
3. Effective Tax Rate (ETR) test, to verify that the ETR of the jurisdiction, as determined under a simplified calculation, is at least 15%

According to the commentaries to the Amendments, the simplified calculations to be applied for the three tests will be defined in the context of the specific safe harbors that the Inclusive Framework will develop.

The Amendments also introduce an optional simplified calculation for nonmaterial constituent entities in line with the OECD guidance on GloBE safe harbors. The option applies on an entity basis, not on a jurisdictional basis.

Changes to the SBIE

The Draft Law, in line with the Minimum Tax Directive, foresees that the amount of GloBE income used as a basis to determine the top-up-tax is reduced by a “SBIE amount”, which is calculated as a percentage mark-up on tangible assets and payroll costs in the relevant jurisdiction.

The Amendments update the rules by integrating the July Guidance on SBIE, which anticipates (i) the possibility for the group to claim only a subset of its total eligible payroll costs and eligible tangible assets when calculating the SBIE and (ii) guidelines for allocating eligible employees and eligible tangible assets that are not located during the entire period in the jurisdiction of the constituent entity that is the employer or owner.

Exclusion of insurance investment entities

The Amendments align the treatment of insurance investment entities to that of investment entities by also excluding insurance investment entities from the definition of intermediate parent entities and partially-owned parent entities and by extending the possibility to elect to use the taxable distribution method to insurance investment entities.

Implementation of OECD guidance

The Amendments update the Draft Law to reflect a number of items from the February  and July  Guidance, including the guidance on:

i) Asymmetric treatment of dividend and distributions

ii) Accrued pension expenses

iii) Equity gain or loss inclusion election 

iv) Excluded equity gains or losses and hedges of investments in foreign operations

v) Simplification for short-term portfolio shareholdings

vi) Excess negative tax carryforward guidance 

vii) Deferred tax assets with respect to foreign tax credits 

viii) Elective taxable distribution method 

ix) Allocation of taxes arising under a blended Controlled Foreign Company regime 

The Amendments also introduce the possibility of implementing through a Grand-Ducal Regulation the outcome of the discussions that are still ongoing at OECD level regarding (i) the treatment of marketable and transferable tax credits and (ii) qualified flow-through tax benefits of qualified ownership interests.

1. Council Directive (EU) 2022/2523 of 14 December 2022 on ensuring a global minimum level of taxation for multinational enterprise groups and large-scale domestic groups in the European Union.
2. OECD (2023), Tax Challenges Arising from the Digitalisation of the Economy – Administrative Guidance on the Global Anti-Base Erosion Model Rules (Pillar Two), OECD/G20 Inclusive Framework on BEPS, OECD, Paris.
3. OECD (2023), Tax Challenges Arising from the Digitalisation of the Economy – Administrative Guidance on the Global Anti-Base Erosion Model Rules (Pillar Two), July 2023, OECD/G20 Inclusive Framework on BEPS, OECD, Paris.
4. See EY Global Tax Alert, Luxembourg publishes draft legislation on implementation of the EU Minimum Tax Directive, dated 14 August 2023.
5. OECD (2022), Safe Harbours and Penalty Relief: Global Anti-Base Erosion Rules (Pillar Two), OECD/G20 Inclusive Framework on BEPS, OECD, Paris.
6. See EY Global Tax Alert, OECD/G20 Inclusive Framework releases Administrative Guidance under Pillar Two GloBE Rules: Detailed Review, dated 9 February 2023.
7. See EY Global Tax Alert, OECD/G20 Inclusive Framework releases additional Administrative Guidance on Pillar Two GloBE Rules: Detailed review, dated 21 July 2023