Approval of the Pillar Two law by the Luxembourg Parliament

Background and summary

The Law implements provisions of the Pillar Two Directive, which is itself based on the OECD/G20 Model Rules on Pillar Two dated 20 December 2021 (“Pillar Two”). The main rules provided for by the Law are the income inclusion rule (“IIR”), the undertaxed profits rule (“UTPR“) and the qualified domestic minimum top-up tax (“QDMTT“).

In line with the Pillar Two Directive, the IIR and the QDMTT will come into effect for fiscal years beginning on or after 31 December 2023, while the UTPR is scheduled to become effective for fiscal years commencing on or after 31 December 2024.

As a reminder, the global minimum tax of 15% would apply to both MNEs and domestic groups with a combined annual turnover above EUR 750 million in at least two of the last four fiscal years, irrespective of their corporate headquarters or global operational presence.

Amendments to the Draft Law

On 4 August 2023, the Luxembourg Government introduced to the Luxembourg Parliament the Draft Law, more details on which you may find in our previous newsletter, here.

Prior to being approved, the Draft Law was subject to certain amendments, some of which we list hereunder. The amendments were proposed to the Luxembourg Parliament on 13 November 2023. They included clarifications, provisions and options agreed at the level of the OECD.

Firstly, the amendments clarified that either Luxembourg GAAP or IFRS would be used for the purpose of calculating the Luxembourg QDMTT. For more details on this tax, please refer to the section “The Law in a nutshell”.        

Secondly, it was specified that the QDMTT of a certain jurisdiction, in order to be eligible for the safe harbor rule, must be compliant with the OECD standards (i.e., form part of a peer review process). As a reminder, under the safe harbor rule, the top-up tax relating to a specific jurisdiction is reduced to zero.

Furthermore, a paragraph was added to ensure uniform treatment of financial instruments between the issuer and the holder. Namely, an instrument issued by one constituent entity and held by another would have to be classified either as debt or equity by both of them. In case of inconsistent classification, the one adopted by the issuer should be applied also by the holder.

Finally, the amendments excluded investment entities and insurance investment entities from the QDMTT scope.

The Law in a nutshell

The Law is largely in line with the Draft Law published in August 2023, and amended in November 2023. It introduces the IIR, UTPR and QMDTT, which should together ensure meeting the minimum level of taxation.

The IIR requires the ultimate parent entity (“UPE”) of the MNE group (as a rule) to include in its taxable income a portion of the income of a foreign constituent entity of the group, if that income is subject to tax at a rate below 15%.

In cases where the UPE is situated in a low-tax third-country jurisdiction or in a third-country jurisdiction that does not administer a qualified IIR, the Luxembourg constituent entity of the same group will be subject to an additional tax based on the UTPR. The amount of tax imposed will correspond to the top-up tax attributed to the group’s low-taxed entities on which the IIR was not collected.

Finally, under QDMTT, a domestic top-up tax will take precedence over the application of both foreign IIR and UTPR for all constituent entities located in Luxembourg that have been subject to low taxation.           

Our observations

As the IIR and the QDMTT will apply to tax years starting on or after 31 December 2023, we would advise taxpayers to consider the newly introduced rules without delay.

Nevertheless, considering the ongoing work at the OECD level aimed at further clarifying Pillar Two rules, potential amendments to the Law may be expected in the future. We would recommend monitoring the developments at the OECD and Luxembourg level in this respect.

Should you require any assistance in assessing the impact of the Law on your organisation, do not hesitate to reach out to the Tax team at Grant Thornton Luxembourg.