ON Nov. 8, the Philippines joined the Organization for Economic Cooperation and Development (OECD)/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS). To date, the Framework has 145 member jurisdictions who have agreed on the Two-Pillar Solution in order to address the challenges posed by the digital economy by leveling the playing field in international taxation, thereby ensuring that multinational enterprises (MNEs) pay a fair share of tax wherever they operate. With its membership, the Philippines commits to participate in the implementation of the 15 action points-BEPS package and the Two Pillar Solution.
I have been monitoring this Two Pillar Solution since 2019. At that time, the discussions were still preliminary, and the rules were not yet concrete, although there was a blueprint in place. However, the pandemic has intensified interest in these solutions as COVID-19 boosted demand for digital goods and services. With the membership of the Philippines in the Framework, we can finally say that the Two-Pillar Solutions has finally come to our shores. This is a game changer in our taxation landscape. This may create unfamiliar territory for taxpayers, whether MNEs or domestic businesses, and also for our tax administrators. The most common question might be — what does it mean for the Philippines?
To simplify, Pillar I will cover the largest and most profitable MNEs that have at least 20 billion euros in revenue. The covered MNEs must allocate their residual profit to market jurisdictions using a formula. For the Philippines, although there may be none or very few headquarters within the threshold located here, it will be a new source of revenue for us. If we are considered a qualified market jurisdiction for these MNEs’ digital businesses, profit can be allocated to us from our subscriptions to these online goods and services.
Meanwhile, Pillar II may be more interesting for Philippine taxpayers. Because of the lower threshold (750 million euros), Framework members are taking steps to implement this as early as next year. Pillar II has four rules: (1) the Subject-To-Tax Rule (STTR), (2) the Qualified Domestic Minimum Top-up Tax (QDMTT), (3) the Income Inclusion Rule (IIR), and (4) the Under-Payment Tax Rule (UPTR). The last two rules are more known collectively as the GloBE (Global Anti-Base Erosion) Rules.
STTR applies to items like interest, royalties, and the like that may be subject to a reduced tax rate or exempted from corporate income tax by virtue of tax treaty. STTR allows the government to tax these income payments at a rate equivalent to the difference between the nominal rate and the 9% STTR floor rate if the tax treaty limits the rate at which these items can be taxed.
Meanwhile, GloBE Rules introduced a 15% global minimum effective tax rate (ETR). For the Philippines, while we have headline corporate income tax rates of 20% or 25%, MNEs operating here can have an ETR lower than 15% after all the deductions, exclusions and credits provided under our Tax Code. We also have income tax holidays granted to MNEs that can reduce their ETR to 0%. This is the situation that GloBE Rules try to eliminate — that in order to compete for inbound investment, aggressive tax incentives are offered. The interlocking IIR and UPTR are designed to address this specific issue. The immediate parent entity needs to pay the top-up tax for the low-taxed income of its constituent entity (whose ETR is less than 15%) under the IIR. Under the UPTR, the Ultimate Parent Entity (UPE) may be denied some deductions or be required to adjust its taxable income to a certain level equivalent to that situation in which the income of low-taxed constituents is to be collected even if it is not subjected to IIR.
Applying these to the income tax holiday granted to Philippine entities, the tax savings here of an MNE will just be paid somewhere else. This creates a situation where the Philippines will not be able to collect the top-up tax on the income earned by a constituent entity operating here if the immediate parent (for IIR) or the UPE (for UPTR) of the MNE is established in a different country. Hence, the Framework also introduced the QDMTT.
QDMTT allows the Philippines to collect a top-up tax to the businesses operating in the country. This top-up tax reduces the amount of top-up tax to be paid by MNEs somewhere else under the IIR and UPTR. On a side note, even the MNEs not within the scope of Pillar II should monitor how Congress interprets the rule when it drafts the necessary bills to implement the QDMTT, since the current rules provide that QDMTT can be applied even to purely domestic groups.
Currently, although this membership to the Framework is a big step for the Philippines, our neighbors are also moving ahead on this. Japan finalized its 2023 tax reform and the implementation of the IIR will take effect in 2024. South Korea also adopted its version of the GloBE Rules while Singapore is expected to implement them starting 2025. Thailand, Taiwan, Indonesia, Vietnam, and Hong Kong have proceeded with their legislative processes to adopt Pillar II.
It may be too early in the game for this Two-Pillar Solution as more countries are still taking a wait-and-see approach, but it is also clear that our tax incentives must be reviewed in line with this development, especially Pillar II. Since our tax incentives will no longer be a competitive edge in attracting foreign direct investment, the government may now consider using the additional funds that can be collected from both Pillars I and II to foster a more sustainable and suitable business environment. Tax certainty and administrative feasibility, true ease of doing business, having climate change-proof infrastructure, and need-based skilled workers can be the next steps toward this new era for the Philippines.
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 P. Visda is a senior manager at the Tax Services group of Isla Lipana & Co., the Philippine member firm of the PwC network.