Transforming the International Tax Landscape
The international tax landscape is on the brink of a significant overhaul, influenced by evolving business models and the forces of globalisation. This shift is poised to reshape the fiscal strategies of national investment policymakers and investment promotion agencies worldwide.
Historically, nations have engaged in what some have termed a “race to the bottom,” competitively slashing corporate income tax rates or eliminating them entirely to lure and retain foreign direct investment (FDI). This practice has led to intense tax competition, with countries vying to offer the most attractive tax conditions to multinational enterprises (MNEs).
In a landmark move in 2020, the Inclusive Framework on Base Erosion and Profit Shifting (BEPS) members agreed to implement a global minimum tax. This initiative aims to guarantee that MNEs contribute a minimum level of tax on profits across their international operations. A minimum tax rate of 15 percent has been established, with specific rules dictating its application.
Under this new regime, MNEs will either pay this tax in their country of operation or, if not collected there, other countries where they have a presence will be authorized to levy the tax. The implementation of this rule will introduce a top-up tax in jurisdictions where MNEs are operating with an effective tax rate below the global standard.
The top-up tax will be collected by the country where the MNE’s headquarters are located, through the Income Inclusion Rule (IIR). In cases where the IIR is inapplicable, an intermediate country may collect the tax through alternative regulations. However, primary countries of operation can apply a top-up tax first if their corporate income tax rate results in a lower effective tax rate, via a Qualified Domestic Minimum Top-Up Tax (QDMTT).
This prioritization allows these countries to safeguard their tax revenues, which might otherwise be collected by the parent company’s country or elsewhere. The adoption of these rules by investor home countries, many of which are OECD members already implementing or integrating these rules into their local laws, indirectly extends their reach globally.
Preferential tax regimes are likely to be impacted as well. Developing countries have often offered various tax incentives to attract FDI, leading to the creation of Export Processing Zones (EPZs), free trade zones, and Special Economic Zones (SEZs), which typically benefit from reduced corporate income taxes. However, with the global minimum tax in place, such incentives may become less effective as home countries could impose a top-up tax if the host country’s tax does not meet the threshold.
Policymakers are now challenged to revamp their investment promotion strategies and consider other value propositions to attract foreign investors. It is crucial for them to reassess tax incentives and preferential tax regimes to ensure they align with their intended objectives and prevent unintended loss of tax revenue to other nations.
