Tax incentives in a Pillar 2 environment – the OECD provides guidance
The OECD’s new report on Pillar 2, entitled, “Tax Incentives and the Global Minimum Corporate Tax,” provides insights into jurisdictions’ future use of tax incentives to continue to attract investments. The report – addressed to governments and tax authorities – sets out several recommendations as well as a number of tax policy considerations.
Many jurisdictions are already in the process of revisiting their tax incentive framework ahead of the contemplated implementation of Pillar 2. Public consultation opportunities are likely to arise, allowing multinationals the chance to provide input on policy decisions within jurisdictions implementing Pillar 2 and its included Global Anti-Base Erosion (GloBE) rules.
Although the OECD’s guidance is meant to provide a basis for jurisdictions to carry out their own analysis of their tax incentives, the report may be a helpful tool in assessing the potential impact of Pillar 2 on the tax profile of multinational companies – and in helping shape their strategy as the implementation of Pillar 2 approaches. Multinationals are encouraged to assess which tax incentives they benefit from.
Some examples of tax incentives affected by the GloBE rules are:
- Tax holidays, low- or zero-tax rates, offshore tax regimes, economic/free trade zones, innovation or IP box regimes, other incentives or rulings exempting income
Tax incentives based on low or zero corporate tax rates, or which are (partially) exempt income from taxation, are likely to be affected by the implementation of the GloBE rules. The rules’ impact on these incentives may be reduced when a company has material operations within the given jurisdiction through the GloBE rules’ substance based income exemption (SBIE) or through the blending of high-taxed income and low-taxed income within the jurisdiction.
The OECD specifically points out that any tax incentive based on capital or labor investments will be less affected through the SBIE provisions of the GloBE rules.
While the report focuses on the GloBE rules, it points out that the subject to tax rule (STTR) will also have implications for the use of certain tax incentives, especially those that provide preferential tax rates to certain types of income that may give rise to nominal tax rates below 9 percent. As the design of the STTR is still under discussion, its interaction with tax incentives remains unseen.
The OECD has called on governments to re-assess the use of these types of incentives.
- Immediate or accelerated depreciation of assets for tax purposes
The OECD indicates that tax incentives with respect to the immediate or accelerated depreciation of assets are less likely to be affected by the GloBE rules because the GloBE rules allow for an adjustment of the GloBE income for temporary differences (with a limit of five years).
One might expect jurisdictions to keep or even expand these types of incentives.
- Refundable and non-refundable income tax credits, such as R&D income tax credits
The topic of income tax credits has attracted a lot of attention, particularly considering that, under the GloBE rules, refundable income tax credits have a fundamentally different treatment compared to non-refundable income tax credits.
In general, income tax credits are reflected in financial statements as an income tax reduction. For GloBE purposes, credits reduce income tax and thereby increase the potential for a GloBE top-up tax. However, unlike non-refundable tax credits, refundable tax credits are not treated as a reduction of income tax, but rather as an increase in income, for GloBE purposes. As a result, the GloBE rules’ impact on refundable tax credits is materially more favorable than for non-refundable credits.
This difference has been subject to debate and resistance, particularly within the US, as many US multinationals have material R&D credits. The UK, on the other hand, provides for a system of refundable R&D tax credits, which arguably results in a competitive advantage for UK-based companies, as compared to US-based competitors. The report does not address this issue, despite the political pressure placed on the OECD because of it.
Governments may be expected to carefully review their income tax credit system and incentives in light of the GloBE rules.
- Expenditure-based incentives, such as payroll/wage withholding tax incentives
Expenditure-based incentives are less impacted by the GloBE rules as additional investments within a jurisdiction will result in an increase of the value of the SBIE for GloBE purposes.
Although one may expect governments to maximize the use of expenditure-based incentives, modeling may be required to determine the monetary value of these incentives.
- Multinationals are encouraged to identify the tax incentives of which they avail themselves and categorize the potential impact that Pillar 2 may have.
- Certain tax incentives are less affected by Pillar 2. Some jurisdictions may focus more heavily on providing these incentives in order to continue to attract foreign investments.
- The OECD report does not provide clarity on the politically sensitive topic of the treatment of refundable versus non-refundable tax credits. In fact, the OECD acknowledges the difference of treatment under the GloBE rules. It is expected that further political debate will follow related to this topic.
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