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Multinationals and jurisdictions may need to rethink their sustainability tax incentives if countries adopt 15% global minimum tax rules.
In brief
- ESG tax incentives have become a major tool in the drive to encourage sustainable business activity, with more than 1,850 incentives available globally.
- The effectiveness of incentives may soon be reduced, as countries adopt the global 15% minimum effective tax rate rules agreed in the Inclusive Framework.
- Jurisdictions and multinationals must take steps now to ensure they are ready for the Inclusive Framework’s GLoBE rules.
With BEPS 2.0 Pillar Two implementation at various stages around the world, it is important for multinational companies and tax jurisdictions to fully appreciate the impact a global minimum 15% effective tax rate (ETR) will have on existing tax incentives.
Pillar Two has been specifically designed by the OECD/G20 Inclusive Framework to eliminate rate-based tax competition between jurisdictions, regardless of the objective and intent behind the tax incentives. Under the Inclusive Framework’s Global Anti-Base Erosion Rules (GLoBE) rules, the financial benefit of many tax incentives could be significantly diluted by a top-up tax should a tax incentive take a multinational’s ETR below 15% in ey.com/en_gl/tax-guides/keeping-pace-with-sustainabilithat particular jurisdiction.
This interaction creates a challenge for many jurisdictions and multinationals that – faced with a climate emergency and challenging emissions targets – have relied on cash and tax incentives to catalyze their ESG goals.
The latest quarterly EY Green Tax Tracker shows more than 1,850 sustainability incentives are offered across 45 countries. While tax incentives will not necessarily take a multinational below the 15% ETR, Pillar Two introduces a significant level of uncertainty and complexity that will force many companies and jurisdictions to rethink their tax and ESG strategies.
ESG tax incentives: understanding the impact on the status quo
To understand the Pillar Two challenge, it is first necessary to understand the status quo. Sustainability tax incentives can be categorized in three broad groups: those that encourage a reduction in natural resource consumption, those that encourage a switch to renewable or alternative energy sources, and those that encourage innovation of new low carbon products and manufacturing processes.
Sustainability tax incentives themselves also come in at least three forms: accelerated tax depreciation and additional tax allowances, concessionary tax rates and tax holidays (for large multi-faceted projects such as factory building), and R&D super deductions and credits (which are used by many jurisdictions globally).
Regardless of category or form, however, all of these sustainability tax incentives will be affected by Pillar Two, subject to certain caveats set out in the GLoBE rules. The OECD has identified one specific category of tax credits – Qualified Refundable Tax Credits (QRTCs) – which would be treated akin to a cash benefit and hence would not face the significant negative impact that other tax incentives face. Such QRTCs would need to be paid or available as cash equivalents to the taxpayer within four years upon the taxpayers satisfying the conditions for the QRTC incentive.
“It’s impossible to accurately measure the exact level of reliance placed on ESG incentives because these incentives are so closely intertwined with foreign direct investment (FDI),” says Bin Eng Tan, EY ASEAN Incentives Leader. “It is clear, however, that ESG tax incentives are an important tool, helping jurisdictions and companies limit emissions as they move towards a carbon-free economy.The bottom line is that the 15% ETR will have a huge impact for both companies and jurisdictions where companies are already close to, or below, that minimum tax threshold.”
The impact of Pillar Two will not be uniform across the globe, however. It is likely to vary according to company, sector and jurisdiction.
In EU countries such as France and Germany where the OECD states there is a composite effective average tax rate of 26% and 27% respectively and Africa, where the average corporate tax rate is 28%, tax incentives are less likely to take a multinational’s ETR below 15%, so Pillar Two may not have a significant impact. But in lower-tax jurisdictions such as some countries in Asia, where the region has an average rate of nearly 20%, the effect is likely to be more pronounced. To put these figures into perspective, the worldwide average statutory corporate income tax rate, measured across 180 jurisdictions, is nearly 24%. When weighted by GDP, the average statutory rate is just over 25%.
The 15% minimum ETR will lead to some companies reconsidering where they locate their business activity, explains Tan. “With tax incentives potentially taken out of the picture, many companies will instead reassess the business environment in the jurisdictions where they operate,” she says. “They will start to look at jurisdictions in a different way: can they get access to the right talent, is he operating environment attractive, are cash grants and other types of incentives available, is land affordable, and so on.”
The future of sustainability incentives
Cathy Koch, EY Global Sustainability Tax Leader, says that sustainability incentives in some form will continue to be crucial in order to help multinationals and governments meet their sustainability goals.
“There’s ongoing concern about extreme climate-related events, so it’s absolutely imperative that the economic signals delivered by jurisdictions remain sharp,” Koch says. “If the minimum global tax counteracts the benefits of certain tax credits and incentives, those economic signals will have to be delivered through other mechanisms, such as grants or carbon pricing.”
There are already many examples of government loans and grants for green investments in sustainable agriculture, renewable or low-carbon energy sources, energy-efficient buildings and electric vehicle infrastructure. Governments are also offering subsidies and grant funding to research institutes, academic institutions and private R&D firms to boost innovation and develop transformative technologies such as renewable energy, carbon capture, waste management, and energy efficiency.
Why is the Pillar Two ETR unique?
