Pillar Two: a new era of International Taxation

Initiated by the OECD and embraced by more than 140 countries, Pillar Two rules were released in December 2021, adopted by a European Directive in December 2022, and transposed into Luxembourg law in December 2023. These rules (along with accompanying acronyms) mark a significant shift in the international taxation of multinationals worldwide, including those operating within or through Luxembourg. It is anticipated that these changes will have an impact in the Luxembourg economy. 

Pillar Two in a nutshell

Multinationals with consolidated annual revenue of at least EUR 750M are in scope of Pillar Two rules. In Luxembourg, these rules apply to fiscal years starting as from 31 December 2023. Some entities, including certain investment and real estate funds, are excluded.

Pillar Two tax (Top-up Tax) is due if in a country where the multinational group operates, it has an effective tax rate (ETR) lower than 15%.

The ETR calculation departs from the entities’ net income and tax expenses as disclosed in their financial accounts but requires a series of adjustments.

Isn't it simple? No!

Although the main goal seems simple, Pillar Two rules are extremely complex. They diverge from existing commercial and tax accounting practices, constituting a third set of calculations which mixes both worlds. Such blending requires numerous adjustments, (re)measurements and controls. The intricate interplay between accounting – serving as the foundation framework - and (different) domestic tax rules presents a substantial increase in the administrative burden for multinationals. Gathering information from different sources such as stand-alone accounting reports, deferred tax accounting, consolidation records, tax documents, IT systems, HR databases and sales reports poses a material challenge and cost in terms of organisation and coordination.

Moreover, different effects apply to transactions that occurred (i) prior to 30 November 2021, (ii) between such date and the initial application of Pillar Two for a Multinational, and (iii) once Pillar Two rules are in effect. Beyond timing considerations, other impacts should be taken into account while applying Pillar Two. A non-exhaustive list of attention points includes:

Scope

• The EUR 750M threshold may comprise amounts that are not necessarily included in a consolidated financial statement.

• Determining in-scope groups sometimes requires a “deemed” consolidation test.

• Identifying various entity types and their corresponding treatments is crucial, including: constituent entities, excluded entities, investment entities, transparent entities, reverse hybrid entities, minority owned parent entities (MOPE) and partially owned parent entities (POPE).

Impacts

• Navigating deferred tax accounting, which is a concept not encompassed by Lux GAAP.

• Non-taxable entities might not automatically fall outside of the scope of Pillar Two, a significant consideration for the Fund industry in Luxembourg.

• Managing transfer pricing and Pillar Two.

• Mismatches between Luxembourg domestic participation exemption and Pillar Two

• Compatibility of domestic tax benefits and Pillar Two

Continuous monitoring 

• Over 20 elections, allowing for deviations from the standard rules, are available and where applicable, should be consistently monitored.

• M&A transactions involving entities within in-scope multinationals might have Pillar Two effects.

• Managing ongoing compliance obligations

In-scope Groups not only should assess whether they operate in low-taxed countries and calculate Top-up Tax liability but also gear up for full Pillar Two compliance. The standard GloBE Information Return includes nearly 500 data points covering different aspects of Pillar Two rules. If Top-up Tax is due, additional tax filings become necessary.

Is there a way to make it simpler?

To provide temporary operational relief to in-scope Groups, Transitional Safe Harbours are available, leveraging from Country-by-Country Report (CbCR) and financial statements data. If one of the relevant tests is met in a country, the Group will not need to conduct a full Pillar Two calculation (for that country).

Are you ready?

Pillar Two is live. It is crucial for multinationals to determine if they fall within its scope. If they do and have presence in Luxembourg (irrespective of the multinational’s headquarter location), anticipating potential tax consequences and establishing a robust process for gathering, analyzing, and disclosing information is imperative.

An in-depth understanding of Pillar Two rules is essential to ensure compliance and prevent unbalanced results and unforeseen outcomes. A new era of taxation has now begun. Are you ready?

This article was first published by Luxembourg Times.