At a glance
- The two-pillar BEPS 2.0 agreement to curb base erosion and profit shifting is gaining wide international support.
- Under the agreement, accounting profit figures will be the basis for determining multinationals’ tax liabilities.
- Although BEPS 2.0 isn’t likely to come into effect until 2024, some jurisdictions are already reassessing their tax rates and incentive schemes.
The global fight against multinational profit shifting to low-tax regimes continues in earnest.
Despite wrangling over the details and likely delays in adopting solutions, almost 140 jurisdictions globally have pledged to back the Inclusive Framework on base erosion and profit shifting (BEPS), which will subject multinational enterprises to a minimum tax rate of 15 per cent.
Attention now turns to the use of accounting profit figures to determine if multinationals are paying the right amount of tax and whether this is a suitable instrument.
Some are already questioning the move. Dr Keith Kendall, chair of the Australian Accounting Standards Board, is one of the critics.
“I think it’s quite inappropriate to use accounting profit as the basis for levying tax, so I’m a bit surprised to hear the OECD [Organisation for Economic Co-operation and Development] is even thinking about this,” he says.
The core of the problem, according to Kendall, is that tax legislation and accounting standards serve two different purposes.
“Accounting figures are trying to obtain a true and fair account of a company’s financial position, whereas tax legislation is a government’s attempt to try to levy an appropriate amount of tax revenue for their spending programs.”
BEPS 2.0: Historic reforms
Few could argue with OECD Secretary-General Mathias Cormann, who has described the latest profit shifting breakthrough, dubbed BEPS 2.0, as “historic” – adding that “this reform will make our international tax system fairer and work better in a digitalised and globalised world economy”.
The BEPS 2.0 initiative builds on previous efforts to prevent multinational profit shifting, and has been hailed as the biggest change to global taxation in a century.
The initiative is designed to enable governments to collect more taxes from global technology giants such as Amazon, Apple and Google, which have long used the intangible value of their mammoth enterprises to justify shifting profits to low-tax regimes such as Ireland, Hungary, Bermuda and the British Virgin Islands.
The challenge now is to finalise implementation of the OECD deal, which groups countries and jurisdictions on an equal footing for multilateral negotiation of international tax rules.
Two pillar BEPS 2.0
The two-pillar BEPS 2.0 agreement is the latest iteration of a long campaign to address the challenges arising from the digitalisation of the global economy.
Pillar 1 lets countries tax profits from goods and services provided by multinational groups with more than €20 billion (A$29.5 billion) in global turnover and profitability above 10 per cent of revenue.
In return, countries that impose digital services taxes, including France and the UK, must remove them.
Pillar 2 seeks to establish a global minimum corporate tax rate of 15 per cent combined revenue of €750 million (A$1.1 billion) or more. The rules do not require low-tax countries to increase their corporate tax rates to 15 per cent, although the changes may ultimately have that effect.
A top-up tax will be imposed on multinationals if their effective tax rate on a jurisdictional basis is below the Pillar 2 tax rate.
Negotiations on the two pillars of the Inclusive Framework proposals have been proceeding in parallel, but opposition has emerged on some fronts.
For example, Pillar 1 is facing criticism from Republican senators in the US Congress, and commentators claim the deal could fall over if the Democrats lose control of the House of Representatives in November’s midterm elections.
Alia Lum, tax policy lead at KPMG Australia, says BEPS 2.0 is an important step towards providing a more equitable allocation of taxing rights to market jurisdictions under Pillar 1.
“But it also tries to stop the race to the bottom for corporate tax rates through these global minimum tax proposals in Pillar 2, and the OECD has done well to get 139 countries to sign up to this because it’s a bit like herding cats,” Lum says.
Lum believes the deal is already having an impact, with a number of jurisdictions responding to the proposals even though they are not yet fully in place.
“Some countries are already looking at reassessing tax-incentive regimes and domestic minimum taxes, and also raising corporate tax rates.”
According to Lum, countries with concessional tax regimes such as Singapore and Hong Kong could, in effect, be forced to raise some tax rates under the new regime.
For example, if an Australian company had a subsidiary in Singapore operating under a 10 per cent concessional tax – remembering that the global minimum rate will be set at 15 per cent – the parent company could collect the additional 5 per cent tax and pay it to the Australian tax authorities.
“Singapore could then say, ‘Well, why are we giving this concession if another country can just take the revenue?’,” Lum explains.
“So, it would encourage Singapore to either get rid of its concessional tax rate, or introduce a domestic minimum tax to effectively have the minimum rate of 15 per cent.”
Higher-tax jurisdictions such as Australia – which applies a full company tax rate of 30 per cent – are less likely to have additional top-up taxes.
As mentioned, one of the most interesting – and potentially contentious – elements of BEPS 2.0 is that accounting profit figures will be used as the basis for determining multinationals’ tax liabilities. This approach is already common in some international jurisdictions, such as the UK.