Barbara Angus, EY Global Tax Policy Leader, says beyond the challenge of reassessing their sustainability tax strategy, multinationals must contend with a new, unique and complex way of calculating ETR.
Unlike other tax calculations, the figure is based on financial accounting data, rather than tax data, and is calculated on a country-by-country basis. “The imposition of top-up taxes is based on an ETR measurement that we have never seen before, and the required computation creates significant complexity,” says Angus.
To calculate this ETR figure, companies need to generate and report on somewhere in the region of 200 data points for each country, many of which involve information not typically included in financial reporting systems. These data are necessary to calculate what the OECD/G20 Inclusive Framework calls GLoBE income.
“This is the income base against which a multinational's effective tax rate is to be calculated,” Angus says. “MNEs probably have a sense of the countries around the world where they may have a lower effective tax rate, but they may well find pockets of ETRs below 15% that they didn’t expect.”
This will be uncharted territory for many multinationals, so financial modeling will be an important tool for a number of reasons. Angus explains that many companies are starting this process by identifying and testing the countries where they think they may have an ETR below 15%. Then, based on the results from that modeling, they are extending the exercise to cover other jurisdictions.
“For many companies, this modeling is an iterative process, starting with the entities in lower-tax jurisdictions, and then expanding to look more broadly throughout the organization,” she says. “This iterative exercise is also proving very helpful for companies as they begin to consider what data they need to develop and maintain in order to comply with the Pillar Two rules.”
Considering the reliance placed upon sustainability tax incentives and the complex nature of calculating GLoBE income, some companies may be hoping the OECD/G20 Inclusive Framework introduces a last-minute exemption for sustainability-focused tax breaks. Angus says this is unlikely, but that additional technical guidance on the treatment of tax incentives is being provided.
“It’s very important to the OECD and the Inclusive Framework member jurisdictions that the GloBE model rules be considered final,” she says. “Jurisdictions need certainty to implement the model rules. If they were to make major substantive shifts in the rules now it would be harder for countries to begin to move forward on their legislative processes.” Such shifts could lead to deviations in how the model rules are implemented from country to country, creating a significant risk of overlapping or double taxation.
“However, there is a recognition that agreed interpretive guidance is needed on a whole range of technical matters,” Angus continues. “This includes guidance on technical issues related to the treatment of tax incentives, including the characterization of some tax incentives as qualified refundable tax credits. Technical discussions within the OECD/G20 Inclusive Framework led to the release of the first tranche of administrative guidance early in 2023, and work on additional guidance is continuing.”
What next for sustainability incentives?
The implementation of the GLoBE rules makes it likely there will be what Tan describes as an “explosion of ESG cash grants” as jurisdictions search for alternative ways of incentivizing desired sustainability behaviors. Instead of enjoying favorable tax rates, multinationals will most likely get money back for making ESG-appropriate investments.
“Up until recently, many governments may have found tax to be a particularly nimble way to provide incentives,” says Angus. “With Pillar Two, however, jurisdictions may want to seek input from businesses as they determine how they can achieve their objectives in other ways.”
To be sure, grants are already in use, albeit at a relatively low level, in jurisdictions such as Switzerland, the Nordic countries, and Singapore. In the US, many states are using grants to incentivize investment in manpower and training.
Jurisdictions in ASEAN such as Singapore and Malaysia also offer cash subsidies on manpower costs around R&D and capability development, while other jurisdictions may have reduced personal income tax rates for expatriates, so that multinationals can more easily attract the expert talent they require. There are also other areas of facilitation such as customs clearances, acceleration of VAT refunds, employment visas, all of which will be attractive to multinationals looking to invest in an ESG-friendly way.
Jurisdictions may also look for ways to incentivize sustainability behaviors without any money changing hands. For example, for capital expenditure-intensive projects, jurisdictions may sell land or rent property at a discounted rate or issue so-called soft loans, which are made on terms that are very favorable to the borrower.
Preparing for Pillar Two: next steps for multinationals and jurisdictions
With countries already beginning to take action now to implement BEPS 2.0 Pillar Two in 2023 to take effect in 2024, multinationals and jurisdictions should start reassessing their sustainability incentive strategy as soon as possible. Among other things:
- Financial modeling will be a powerful tool for multinationals, helping them conduct a full assessment of the tax incentives they use and calculate whether these incentives reduce their Pillar Two ETR below the 15% threshold.
- Jurisdictions should assess what the GLoBE rules mean for sustainability tax incentivization on a sector-by-sector, region-by-region and business-by-business perspective.
- Jurisdictions should investigate alternative ways to incentivize sustainability behaviors, while multinationals should seek out and potentially relocate activity to jurisdictions where alternative incentives are available.
- As a matter of urgency, multinationals should review what data points they need in order to calculate the specific Pillar Two ETR and set in place the reporting processes necessary for generating and collating this information.
Summary
A global minimum tax will have broad ramifications for how many multinational corporations seek government incentives intended to promote their sustainability goals. Currently, many of those incentives are offered through the tax code, however, under the GLoBE rules, those incentives lose their financial value for companies if they face top-off taxes in some jurisdictions. Other incentive mechanisms including grants and carbon pricing may soon grow in popularity. Sorting through the options will be a challenge.
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