A new global tax system is coming, putting globally-active Luxembourg firms, especially investment funds, into a desperate search to see whether they could be exposed to pay a potentially substantial top-up tax, according to rules that, to some, could seem just mean.
The OECD’s Pillar Two tax system, designed to make multi-national companies – including investment funds - pay a global minimum 15% tax, will be an additional tax reporting system creating a substantial additional workload.
To comply, you must calculate your tax base for Pillar Two purposes. Then you compare the taxes you’ve paid that are recognised under the rules. This sets your “effective tax rate” explained Andreas Medler, an Atoz partner in international & corporate tax at a recent briefing at Atoz’s Luxembourg offices. “The difference to 15% may lead to a top-up tax, an additional tax burden.”
New Diekirch tax office
The work also comes in the form of additional tax filing obligations, including the GloBE information return, which is the Pillar Two tax form. A new tax office has been opened in Diekirch to administer the new taxes here. This includes the “qualified minimum domestic top-up tax”. Luxembourg’s parliament is still working on a bill implementing the new tax rules.
“The key notion of what is defined as a multinational group under Pillar Two all refers to consolidation,” said Medler. To be subject to the tax, companies need to exceed turnover thresholds of 750 million euros in at least two of the four preceding years, the same threshold as for country-by-country reporting.
However, “even if such entities are not fully consolidated on a line-by-line basis, they may nevertheless form part of the MNE group for Pillar Two purposes,” Medler said, referring to MNE as a multinational enterprise.
Shadow consolidations
Medler said the entities might have been excluded because they were too small or held for sale. “That rings a bit of a bell in the private equity sector,” he said. In such a case, companies may even be required to perform some kind of “shadow consolidation.”
If the fund manager is required to consolidate their fund it would mean they “need to start asking your investors whether they’re consolidating, they’re not consolidating, and on the basis of which accounting standard.” Only some standards are acceptable, Medler said.
Under Luxembourg law, there are many exemptions, said Medler. “Any funds like specialised investment funds, Sicars, Raifs, they all benefit from different exemptions based on their special fund laws.”
Hoping for clarification
However, said Medler, “it’s not really entirely clear yet whether this is also a permissible or detrimental exemption and whether this requires deemed consolidation.” There’s strong market sentiment that this is not detrimental, he said. “But there are some other more gray-zone exemptions which are not entirely clear at all.”
He pointed to the SCSp, which is exempt due to its legal form. “So does that mean that I need to consolidate or not based on a deemed basis?”, asked Medler, who said the legal profession is “strongly hoping for a bit more clarification by the legislator.”
The vast majority of Luxembourg-based investment funds “will not be impacted” by Pillar Two, but fund administrators will have to first examine “every single case”, said Medler.
Nearly everyone excluded
As many as 98% of investment funds will not be impacted, either because they are “not in scope” or because they qualify for “certain carve-outs”. “When taking these two points together, I think that we can carve out easily 97-98% of all investment funds,” said Medler.
Even so, “managers still need to be aware of the few funds in your portfolio that are impacted.”
In the few cases where a fund is in scope for the top-up tax, taxpayers should be aware that the Pillar Two rules contain at least one “quite mean rule”.
Investment entity status
It is important to understand whether you’re an investment entity, Medler said. Pillar Two requires you to compute the result on a country-by-country basis and separately for investment entities.
“For all the Luxembourg investment entities which form part of the same group, you need to calculate the results separately,” he said. This precludes investment entities from benefiting from tax payments made by non-investment entities that are part of the same MNE group in the jurisdiction in question.
If the fund has a few operating entities in a country, they might be subject to an average tax rate of perhaps 25%. If this was blended with “less top-up taxed” investment funds, they’d pay less tax, Medler explained. “That’s kind of the mean thing, actually,” he commented, explaining that the OECD was aware that investment funds are usually tax-exempt.
Maximising tax impact
“By separating the buckets they want to maximise the impact. That’s actually a quite mean rule in the Pillar Two framework.”
Luxembourg released its draft law implementing the new OECD framework in early August. If passed, it would introduce three new Luxembourg taxes. It would impose the income inclusion rule tax and qualified domestic minimum top-up tax for fiscal years starting on or after 31 December 2023, with the undertaxed profits rule being effective for fiscal years starting on or after 31 December 2024.