Kendall points out that modern accounting standards have to address a vast array of user needs – covering regulators, investors and, in an era when sustainability has come to the fore, other stakeholders, customers, employees and people with an interest in examining the use of common resources.
“That’s just a flavour of the sorts of purposes for which accounting reports are being used, whereas there’s really only a single user for a tax return, and that’s the government,” he says.
“So, there are a lot of policy decisions embedded in tax legislation, many of which don’t align with accounting treatment.”
Kendall says the result with tax legislation is that governments can make explicit choices, which sometimes will cause deviations from accounting profit. This includes accelerated depreciation, which encourages spending on certain types of assets and in certain sectors of the economy.
“That’s not captured in accounting profit.”
Governments may also make policy decisions not to allow a deduction for certain expenditure, including spending on entertainment.
“So, taxable profits will be higher as a result of that, whereas entertainment expenditure is fully expensed for accounting purposes. We’re potentially undoing a lot of those policy decisions by going and doing this.”
A work in progress
While CPA Australia agrees that tax reporting and financial reporting have different objectives, it has argued that, in the case of BEPS 2.0, there may be some justification for using accounting profit as the starting point for the calculation of the minimum tax.
This is because financial reporting rules under International Financial Reporting Standards (IFRS) have been adopted in about 180 jurisdictions and provide a consistent base on which to begin.
CPA Australia contends that extra work is needed, and is already under way, in “flexing” accounting profits to arrive at a globally accepted taxable profit, with the OECD currently developing the Model Rules that will form the basis of the tax rate calculation.
Lum can understand why the OECD has opted to use profit figures. “It’s difficult to design a global system that works for a lot of countries, because every country has its own different tax regime, whereas accounting standards are a lot more standardised around the world,” she says.
“It does add a lot of complexity, but the alternative of trying to mirror tax regimes around the world would have been a lot more difficult, so at least this provides some sort of globally consistent framework.”
Kendall notes that there have been circumstances in the past where the Australian Government has used accounting figures for taxation purposes – not for levying tax, but as a step along the way.
He cites the thin capitalisation tax rules that limit and cap the amount of debt-related deductions an Australian taxpayer can claim for tax purposes.
“But it did create a few headaches [with clients’ tax positions] that a lot of people didn’t see coming.
The government sometimes decides to use accounting figures, but it doesn’t always produce the results that people expect, which is another reason why [the OECD] might want to stay away from this.”
Lum says the Pillar 2 proposal goes beyond imposing a minimum tax rate of 15 per cent of accounting profits. She notes that the Pillar 2 calculations will adjust for factors such as book to tax timing differences like accelerated depreciation, and allow for adjustments for certain tax-exempt dividends and disposal gains.
“So, it does attempt to reflect a globally consistent base that looks closer to taxable profit rather than accounting profit. In that regard it is better than the US proposal a few years ago to bring in a minimum tax based on 15 per cent of pre-tax book income, which received a lot of pushback from accounting and tax experts.”
The BEPS 2.0 move is expected to reallocate more than US$125 billion (A$180 billion) in profits from about 100 of the world’s largest and most profitable multinationals to governments worldwide. The arrangement is set to be reviewed in seven years.
However, compliance costs are now one of the key concerns for Australian and other multinational companies. Lum says a compliance impost is inevitable.
“Even if a group doesn’t end up having to pay any top-up tax – and this is particularly the case for Australian-headquartered groups with a 30 per cent tax – they will have to do a lot of compliance and work through these complex calculations in order to prove that they don’t have any top-up tax.”
She adds that the “granularity” of the data required, including details of deferred taxes, will create a need for systems redesigns and data-management projects to ensure calculations are done in a timely manner.
“This is not just for your eventual filings, but also for things such as cash flow forecasting or being able to facilitate quick business decisions, because it’s hard to work out what tax you’re going to pay on something quickly when it’s so complex.”
Lum believes multinationals may need external support or have to recruit a broad range of financial skill sets to prepare for the BEPS 2.0 changes.
Despite some “difficult discussions” in relation to the technical aspects of Pillar 1, Secretary-General Cormann has publicly stated his confidence that the BEPS 2.0 agreement will eventually be adopted. He has suggested the implementation of Pillar 1 is likely to be deferred until 2024, but this does not mean the delay will necessarily extend to Pillar 2.
Lum notes that Australia has not yet committed to a start date for the reforms, while the UK and the European Union are aiming for a 2024 launch.
However, the European Union directive to approve the Pillar 2 proposals has been held up by Hungary, which rejected a recent attempt to gain EU-wide approval. She says the delays and uncertainty are a cause for concern for some multinationals.
“It does make project management quite complex for groups when they need to get everything in place, but each country is coming back with potentially different start dates.”