Why there is a silver lining in BEPS 2.0 for Singapore

With BEPS 2.0 minimizing tax competition, Singapore can focus investors on its enduring economic fundamentals and retune its tax system. 

In brief

• Singapore was among more than 130 countries that agreed on the key elements of a two-pillar solution to current international tax challenges in July.
• The lack of a global tax consensus could result in unilateral actions by countries that impose greater tax burdens and raise tax compliance costs worldwide.
• Singapore can consider introducing an alternative minimum tax regime to help avoid any unintentional relinquishment of taxing rights resulting from BEPS 2.0.

In July 2021, over 130 jurisdictions, including Singapore, agreed to the key elements of a two-pillar solution under BEPS 2.0 to address today’s international tax challenges. Pillar One reallocates profits of the largest multinational enterprises (MNEs) — those with a global turnover exceeding €20b and a profit margin above 10% — to jurisdictions where goods and services are consumed. Pillar Two requires profits to be subject to a minimum tax of at least 15%, regardless of where the profits are being recognized. Further details, including the implementation plan, are expected to be finalized by October 2021.

With Pillar One, Singapore profits of foreign MNEs in scope may be reallocated to other jurisdictions, resulting in revenue loss for the country. With Pillar Two, the efficacy of Singapore’s tax incentives in attracting investments may be limited by the global minimum tax proposal. 

The BEPS 2.0 proposal is likely to negatively impact smaller countries disproportionately. While the full impact on Singapore is not yet certain, the country will have to make adjustments. Is there a silver lining amid the change?

Supporting substance-based investments

The use of tax incentives has been important to Singapore’s strategy of attracting large-scale investments into the country to drive economic growth and job creation. With tax incentives, MNEs could pay an effective tax rate below the headline corporate tax rate of 17%.

Singapore has made various adjustments to its tax incentive schemes over the years to help prevent harmful tax practices and take substance and transparency into consideration. For example, tax incentives like the Pioneer Certificate Incentive and the Development and Expansion Incentive, which encourage companies to grow capabilities and conduct new or expanded activities, demand significant business commitments in terms of headcount and local business spending requirements.

Currently, MNEs can achieve similar tax-efficient outcomes without strings attached should they locate themselves in jurisdictions like Ireland (12.5%), Hungary (9%) and Dubai (0%). The proposed global minimum tax of 15% eases competition based solely on tax rates.

Moreover, Pillar Two proposes a formulaic substance carve-out that will exclude an amount of income that is at least 5% (7.5% for the five-year transition period) of the carrying value of tangible assets and payroll. This is a compromise for countries and economic zones that have long used tax incentives to attract investments. While the carve-out is not expected to be significant, it helps cushion some impact from the global minimum tax proposal.

Overall, for the smaller nations like Singapore, the curtailing of tax competition from the global minimum tax proposal will drive a greater focus on economic fundamentals. Singapore’s long-standing merits in its institutions, infrastructure, labor market and financial and legal systems — qualities it has conscientiously nurtured for decades — would arguably be an even greater source of distinctiveness.

Implications for Singapore

It is unlikely these new tax rules will lead to an exodus of foreign MNEs in Singapore. For an MNE headquartered in a G7 country with a headline tax rate of 30% or more, Singapore’s headline tax rate at 17% remains meaningful. Further, Singapore remains attractive as a hub in Asia, a region that continues to enjoy a promising growth narrative.

Indeed, in a COVID-19 world, the bigger forces working against Singapore are less of these evolving tax rules and more of companies’ shift toward decentralized decision-making and ways of working driven by technological advancement and the need for agility. This may erode the relevance of hub locations like Singapore. Singapore must upskill its local workforce and complement it with foreign talent to support the growth of various technology-driven industries challenged by the current manpower crunch as tech giants scale up their operations in the country. With the scarcity of land, Singapore needs to think beyond its shores to include its closest neighboring locations like Johor, Batam and Bintan as potential areas of operation for MNEs that choose to establish a hub in Singapore.

MNEs can anchor their regional headquarters and R&D activities in Singapore to serve as the Southeast Asian control tower, while tapping regionally into more cost-efficient manufacturing solutions. Facilitating the flow of goods, services, manpower and technology through government-to-government cooperation will be vital to make such multi-hub operating models a success.

Redesigning the corporate tax regime

G20 countries are expected to be the first movers to adopt the global minimum tax proposal. Even if these global tax rules were not adopted widely, developments in the US would have similar implications as BEPS 2.0 for US MNEs with a Singapore presence and Singapore MNEs with US operations.

The Biden administration’s proposed tax plan dubbed Stopping Harmful Inversions and Ending Low-tax Developments (SHIELD) seeks to deny deduction for a wide range of payments (including cost of goods sold) made directly or indirectly to a low-taxed jurisdiction that does not have a strong minimum tax regime. This may compel Singapore to introduce an alternative minimum tax (AMT) or equivalent regime.

An AMT requires corporate earnings to be subject to tax at a certain floor rate and such a move can help Singapore avoid any unintentional relinquishment of taxing rights when BEPS 2.0 is in place.

The potential loss of tax revenue for Singapore arising from Pillar One can be backfilled with the added tax collection as a result of implementing Pillar Two and the AMT. The added tax revenue can then be channeled to support businesses in the form of grants, subsidies and financing as alternative tools, in the absence of tax incentives, to attract targeted investments into Singapore.

Having said that, reforming the country’s long-standing corporate tax regime is not a small feat to rush into. Singapore should continue to monitor the global adoption of BEPS 2.0 and the US tax developments when designing its future corporate tax regime. Hub locations like Hong Kong, Ireland, Singapore and Switzerland can also learn from one another’s experiences. 

Potential impact on Singapore-headquartered businesses

Pillar One is likely to impact only a handful of Singapore-headquartered MNEs outside the extractive and regulated financial services industries, given the high turnover threshold. However, the turnover threshold may be reduced to €10b seven years after Pillar One comes into force.

Pillar Two is expected to affect a wider group of businesses and Singapore-headquartered MNEs should begin to examine the impact on their business operations in view of two clear outcomes of the proposal.

Firstly, global effective tax rates will rise. Companies will need to sharpen their cash tax planning strategies to increase liquidity or otherwise reduce and defer tax liabilities. For example, how can the company accelerate tax deductions, mitigate gross level withholding taxes through the use of double tax treaties, or maximize foreign tax credits? In some cases, simplifying the existing business structure may be warranted to streamline operating costs.

Secondly, new tax reporting obligations will also arise from BEPS 2.0 proposals. This potentially means an increased burden on the tax function as well as a more pressing need for accounting systems and technologies that support quality data and reporting compliance. Performing a BEPS 2.0 impact analysis will stress test the organization’s readiness for the future of tax.

The journey into a new tax world began years ago. The “good, bad and ugly” of the ensuing changes continue to be debated, but it looks like the only way is to stride forward.

This article was first published on the CNA website on 30 July 2021.