Landmark corporation tax deal changes the game

Dean Rolfe Tax partner, KPMG Singapore

On June 5, the Group of Seven advanced economies, popularly known as the G7, issued a statement which gives significant momentum to the negotiations between the 139 jurisdictions in the Inclusive Framework on the base erosion and profit shifting (BEPS). The G7 comprises the United States, Japan, Germany, France, the United Kingdom, Canada, and Italy and their resolution of several long-standing disagreements removes key obstacles to the ultimate global agreement.

The intention is to reach a global agreement on updated international tax rules for release at the G20 finance ministers meeting in early July. If agreement is achieved this would be the culmination of many years of work to seek global compromise and would arguably represent the biggest change to international tax rules in over a century.

Two core issues are addressed with two separate sets of rules. The first set, the Pillar One rules, involve the reallocation of taxable profits of the largest multinationals to ‘market jurisdictions’ which includes Vietnam.

This will apply regardless of physical presence but only to the largest 100 multinational companies, likely to be those companies with a total global revenue exceeding EUR20 billion ($24.36 billion).

The second set, the Pillar Two rules, seek to set a global minimum effective tax rate (likely to be 15 per cent) for large multinationals operating around the world. The idea is that the location chosen for business activities cannot be used to achieve more desirable (lower) tax outcomes.

The G7 position is generating substantial interest in how individual multinationals will be affected by the final rules. For Pillar Two, the main issue is the negotiation of the global minimum tax rate (GMTR) amongst the 139 inclusive framework members.

The G7 statement seeks an effective tax rate of at least 15 per cent and that this rate should be calculated on a country-by-country basis and not on a global or entity basis.

Vietnam has a corporate tax rate (CIT) of 20 per cent, but also offers many tax incentives that will mean some taxpayers do not pay this rate of tax.

With a proposed global minimum tax rate of 15 per cent, many tax incentive regimes across the Asia-Pacific region will be impacted, including tax holidays and temporary tax rate reductions. Special economic zones set up to offer long-term tax rate reductions (below the proposed 15 per cent tax rate) will be particularly hard hit.

Vietnamese tax incentives relating to manufacturing will be impacted in particular and may result in a top-up tax being paid in a foreign jurisdiction. This means that multinationals operating in Vietnam will be assessed to see if the minimum tax rate (say 15 per cent) is met.

If not, then a top-up tax will be applied and collected in the jurisdiction of the ultimate parent entity. This will obviously mean that countries with low CITs or which offer generous tax incentives will be impacted.

It should be noted though that the value of tax incentives to multinationals operating in large market economies may, in some instances, be protected by a special Pillar Two rule feature. This lets the tax burdens of all local subsidiaries, both highly taxed and incentivised, be aggregated when calculating whether the country tax burden is above or below the minimum rate.

Multinationals may, in some cases, have more than one entity in the same country with which to perform such aggregation. This is referred to as jurisdictional blending and will require detailed calculations on a case-by-case basis.

For the largest 100 global taxpayers, there will also be a reallocation of profits under Pillar One to market jurisdictions including Vietnam. While it is not yet clear precisely how these rules will operate, based on previously-issued public drafts, there is an expectation that jurisdictions in the region with large markets, in particular the region’s most populous countries, will benefit from a reallocation of profits.

It should be noted though that a lot of detailed factors will impact the final assessment, including whether much of a given multinational’s profits are already booked in the market jurisdictions like Vietnam under existing transfer pricing rules.

Regionally, there will be jurisdictions that stand to gain additional tax revenue from these measures and those that will not. Regional governments will need to determine how to respond to these proposals. Such responses could include a no-change policy, particularly where those tax incentives are also enjoyed by a number of taxpayers outside the scope of the Pillar Two rules.

Responses could also include a repeal or increase in incentive tax rates to meet the GMTR or the introduction of local alternative minimum tax. Other responses might include the replacement of tax incentives with cash grants.

It will be very important for multinational groups to obtain certainty on existing jurisdiction-level tax incentives and any plans to wind back, modify, or repeal such incentives to assist with long-term business planning.