Luxembourg amends its draft law introducing global minimum tax

As a reminder, the draft law aims at transposing the EU Council Directive 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 Union, known as the EU Pillar Two Directive or the GloBE (Global anti-Base Erosion) Directive. The EU Pillar Two Directive aims to implement a jurisdictional minimum taxation of at least 15% and is based on the OECD Model Rules on Pillar Two that were released on 20 December 2021, with some necessary adjustments to guarantee conformity with EU law.

The draft law foresees the implementation of 3 new taxes in Luxembourg, an Income Inclusion Rule tax (hereafter “IIR”), an Undertaxed Profits Rule tax (hereafter “UTPR”) and a Qualified Domestic Minimum Top-up Tax (hereafter “QDMTT”). For a detailed review of the draft law, please refer to our prior newsalert.

Introduction of the Local Accounting Standard Rule

Based on the proposed amendments, it has been clarified that Luxembourg would introduce the Local Accounting Standard Rule for the purpose of calculating the Luxembourg QDMTT. This means that the QDMTT for Luxembourg entities should be calculated either under Luxembourg Generally Accepted Accounting Principles (Lux GAAP) or IFRS. Whether Lux GAAP or IFRS should be followed would depend on the accounting standard which is used for statutory filing purposes in Luxembourg. If there are entities using different accounting standards for statutory filings in Luxembourg (e.g., one using Lux GAAP and another IFRS), there is a tie breaker rule foreseeing that calculations shall be made under IFRS, irrespective the number of entities preparing statutory accounts under Lux GAAP or IFRS. Furthermore, if there is a Luxembourg entity which has a fiscal year which deviates from the group financial year, the QDMTT calculation shall generally be based on the accounting standard used for consolidation purposes (with some exceptions in case it would not be reasonable to follow such accounting standard and subject to conditions). The IIR and the UTPR would continue to be calculated based on the accounting standard used for consolidation purposes (with some exceptions).

The amended draft law now also mentions that other countries may follow the Local Accounting Standard Rule which would not prevent those jurisdictions to potentially qualify for the QDMTT safe harbour. In such cases, Luxembourg would switch off the application of the IIR and UTPR for jurisdictions that are considered to have a qualified QDMTT. Whether a jurisdiction has a qualified QDMTT would be determined through a peer-review process organised by the OECD Inclusive Framework. Luxembourg is expected to remain close to the rules as provided by the OECD in order for its QDMTT to qualify for the safe harbour rule in other jurisdictions.

Observation: The introduction of the Local Accounting Standard Rule is in line with recent developments in several other jurisdictions. Groups should assess the potential impact on modelling exercises that have been performed for their Luxembourg entities. Further, the comments to the amended draft law mention that, similar to the IIR and UTPR, the QDMTT should take into consideration deferred taxes which are recorded only in the consolidated accounts but not in the statutory accounts (which has been clarified through the Administrative Guidance of February 2023). This would be specifically relevant for entities preparing their statutory accounts under Lux GAAP, which currently does not allow the recording of deferred tax assets.

Introduction of the Local Accounting Standard Rule

Investment Entities and Insurance Investment Entities, within the definition of the Pillar Two rules, would be excluded from the application of the Luxembourg QDMTT. A similar exclusion is foreseen for IIR and UTPR purposes.

Observation: The exclusion from the QDMTT of Investment Entities and Insurance Investment Entities is a welcome clarification to the Luxembourg rules. This would ensure that those entities keep their tax neutral character and external investors would not be (indirectly) impacted by top-up tax to be potentially paid by those entities. This however requires that the entities qualify either as an Investment Entity or an Insurance Investment Entity within the meaning of the definitions foreseen in the Pillar Two rules. Furthermore, it does not prevent another jurisdiction applying the IIR or the UTPR with respect to the income of such entities if the entities form part of a Pillar Two group.

Inclusion of the notion of Marketable Transferable Tax Credits 

The concept of Marketable Transferable Tax Credits has been included in the amendments of the draft law. Under the Pillar Two rules, such credits could under conditions be treated in the same manner as Qualified Refundable Tax Credits (i.e., tax credits that are refundable in cash or cash equivalent within a period of 4 years as from the entitlement of the tax credit). This means that Marketable Transferable Tax Credits could be treated as income for the seller of the credit rather than as a decrease of Pillar Two covered taxes. As a result, there would be less impact on the jurisdictional effective tax rate. The amended draft law recognises that certain work is still ongoing at the level of the OECD with respect to Marketable Transferable Tax Credits and a Luxembourg grand-ducal regulation shall outline further details with respect to the treatment of such tax credits in Luxembourg.

