The EU’s pillar two directive was by the Luxembourg parliament late last year, and entered into force on 1 January 2024. The multilateral policy forum OECD developed the pillar two tax package tax challenges stemming from digitalisation of the economy globally, and aim to ensure that multinational groups with consolidated revenue of more than €750m a year are subject to a minimum tax rate of 15% in each jurisdiction where they operate.
Delano reached out to Thierry Lesage, partner in the tax law practice of Arendt & Medernach, to discuss the pillar 2 reforms and hear his thoughts on the challenges and implications for multinational entities operating in Luxembourg.
Dina Jaber: Can you provide an explanation of the recent tax reform known as pillar two and its primary goals? And the progress of adaptation so far?
: The OECD has proposed a two-pillar approach to address gaps in the existing rules that allow large multinational enterprises (MNEs) to avoid paying taxes. Pillar one seeks to reallocate part of taxable income to market jurisdictions. Pillar two seeks to enforce a global minimum corporate income tax at an effective rate of 15%, calculated on a jurisdiction-per-jurisdiction basis. While primarily targeting MNEs, these new rules may also have implications for investment fund structures.
Pillar two is implemented at the European level through a directive adopted in December 2022 and due to be transposed by each European member state essentially by the end of last year.
Luxembourg introduced these rules into domestic law with the enactment of the law of 22 December 2023.
However, ongoing adjustments may be necessary as Luxembourg is expected to incorporate any administrative guidance issued by the OECD from time to time.
What specific changes or challenges do you foresee for international companies operating and funds domiciled in Luxembourg in response to pillar two tax reforms?
The main challenges that multinational groups will face with pillar two are the cost and burden associated with compliance. On the one hand, most MNEs have an effective tax rate already above 15%.
Pillar two also contains rules allowing an effective tax rate lower than 15% in certain jurisdictions, like the substance-based income exclusion rule, safe harbour rules and special rules applicable to shipping. This means that in many cases, no top-up tax or only an insignificant amount will be due.
On the other hand, international tax rules already contained provisions targeting artificial profit shifting to low-tax jurisdictions, like country-by-country-reporting (CBCR), which gives a snapshot of key tax metrics in all the jurisdictions where a multinational group operates.
In my view, a proactive and coordinated use of CBCR by tax authorities in order to perform targeted transfer pricing audits would have led to the same or even better results than pillar two.
With the introduction of pillar two, what are the implications for Luxembourg’s tax landscape, in terms of competitiveness compared to other jurisdictions as a hub for multinational companies looking to establish their presence in Europe?
Pillar two is a global reform adopted at the level of the OECD/G20 inclusive framework on Base Erosion and Profit Shifting, which means that a total of close to 150 countries including all major economies are due to implement it. Pillar two rules should be similar in all these countries, creating some level-playing field.
This being said, the minimum 15% tax rate should also become a new benchmark. Some countries will raise their domestic corporate tax rate to 15% (like Ireland) while some others which were a no-tax jurisdiction have just introduced a corporate income tax (like the United Arab Emirates).
For Luxembourg, the pledge made by the new government to reduce corporate taxes to a level closer to OECD/EU averages is welcome.
What do you consider to be the optimal approach or your recommendation for industry players in preparing for the potential impacts of pillar two tax reforms to ensure both compliance and competitiveness?
MNEs have already been on track for some time. They have set up task forces and are adapting their enterprise resource planning systems. While substantial work is still required, readiness is expected.
Potential implications for the fund industry are more delicate to handle. The OECD has always recognised the necessity to preserve the tax neutrality of funds, which are understandably not the primary target of pillar two.
However, certain fund structures can exceptionally be subject to a pillar 2 top-up tax, for instance in the case of managed accounts. Furthermore, as accounting consolidation requirements are the starting point of pillar two, a critical review of consolidation obligations is key for alternative investment funds.
This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. .