Implications of global minimum tax rate on investment environment

The concept of a global minimum tax rate, contained within a framework developed by the OECD/G20 Inclusive Framework, has caught the attention of numerous global companies. The Investor talks with Robert King, Indochina Tax Market Leader at EY, about his recommendations for implementation and maintaining an attractive investment environment.

How could the minimum tax rule impact Vietnam’s investment environment when implemented?

The concept of a global minimum tax rate is contained within a framework known as BEPS 2.0 Pillar 2 (“Pillar 2”). This framework has been developed by the OECD/G20 Inclusive Framework. There are 140 countries making up the Inclusive Framework, including Vietnam. While the details of the proposed new rules are still being developed and refined, 136 countries, representing more than 95% of global GDP, have supported the principle of the new framework. This is important, because as you will see, the proposed new rules could impact Vietnam’s investment environment even if Vietnam itself does not adopt them.

The concept of a global minimum tax was designed to counter what has been described as a “race to the bottom” in terms of countries lowering their corporate taxes to promote foreign investment. With increasing globalization and digitalization it is easier than ever before for large corporate groups to choose where they want to locate manufacturing and their support functions.

While many factors go into a decision about where to invest, one important point is the amount of tax levied in a particular location. In this regard countries trying to attract foreign investment offer tax incentives. The higher the tax incentive the more attractive the destination to the foreign investor. Vietnam offers tax incentives in the form of a tax free period and reduced tax rate to promote investment in specific locations, specific sectors and of a particular scale. Many other ASEAN countries also offer incentives.

Pillar 2 will introduce a number of different mechanisms designed to achieve a minimum tax rate in each country in which a large multinational group operates. The precise rules are complex, but broadly speaking a multi-national group will need to assess, on a country-by-country basis, whether their effective tax rate in that country is more or less than 15%. If it is less that 15%, some form of top-up tax may be levied to bring the tax up to the 15% minimum.

To use Vietnam as an example. If a large multi-national group’s effective tax rate on its Vietnamese operations is less than 15% (for example because the Vietnam subsidiaries are enjoying tax incentives) and the country where the head company of the group is based has introduced Pillar 2, then the head company in the group (referred to as the Ultimate Parent Entity in the Pillar 2 Model Rules) would be required to pay additional tax in that country to make up for the underpayment of tax in Vietnam.

If the headquarter country has not introduced Pillar 2, and there are other intermediary companies between the Ultimate Parent Entity and Vietnam subsidiary, or there are sister companies, and any of those companies are located in countries that have introduced Pillar 2, then the top-up tax could be levied in those countries. This is why these rules can create a tax liability in respect of profits earned in Vietnam even if Vietnam itself does not implement the rules.

To the extent a global minimum tax liability reduces or negates the benefit of a tax incentive, this will have a detrimental effect on the return on investment of corporate groups that have already made an investment on the basis of a tax incentive. This is likely to be seen as an unfair outcome when the investment was made in good faith on the rules available at the time.

Secondly, for companies who have not yet invested, they will have to factor in the global minimum tax in their investment decision. Therefore, to the extent that the tax incentives are one of the attractions of investing in Vietnam, this could make Vietnam a less attractive destination. It should however be noted that other countries offering tax incentives will encounter similar issues.

Could you please share the implementation schedule of this rule?

There are a number of components to Pillar 2, but it was originally hoped that the core rules would be introduced in 2022 and take effect from 2023. It is looking increasingly likely that this timeframe will be pushed back by 12 months. Ultimately however the implementation is a sovereign issue. So while the majority of countries may be expected to implement new rules in 2024 there may be some early adopters in 2023 and late adopters in 2025.

Currently more than 140 countries endorsed BEPS 2.0. How do other countries react to implementing the rule, specially for developing countries like Vietnam?

It is too early to tell how countries will deal with the impact of the global minimum tax on foreign investment. What is important at this stage is to properly understand how the rules will impact existing investors, and the likely impact on future investors, and to assess what changes may be required to the domestic tax regime as well as the incentives offered.

We would therefore recommend the establishment of a working group to analyze these matters and make appropriate recommendations to policy makers.

We would also strongly recommend that corporate groups model the impact of these proposed new rules on their operations. This will help them make appropriate recommendations to such a working group as well as government policy makers.

What is clear is that attracting foreign investment will remain critical to all countries, both developed and developing. Pillar 2 will not change that. Countries will still be competing for investments, and such things as the operating environment, supporting infrastructure, access to transport, political stability and workforce will gain even more importance. Countries will therefore need to assess what the new balance should be between tax incentives, other financial incentives, and investing in its operating environment in the world of Pillar 2. In this assessment it should not just be the potential new investors that are considered but existing ones too.

Vietnam and other developing countries with the same circumstances may require a transitional provision like extending the application period by two-three years. What are your recommendations for implementing the minimum tax rule and maintaining an attractive investment environment to big investors in Vietnam?

Under Pillar 2, if Vietnam does not tax impacted companies at the minimum 15% tax rate, profits will likely be taxed in another country. Therefore, Vietnam should consider adapting its domestic tax rules by levying tax up to the minimum tax rate, otherwise it effectively loses its taxing rights to another country.

To the extent that Vietnam does decide to increase its domestic tax so that it does not lose its right to tax, Vietnam may separately consider having other policies to incentivize foreign investment, or existing investors, in different ways. This could be some kind of grant to reimburse particular expenditure, cheap financing, provision of workplace benefits, supporting infrastructure etc.