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Luxembourg publishes draft Pillar Two legislation

9 August 2023

Luxembourg Tax Alert

At a glance

On 4 August 2023, the Luxembourg Chamber of Deputies published draft legislation implementing the EU Pillar Two directive. The rules of the directive are designed to ensure that multinational and domestic groups with annual consolidated revenue of at least EUR 750 million pay taxes at an effective rate of at least 15% on profits derived in each jurisdiction where they operate.

A closer look

Based on the explanatory statement of the council of government, the draft legislation closely reflects the EU’s Pillar Two directive, which is based on the Pillar Two model rules of the OECD/G20 Inclusive Framework on BEPS (“OECD inclusive framework”). The Pillar Two directive contains certain adjustments from the OECD model rules to ensure conformity with primary EU law (notably the inclusion of domestic groups in the scope of the rules).

The draft legislation would operate as a separate tax law that would apply independently from the Luxembourg income tax law.

The Luxembourg draft legislation introduces the following rules:

  • Income inclusion rule (IIR): As from financial years beginning after 31 December 2023, the IIR would apply on a top-down basis such that, in most cases, any tax due would be computed and paid by the group’s ultimate parent company to the tax authority in its country. The tax due would be the “top-up” amount needed to bring the overall tax on the profits in each country where the group operates up to the minimum effective tax rate of 15%.
  • Qualified domestic minimum top-up tax (QDMTT): As from financial years beginning after 31 December 2023, the QDMTT would ensure that the low-taxed profits of the Luxembourg entities of a group would be subject to a Luxembourg top-up tax, which would prevent other jurisdictions from taxing the undertaxed Luxembourg profits.
  • Undertaxed profits rule (UTPR): As from financial years beginning after 31 December 2024, the UTPR would apply as a secondary (backstop) rule in cases where the effective tax rate in a country is below the minimum rate of 15% but the IIR has not been fully applied. The top-up tax would be allocated to countries where the group operates and that have adopted the UTPR based on a substance formula (tangible assets and payroll).

According to the explanatory statement to the draft legislation, the OECD Pillar Two model rules, as well as current and future guidance issued by the OECD, would be used as a source of interpretation when applying the rules contained in the legislation.

In line with the guidance provided by the OECD inclusive framework, the Luxembourg draft legislation provides a transitional country-by-country reporting safe harbor, which is a short term measure to exclude a group’s operations in lower-risk countries from the requirement to prepare a full Pillar Two calculation.

Also, the commentaries to the draft legislation clarify the scope of Luxembourg taxes that should be considered as covered taxes for purposes of the rules. The non-exhaustive list includes the corporate income tax, the municipal business tax, and the net wealth tax.

The draft legislation follows the EU Pillar Two directive with regard to compliance requirements. An information return and tax return would be required to be filed no later than 15 months after the end of the fiscal year (18 months for the first fiscal year). The penalty for late or incomplete filing would be capped at EUR 250,000.

It also clarifies that the statute of limitations for the Luxembourg tax authorities to assess the Pillar Two returns would be 10 years.

Next steps

The parliament will now review, potentially modify, and vote on the draft law before the end of 2023 (in line with the date foreseen in the EU directive). General elections will be held in Luxembourg in October 2023. Such elections may not affect the mandatory review by the council of state and chamber of commerce, but may affect the legislative process (especially if amendments are required following the opinion of the council of state). As such, one may anticipate that the vote on the draft law would occur rather late in 2023.

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