On Nov. 8, the Philippines officially accepted the Organisation for Economic Co-operation and Development’s invitation to join the Inclusive Framework (IF) on base erosion and profit shifting (BEPS). The announcement is timely, as other countries, including our Asian neighbors, have expressed their intention to join or have started drafting their own BEPS legislation earlier this year.
In 2021, 136 member jurisdictions of the IF forged a new global tax deal — the Two-Pillar solution—with the aim of curbing tax avoidance by Multinational Enterprises (MNEs). The Two-Pillar solution was years in the making and represents the most significant tax reform in decades. The Global Anti-Base Erosion (GloBE) Rules, a core component of BEPS 2.0 Pillar Two, seek to limit unhealthy tax competition — the so-called “race to the bottom” for corporate tax rates — among jurisdictions by introducing a 15% global minimum tax rate.
This is the fifth article in our series following the 2nd SGV Tax Symposium, which focused on how a sustainable and effective tax ecosystem can advance the sustainability agenda for both the public and private sectors. This article will discuss how BEPS 2.0 Pillar will impact the Philippine tax landscape.
WHAT IS THE BEPS 2.0 PILLAR 2 ARCHITECTURE?
Applies only to large MNEs. Under the GloBE rules, the 15% global minimum tax rate applies only to large MNEs — particularly those with annual consolidated revenues of 750 million euros (or equivalent) in two of the last four years. Essentially, purely domestic firms or MNEs falling below the 750 million euro revenue threshold are excluded from the coverage of Pillar 2.
GloBE Effective Tax Rate (ETR) is below 15%. Once an MNE is considered in-scope, the group determines the ETR of the entities per jurisdiction and compares this with the 15% global minimum tax rate. If the ETR of an entity is lower than the 15% minimum rate (deemed as a low-taxed entity), an additional tax called the ‘top-up tax’ becomes due.
When computing the ETR, the GloBE Rules apply to all low-tax outcomes as a wholesale policy. Therefore, it does not provide any exceptions or preferences for reduced tax rates intended to encourage specific sustainability efforts (e.g., investments in renewable energy), or those granted for specific industries or activities.
New charging and collection mechanism. Through an ordered system of top-up taxes, the GloBE Rules recognize a new set of taxing rights, allowing various jurisdictions to collect the top-up tax irrespective of the low-taxed entity’s physical location or tax residency. The Pillar 2 system effectively deviates from the tax system where income is typically collected by the source jurisdiction or the immediate parent’s jurisdiction. By design, the GloBE rules allow not only the domestic jurisdiction (where the low-taxed income is earned) to collect the top-up tax via the Qualified Domestic Top Up Tax (QDMTT), but also the ultimate or intermediate parent jurisdiction via the Income Inclusion Rule (IIR) or another related entity within the Group via the Undertaxed Payments Rule (UTPR).
Common approach. Adopting the GloBE rules is not mandatory for all countries. However, to ensure uniform implementation, the rules provide a common approach to be adopted by the implementing jurisdictions. To date, a few countries have enacted their own Pillar 2 legislation, such as Japan, South Korea, and the UK. Additionally, more than 40 countries — including the Philippines — have signified their intention to adopt the GloBE Rules or are in the process of passing local legislation, with anticipated implementation by 2024 to 2025.
THE PHILIPPINES IN THE BEPS 2.0 WORLD
With the Philippines joining the IF, our adoption of the Pillar 2 rules will become a critical piece of local legislation. It will determine the top-up tax mechanism to be applied to low-taxed entities of Philippine and Foreign MNEs, and the alternative incentives we need to complement it.
For developing countries like the Philippines, incentives have been traditionally used as a stimulus mechanism to boost employment, foster technology transfer, encourage capital inflow and foreign currency, and promote overall growth. As an investment hub, the country is home to many enterprises in the manufacturing, business process outsourcing, and renewable energy space, which benefit from income tax holidays or special income tax rates. As such, entities enjoying these incentives will likely have a jurisdictional ETR of below 15%, for which a top-up tax will be due.
Local enterprises that benefit from these incentives will be the most affected in case we adopt the QDMTT since the Philippines will now have the primary taxing right over these low-taxed entities. For Philippine-headquartered conglomerates with operations in other low-tax jurisdictions, the country will likewise have the right to collect the top-up tax through the IIR or UTPR.
IS THIS THE END FOR TAX INCENTIVES? NOT NECESSARILY.
Certain incentives that are grounded on substance (e.g., payroll, tangible assets), are expenditure-based (e.g., accelerated depreciation), or are not income tax-related, appear to work better in a Pillar 2 environment. Our neighbors in ASEAN are similarly re-assessing the design of their tax incentives. For instance, as part of their Pillar 2 implementation, Malaysia and Vietnam are exploring cash grants and qualified refundable tax credits. Other alternatives being considered include non-income tax incentives, interest-free loans, and relaxation of ownership rules. The Philippines could explore similar approaches that can be localized to align with the government’s investment policy.
In the long term, however, as designing incentives becomes more complex and challenging in a Pillar 2 environment, we may eventually need to shift our focus toward non-tax investment drivers, such as general operating conditions, infrastructure, human capital, access to talent, and ease of doing business, to remain competitive in the market. These measures have been viewed to deliver more sustainable, long-term value to investors.
STRIKING A BALANCE IN A PILLAR 2 ENVIRONMENT
The BEPS Project is arguably the most ambitious and comprehensive tax initiative we have seen. As more countries enact their own Pillar 2 legislation, we can anticipate significant changes in the tax landscape. For affected MNEs, an impact assessment, incentives review, group-wide BEPS compliance, and Pillar 2 planning should now take precedence in their tax and finance agendas. Engaging with the regulators is also a must to ensure a smooth transition to a Pillar 2 environment.
This entire process will likewise involve a delicate balancing act by the government. Surely, this will require more than just adopting a top-up tax legislation. A major policy reform should go along with it to address the long-term impact of top-up taxes to existing and future investors. A comprehensive solution should definitely be on the table, otherwise, the intended benefits of our Pillar 2 adoption may well be short-lived.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.
Maria Margarita D Mallari–Acaban is a tax principal of SGV & Co., and Mira Ramirez-Uy is a tax senior director of SGV & Co.