In brief
As the OECD released its much anticipated fourth set of Pillar 2 agreed administrative guidance on 17 June 2024, Luxembourg released Bill No. 8396 ("Bill") on 12 June 2024. The Bill will amend the Luxembourg law of 22 December 2023 ("Pillar 2 Law") implementing 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 union ("Pillar 2 Directive").
Insofar as the Pillar 2 Law has not yet been able to explicitly take into account all of the agreed administrative guidance adopted, respectively, in February, July and December 2023 at the level of the OECD's Inclusive Framework, this Bill aims to incorporate the clarifications and additional technical provisions resulting from the 2023 agreed administrative guidance.
In more detail
Clarifications for the investment fund industry
Scope of application of the Pillar 2 rules
In a nutshell, the Pillar 2 treatment of an entity that is part of an investment fund structure will depend primarily on whether the entity is an investment entity (i.e., an investment fund, a real estate investment vehicle or an entity held by one of these two vehicles that meets certain additional conditions) and an ultimate parent entity (UPE) (all these terms being defined under the Pillar 2 Law).
In that context, the Bill clarifies the scope of application of the Pillar 2 rules in the investment fund industry. The key criteria here is whether the Luxembourg law requires consolidated financial statements to be prepared.
If we already knew that an investment fund that is a UPE is an excluded entity for the purposes of the Pillar 2 Law, the Bill now clarifies1 the following:
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An investment fund or a real estate investment vehicle, which is not a UPE, for the sole reason that it is not required to prepare consolidated financial statements under the acceptable financial accounting standard2 or authorized financial accounting standard3 is to be assimilated to an excluded entity.
The entities that are held by such an investment fund or a real estate investment vehicle (i.e., Luxembourg special purpose vehicles) and that meet certain criteria (in terms of holding and activity as defined under the Pillar 2 Law) are considered excluded entities for the purposes of the Pillar 2 Law.
Excluded entities are not subject to the Pillar 2 Law but are to be taken into account when verifying whether the group's annual turnover is equal to or greater than the EUR 750 million threshold.
The deemed consolidation test
In addition, the Bill clarifies the "deemed consolidation test."
According to the agreed OECD guidance adopted in February 2023, the deemed consolidation test is drafted in conditional terms and only applied where the Global Anti-Base Erosion (GloBE) rules depend on a determination that is based on a group or entity's financial statements or financial accounts and the relevant group or entity does not prepare consolidated financial statements using an authorized financial accounting standard.
When this situation occurs, the OECD administrative guidance, the Pillar 2 Directive and the Pillar 2 Law all provide that where the UPE does not prepare consolidated financial statements, the UPE's consolidated financial statements are those that would have been prepared if such entity were required to prepare such financial statements in accordance with an acceptable financial accounting standard or another financial accounting standard that is adjusted to prevent any material competitive distortions.
In that context, the Bill specifies that the deemed consolidation test does not change the rules that apply under the applicable financial accounting standard. This means that if an entity, such as an investment entity, is not required to consolidate on a line-by-line basis under the acceptable financial accounting standard that is, or would be, applicable to it, the deemed consolidation rule does not require a line-by-line consolidation to be performed.
The Bill then clarifies that the deemed consolidation test is not an alternative rule to the Luxembourg local provisions governing consolidation requirements and exemptions. Indeed, according to the commentary of the Bill's articles, entities such as investment funds, which benefit from legal exemptions from the obligation to consolidate companies held as investments, are not required to carry out the deemed consolidation test, which means that these entities do not have to check whether there is an obligation to consolidate under another acceptable accounting standard.
This can be explained by the fact that the deemed consolidation test has been implemented mainly to cover (i) situations of offshore jurisdictions without accounting rules and consolidation requirements in order to ask whether a consolidation group would have existed if the application of the accounting standard was compulsory, as well as (ii) jurisdictions whose local generally accepted accounting principles (GAAP) are not an acceptable financial accounting standard.
Therefore, the deemed consolidation test should not cover Luxembourg entities that apply an acceptable financial accounting standard (such as Lux GAAP or IFRS) and that, under the Luxembourg law, are exempted from the consolidation obligations.
Finally, the Bill clarifies that (i) the deemed consolidation test does not treat a person as holding a controlling interest in an entity if the applicable accounting standard does not require that person to consolidate the entity in question on a line-by-line basis, and (ii) an entity that carries out a line-by-line consolidation on a voluntary or contractual basis cannot on this basis alone be considered to have a controlling interest in the entities subject to voluntary consolidation.
Other clarifications
In addition to this clarification for the Luxembourg fund industry, the Bill also provides additional clarifications on the following topics (among others): country-by-country safe harbor; treatment of hybrid arbitrage arrangements under the transitional country-by-country reporting safe harbor; qualified domestic minimum top-up tax; deferred tax expenses; equity investment inclusion election; definition of revenue; non-deductibility of an insurance company's technical provisions; and treatment of operational leases and filing deadlines.
What is next?
The Bill will now follow the usual legislative process through parliament.
As the main purpose of the proposed amendments is to clarify the interpretation and application of certain provisions of the rules already implemented in the Pillar 2 Law, once passed, the amendments made by the Bill would apply to tax years commencing on or after 31 December 2023, i.e., on the same date of application as the provisions of the Pillar 2 Law.
The Pillar 2 Law should be amended again in the future to take into account the fourth set of the OECD's agreed administrative guidance released on 17 June 2024 and any other instructions to come. For more information on the fourth set of the OECD's agreed administrative guidance, you may refer to our recent alert: International: Fourth Set of Administrative Guidance for Pillar 2: More Guidance, More Complexity.
Given the complexity of the rules, we have also developed a tool to help you navigate Pillar 2.
For further information on what these developments mean for you or your organization, please get in touch with your usual Baker McKenzie contact.
Authors : Diogo Duarte De Oliveira, Antonio Weffer, Amar Hamouche and Olivier Dal Farra
1 In line with point 45 of Chapter 1 of the Commentary to the Global Anti-Base Erosion Model Rules issued on 14 March 2022.
2 This means "the International Financial Reporting Standards (IFRS) or IFRS as adopted by the European Union pursuant to Regulation (EC) No. 1606/2002 of the European Parliament and of the Council dated 19 July 2002, as amended, and the generally accepted accounting principles of Australia, Brazil, Canada, the member states of the European Union, the member states of the European Economic Area, Hong Kong (China), Japan, Mexico, New Zealand, the People's Republic of China, the Republic of India, the Republic of Korea, Russia, Singapore, Switzerland, the United Kingdom and the United States of America".
3 This means "in respect of an entity, a set of generally acceptable accounting principles permitted by an authorized accounting body in the jurisdiction where that entity is located. For the purposes of this definition, "authorized accounting body" means the body with legal authority in a jurisdiction to prescribe, establish or accept accounting standards for financial reporting purposes".
