Philippines cedes tax revenue under global minimum tax rules
To expedite the revival of the economy from the pandemic and restore its trajectory towards upper middle-income status, the government has eased restrictions on foreign investment by amending foreign ownership rules for public services and retail. While the Corporate Recovery and Tax Incentives for Enterprises (CREATE) law reduced our regular corporate income tax (CIT) rate to 25%, the Philippines still has one of the highest CIT rates in Southeast Asia. CREATE also rationalized the tax incentives granted to registered business enterprises (RBEs), allowing them to enjoy up to 17 years of income tax holidays (ITH), a 5% special corporate income tax, or enhanced deductions, among other fiscal incentives. However, these fiscal incentives may not look as enticing as before for large multinational enterprises (MNEs) considering investment in the Philippines. This article hopes to explain why.
The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting published the Global Anti-Base Erosion (GloBE) Model Rules on Dec. 20, 2021. GloBE Rules introduce a coordinated system of taxation to ensure that large MNEs pay a minimum level of tax on the income they earn in every jurisdiction in which they operate. A top-up tax will be imposed on their profits should their jurisdictional effective tax rate (ETR) fall below the minimum rate. The 70-page GloBE Rules provide for a global minimum tax rate of 15% for MNEs with a turnover of more than 750 million euros. Ultimate Parent Entities (UPEs) such as pension funds, government, international and non-profit organizations as well as investment funds and real-estate investment vehicles are excluded from the scope of the GloBE Rules. Transitional safe harbor rules and a regulatory framework for the development of a potential permanent safe harbor were also published on Dec. 20, 2022.
Simply put, GloBE Rules are two interlocking rules — the Income Inclusion Rule (IIR) and the Undertaxed Payment Rule (UTPR). IIR requires the immediate parent entity to pay the top-up tax with respect to the low-taxed income of a constituent entity (an entity of the MNE Group in a country where the ETR is below the minimum rate). Otherwise, the UTPR will deny deductions or require an equivalent adjustment on the UPE level to the extent that the low-taxed income of a constituent entity is not subject to tax under IIR. The determination of whether a top-up tax is required, either through the IIR or the UTPR, is based on a complex calculation of the ETR for a specific jurisdiction. In computing the jurisdiction ETR, the GloBE Rules provide for modified deferred tax calculations for the timing differences, the treatment of losses, and an elective substance-based carve-out that may reduce the profits subject to top-up tax. Carve-outs are based on the level of payroll and the carrying value of certain tangible assets within a jurisdiction.
Based on the above rule, however, there may be instances when a certain jurisdiction will not be able to collect the top-up tax on the income earned by a constituent entity operating in its jurisdiction if the immediate parent or the UPE of the MNE is established in a different country. Hence, the GloBE Rules also introduced a Domestic Top-up Tax. Countries can now impose a specific tax in their own jurisdiction to increase the ETR on certain profits, excluding those that are subject to substance-based carve-outs, to the 15% global minimum ETR. It will allow a jurisdiction to ensure that the tax is collected therein and will not be ceded to another jurisdiction under either the IIR or the UTPR. If the low-tax jurisdictions adopt this domestic top-up tax, it will reduce the complexity of the GloBE Rules and will achieve the primordial goal of the Pillar 2 project which is leveling the playing field for tax competition. Participating countries must have enacted the appropriate domestic legislation in 2022 since the plan is for the IIR to be effective in 2023 while the UTPR can come into effect in 2024.
To briefly illustrate, let’s consider an RBE enjoying ITH in the Philippines. Its immediate parent is a Singapore entity and the group is ultimately owned by a Japanese company. Both Japan and Singapore and other neighboring countries are currently adjusting their laws to account for the possible effect of the GloBE Rules. However, to date, the Philippines has not yet signed on to this two-pillar solution (including Pillar 2) which aims to address tax challenges arising from the digitalization of the economy (BEPS 2.0). Hence, since the Philippine RBE will be effectively paying 0% ETR to our government, the Singapore or Japanese company, through IIR or UTPR respectively, will pay a top-up tax in their respective jurisdictions to meet the 15% global minimum ETR. This will be a certain revenue loss to the Philippine government as it cedes taxing rights on the low-taxed income of this RBE. Moreover, from a group ETR perspective, MNEs will be paying this global minimum tax rate which dilutes their tax savings in the Philippines.
Though the potential uncollected taxes are as clear as daylight, our policy makers may also see this as only a time-bound setback. RBEs may only enjoy up to 17 years of tax incentives. Afterwards, they will be subject to the 25% regular CIT, which is much higher than the 15% global minimum tax. Other than the contribution of CIT to our gross domestic product, the Philippine government may have also considered other factors in not yet joining BEPS 2.0. The danger of losing the jobs created by foreign investors who may pull out their investments if they lose their tax incentives, and the requirement to abandon unilateral digital service tax (which is a pending bill in the Congress) may have restricted our government from being part of this Inclusive Framework. Nonetheless, these is all mere speculation on my part. I assume that a thorough and detailed impact assessment of this two-pillar solution must have been discussed by our economic managers and policy makers. I eagerly await how things evolve as more countries sign on to the framework.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Mac Kerwin Visda is a manager at the Tax Services department of Isla Lipana & Co., the Philippine member firm of the PwC network.