Observation: While Marketable Transferable Tax Credits currently do not exist in Luxembourg, this would be specifically relevant for Luxembourg entities applying the IIR or the UTPR for foreign entities that sell or benefit from such credits (e.g. US companies that are entitled to certain tax credits under the US Inflation Reduction Act). It remains to be seen whether the Luxembourg investment tax credits, which currently are neither refundable nor transferable, would be amended in the future in view of being qualifying under the Pillar 2 rules.

Inclusion of the Equity Gain or loss inclusion election

The Equity Gain or loss inclusion election as foreseen by the Administrative Guidance of February 2023 (see section 2.9 of the Administrative Guidance of February 2023) has been included in the amended draft law. The election allows to a certain extent, to align the Pillar Two treatment of income/gains and charges/losses on equity participations with the local tax treatment. The election would be a jurisdictional election, applicable to all shareholdings held by constituent entities located in Luxembourg and would apply for 5 years (with automatic renewal, unless revoked).  

Observation: The amended draft law does not seem to restrict the application of the election to entities consolidated under the equity method. This would be a welcome clarification for Luxembourg entities that record an impairment charge or a loss on equity participations as it would allow the alignment of the Pillar Two treatment of such charges/losses with the local tax treatment (i.e., allowing for such charges/losses to be taken into consideration for the determination of the GloBE income/loss). It is not clear yet whether such an election could also have an impact for carried forward tax losses generated during the Transitional period (i.e. as from 1 December 2021 up to the first year of application of the Pillar Two rules).

Inclusion of a permanent safe harbour rule and UTPR safe harbour

The amended draft law includes the permanent safe harbour rule as announced, but yet to be finalised, by the OECD in December 2022. The permanent safe harbour rule would follow a similar 3 test safe harbour as the OECD transitional country-by-country safe harbour rule (de minimis test, simplified effective tax rate test and routine profits test). The transitional country-by-country safe harbour rule would generally be available for 3 fiscal years and would be based on the information included in the country-by-country report and certain information included in the financial statements. The permanent safe harbour tests should not be limited in time, though the concrete basis for the “simplified calculations” is still to be released by the OECD.

Furthermore, the amended draft law includes the transitional UTPR safe harbour rule as included in the Administrative Guidance of July 2023. This UTPR safe harbour rule would deem the top-up tax calculated for the ultimate parent entity jurisdiction to be zero if the ultimate parent entity jurisdiction has a corporate income tax rate of at least 20%. The UTPR safe harbour shall apply for periods which run no longer than 12 months and that begin on or before 31 December 2025 and end before 31 December 2026.

Observation: Luxembourg seems to anticipate the finalisation of the permanent “simplified calculation” safe harbour rule by the OECD, with the Luxembourg draft law recognising that work is still being undertaken at the level of the OECD Inclusive Framework. Hence, until the OECD releases further details on the basis for calculating the permanent safe harbour, the rule should not yet be applicable in Luxembourg.

With respect to the UTPR safe harbour, such safe harbour could be useful for groups that do not meet the requirements of the transitional country-by-country safe harbour rule. However, applying for the UTPR safe harbour would exclude the application of the transitional country-by-country safe harbour rule for the following year (2026 for calendar year groups) as the latter safe harbour rules applies a “once-out, always out”-principle. Hence, groups are recommended to assess which safe harbour to apply for the jurisdiction of the ultimate parent entity to avoid potentially losing the application of the transitional country-by-country safe harbour rule for the following year.

Other updates

Other updates to the draft law have been introduced to reflect the Administrative Guidance of February and July 2023. It is worth mentioning that the amendments to the draft law reflect the inclusion of the anti-abuse rule foreseen in Art. 8.2 of the OECD model rules on Pillar 2. Hence the Luxembourg tax administration could deny the application of a safe harbour where it considers that top-up tax should have been due in Luxembourg (subject to a certain process and timeline).