Background
The implementation of the Organisation for Economic Co-operation and Development’s (OECD’s) Pillar II rules in Europe, and in the Luxembourg law on 22 December 2023 (the Pillar II Law) in particular, has been a major development in international taxation, introducing a minimum 15% effective tax rate for large multinational groups. With some key clarifications introduced in recent amendments in the Pillar II Law, this is an opportune moment to provide an update for fund managers and stakeholders on the impact of the Pillar II Law for Luxembourg-based investment funds.
A Quick Recap: What Is Pillar II?
Pillar II establishes a coordinated global framework to ensure large groups pay a minimum level of tax in respect of each jurisdiction in which they operate. The regime applies to groups with consolidated annual revenues of at least €750 million in at least two of the four preceding fiscal years. The mechanism functions via three core rules:
- Income Inclusion Rule (IIR): A top-up tax collected by a parent entity with respect to low-taxed entities within the group.
- Undertaxed Profit Rule (UTPR): A backup rule that allocates residual top-up tax among Pillar II jurisdictions within the group if not fully collected via IIR or a QDMTT (see below).
- Qualified Domestic Minimum Top-Up Tax (QDMTT): Local tax rules that allow a particular country to apply a top-up tax, based on Pillar II principles, with respect to local entities within a Pillar II group. This effectively has priority over other Pillar 2 taxes because it operates to increase the effective tax rate for the group as a whole.
What Does Pillar II Mean for Investment Funds?
While the OECD and EU frameworks aim to preserve the tax neutrality of collective investment vehicles, the application of the Pillar II rules to the investment fund industry remains complex and requires careful analysis.
One of the key tests for inclusion under Pillar II is whether an entity forms part of a ‘group’; this is determined by reference to whether it prepares consolidated financial statements under an acceptable financial reporting standard. In Luxembourg, investment funds often benefit from specific exemptions from preparing consolidated financial statements, including in respect to their investments. This notably applies to specialised investment funds, (SIFs) reserved alternative investment funds (RAIFs), and investment companies in risk capital (SICARs). As such, these Luxembourg investment funds are typically not considered to be part of a group under the Pillar II framework and are therefore likely to fall outside the scope of the rules.
Those investment funds without a consolidation exemption may be treated as an ‘excluded entity’ by virtue of being investment funds. The definition of ‘investment fund’ requires multiple conditions to be satisfied, including but not limited to (i) being designed to pool assets from a number of investors, some of which are non-connected; (ii) investing in accordance with a defined investment policy; and (iii) being, or its management being, subject to the regulatory regime, including appropriate anti-money-laundering and investor protection regulation, for investment funds in the jurisdiction in which it is established or managed.
Being an excluded entity does not prevent that entity from forming part of a group for Pillar II revenue computational purposes, but it does exempt the excluded entity from paying any Pillar II taxes and from having Pillar II compliance obligations. It can also be relevant in enabling entities that are wholly or substantially owned by the fund to qualify as excluded entities.
The initial Pillar II Law confirmed that investment funds acting as ultimate parent entities (UPEs) are generally excluded entities under Pillar II. However, there was concern that not all investment funds that otherwise qualified would benefit from this exemption, as a result of them not being UPEs.
Key Clarifications for Investment Funds Structures
A significant area of uncertainty has revolved around special purpose vehicles (SPVs) owned by investment funds. The initial legislation left open questions regarding whether these SPVs could be considered excluded entities, particularly when their parent funds were not required to prepare consolidated financial statements and so were not UPEs.
Amendments to the Pillar II Law introduced on 19 December 2024 have brought much-needed clarity in this area. The amendments confirm that SPVs of investment funds or real estate investment vehicles can be treated as excluded entities. This applies even if the investment fund or real estate investment vehicle is not required to prepare consolidated financial statements (and so is not a UPE) and is not subject to deemed consolidation.
Consequently, Luxembourg SPVs in particular owned at least 95% (or 85%, in the case of equity investments) by such investment funds will also be classified as excluded entities, ensuring they do not have tax burdens under Pillar II.
Where Does This Leave Investment Fund Managers?
While many investment funds will fall outside the direct scope of Pillar II due to their structure, not all will benefit from the available carve-outs described earlier. Even if a fund is exempt from preparing consolidated accounts or qualifies as an excluded entity, risks remain. For instance, if an investor belongs to a Pillar II group and holds at least 50% of the fund, the investment fund could be considered a joint venture for Pillar II purposes, bringing it within scope.
Additionally, the Pillar II exclusion rules do not extend to the corporate entities within an investment manager’s own group. As a result, large fund management groups — i.e., those exceeding the revenue threshold — may still face Pillar II compliance obligations. Fund managers must therefore assess their structures carefully — particularly in light of the QDMTT and potential exposure under the UTPR if other jurisdictions do not implement equivalent legislation.
Conclusions and the Current State of Play
We note that while laws relating to Pillar II are now in force across the EU, their future is not entirely clear because President Trump has formally withdrawn US support for the OECD Global Tax Deal (including Pillar II) and requested the US Treasury draw up a list of options for measures the US should adopt to respond to countries that do adopt the OECD Global Tax Deal. It is possible that global coordination related to Pillar II may now waver as countries consider their position in response to possible US retaliation (which retaliation could have material implications for non-US corporations and individuals with US income).
However, despite this uncertainty, Pillar II remains in force, and stakeholders must apply the rules unless or until guidance changes. Luxembourg’s implementation of Pillar II reflects a pragmatic approach, tailored to the investment fund industry. With clearer rules now in place thanks to the amendments to the Pillar II Law, fund managers should engage in a detailed impact analysis to confirm their own status and that of the funds they manage to ensure that they are equipped to comply with the new filing and administrative obligations. Staying informed and coordinating closely with tax advisers will be critical in navigating this evolving international tax landscape.
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